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How fiscal policy affects the wider economy

The Reserve Bank has presented a framework for considering how fiscal policy affects the wider economy, an important issue for monetary policy.

The framework appears in an article in March 2007 issue of the Reserve Bank of New Zealand Bulletin, released today.

A key message is that the specific details of new spending or taxation initiatives, and their overall scale, need to be taken into account when analysing how economic activity or inflation may be affected. The impact of fiscal policy changes and their significance for monetary policy will also depend on the state of the economy at the time they occur.

The article notes that increases in spending can have a relatively large impact on economic activity if they prompt additional private sector spending. For example, spending on public infrastructure may lead to additional business investment.

The effects of tax policy changes on economic activity are likely to depend partly on the incentives these create to save, work or invest, as well as their initial effect on household or business incomes. For example, dollar for dollar, cutting company taxes is likely to boost demand more than tax cuts designed to support savings. While some spending or tax changes can impact on the economy's capacity to produce goods and services, particularly if they affect business investment or labour force participation, these effects are likely to be reasonably slow.

As explained in the Bank's March 2007 Monetary Policy Statement, Government spending has been rising in recent years. Until recently the increase in spending has been more than matched by rising tax revenues. However, the article suggests that increases in spending in recent years may have stimulated activity, because not all of the income that was paid as tax would otherwise have been spent. Fiscal policy is expected to remain stimulatory over the next two fiscal years.

The second article of this issue of the Bulletin examines the country's productivity record, drawing on new productivity data recently released by Statistics New Zealand. The new data suggest that when ‘hard-to-measure' sectors are excluded, New Zealand's productivity performance over the past decade appears to have been better than previously believed and compares favourably with Australia's.

The third article considers how emerging Asia has affected inflation in advanced economies over recent years The fourth article undertakes a comparison of price movements in New Zealand with those in Australia, drawing on detailed data from each country's CPI.

For further information contact
Anthea Black
External Communications Adviser
Ph 04 471 3767, 021 222 5225, [email protected]