Gareth Morgan, Director of Gareth Morgan Investments
There has been financial market concern that the rise in German interest rates would lead to other members of the. EMS having to raise their rates in order to preserve the current alignment of EMS currencies. This concern arises because of the likely deepening of Europe’s recession in the event the interest rate hikes do spread.
If only financial markets didn’t have so much confidence in the German’s ability to conquer their inflation or alternatively, if only financial markets had more confidence in the rest of Europe controlling their inflation without the need for the Bundesbank to provide them their cues. Such confidence would allow the rest of Europe to sponsor lower interest rates earlier and escape recession without having to wait for Germany. But financial markets have no confidence that the rest of Europe won’t be tempted to cut rates to such an extent that inflation is re- ignited. Europe’s recession will last until the first of two outcomes emerge: Germany caps its inflation and starts moving its rates down; or the monetary policy of the other Europeans earns the respect of international capital market. It will be the former. Respect is earned only after price stability has been demonstrated.
Similar arguments can be mustered for the conduct of fiscal policy. The quality of budget deficits is very important as to how capital markets rate a country. To the extent that deficits are run to finance demonstrably high quality investment projects, creditors may ascribe a low risk premium to a government’s paper. To the extent deficits are run to fund government consumption or welfare transfers, creditors will grade the paper issued lower. The evidence for governments being able to run deficits for high quality investment purposes and that quality is measured in terms of ability to service the debt from income generated – is less common than the evidence for low quality government investment decisions. In NZ, B11 Birch’s Think Big projects are an outstanding example of the latter.
Current NZ taxpayers have inherited the economic burden afflicted by the twin deficit pollutants of Think Big investment and Think Big welfare state transfers. The risk premium ascribed to the economy is measured by the real interest rate private sector borrowers must pay, despite the reality that their demand for borrowing is currently very low, To this dervish deficit duo we should now prepare to add the latest Think Big Birch programme – fantasy employment schemes. For each play job Birch the benefactor bestows, he retards the domestic side of economic recovery.
As with their Think Big investment, superannuation and welfare projects of yore we again see a National government in pursuit of short term political profit at the expense of medium term economic benefit. As is the case with Europe and its monetary policy, the benefits from fiscal responsibility have to he earned via a demonstrable commitment to deficit control, With Richardson’s phoney rhetoric of fiscal commitment coupled with Birch’s contrary fiscal expansive, NZ hasn’t even begun this reform.