I’m not a financial economist, but I occasionally take a look at the Reserve Bank’s fantastic collection of credit statistics. Their short-term and long-term data series often say a lot about where the New Zealand economy’s currently going and where it’s been.

One interesting indicator is the 10-year New Zealand government bond yield, which measures the interest rate that the government must pay on its debt. Here’s a chart of the last 20 years of government bond yields (unadjusted for inflation):

NZ government bond yields 1995-2015

As you can see, bond yields were pretty consistent throughout the mid-2000s – sitting at around 6%. However, they started a major downward slide in 2011, rose in 2013, and then fell back again in 2014. At the time of writing (12 August 2015; these posts are written and scheduled in advance), bond yields were sitting at 3.29%.

Essentially, the government’s borrowing costs are sitting at historic lows. This is important for two reasons.

First, it is a symptom of persistent economic weakness in New Zealand and the rest of the world. Pessimism about growth prospects has led people to prefer to lend money to governments, where they can get a lower but more certain return, rather than invest in businesses. The more people try to lend to governments, the more bond rates are driven down.

Second, low government bond yields enable governments to borrow more to make long-term investments in infrastructure and state housing. This doesn’t mean that we should simply borrow money and spend it at random. We still need to exercise some rigour in project selection and economic evaluation, and ensure that we’re not overheating the construction industry by trying to do too much at once.

However, it does mean that we can afford to go a bit further down the list of worthy projects. Many of the issues currently bedevilling New Zealand – Auckland’s growth pressures and Christchurch’s halting rebuild – could be addressed if central government simply borrowed a bit more money to build new streets, public transport facilities, cycleways, and housing developments. It’s literally never been cheaper.

Share this

18 comments

  1. I think it’s a rather narrow perspective to say Bond Rates are low so we should borrow more.

    There are so many other factors to take into account e.g. current borrowings, economic outlook, future interest rates, value of projects etc. You touch on some of these but your analysis is extremely limited to put it nicely.

    I think it’s also important to note that persistent economic weakness is not something we have experienced in New Zealand. GDP growth of between 2-3% is not economic weakness.

    1. Low interest rates are simply a signal that we can afford to borrow more.

      There are reasons why we might be leery of actually taking that opportunity. Personally, I’m not that bothered about overall debt levels – NZ remains on the low end of the OECD, and our long-term fiscal picture is much more affected by superannuation costs than decisions about infrastructure spending over the next 5-10 years. But I am concerned about (a) maintaining discipline in project selection and (b) recognising that some sectors of the economy, such as heavy construction, are already close to capacity. Others could have different views, of course!

      With regards to the NZ economy, I’d observe that productivity growth has been dismal over the past decade or so. For example, since the trough of the recession in 2009, multifactor productivity has grown by only 0.9% per annum. In other words, most GDP growth has simply reflected population growth rather than increasing productivity.

      I’d tend to defer to the Productivity Commission when it comes to explaining why this is happening, but a shortage of appropriate public investment is a potential contributor.

    2. I wouldn’t say narrow.

      I would say it’s a truism that when a government bond rate is low, then that government can – ceteris paribus – afford to borrow more.

  2. Most of that GDP growth is concentrated in a very few parts of the economy (like the construction sector for Auckland & Christchurch, and until last year, dairy).

    So while the headline GDP looks good, it masks a underlying malaise in the rest of the economy.

    The only reason the Government is not borrowing for the big ticket stuff is that they don’t want it be on their books so they spout the mantra of fiscal prudence, and needing to avoid long term commitments to repay the debt. Strangling the economy as they do so – yet they’ll happily bind themselves and future governments for the next 30 years for ircon-clad “use or pay” PPPs on RONS like Transmission Gully and the PuFord and heaven knows what else (East West Highway?) without giving a damn or second thought.
    Because its off the Government books.

    And when the risk is all on the Government for those PPPs because the PPP has made it so, and the annual cost of running the PPP exceeds the 10 year bond rate for borrowing, why bother? Why not borrow the money for it for 10 years at interest rates that are at historic lows, build the PPP themselves?

    We’re not Greece, Ireland, Spain or Portugal. We won’t be facing junk level government bond rates anytime soon.

    And in the next 10 years the economy will pick up again (assuming that all the most appropriate for NZ Inc, infrastructure projects are built), and the increased tax revenues will allow the debt to paid off sooner than later. Hows that a bad thing?

    1. I disagree with your economic analysis.

      I’m a Chartered Accountant so I get to see first hand what’s happening in the economy.

      Almost without exception our clients have enjoyed a good year in 2015. The growth is across the board in the New Zealand economy.

      1. Predictions are hard, especially about the future. Here’s some relevant data:
        * real GDP growth in the March quarter was not spectacular – up 0.2%, which is below the rate observed in 2013 and 2014.
        * ANZ’s business confidence index has dipped rapidly in 2015 and now indicates that most businesses are pessimistic about the general economy. (But their short-term forecast for their own activities has held up better.)
        * Treasury’s most recent medium-term economic forecast is picking real GDP to grow at an annual rate of around 2.8% over the next 4 years. That being said, that’s based on some assumptions, e.g.: “Dairy prices are forecast to recover from current low levels in the second half of 2015.”

        I don’t think either pessimism or optimism is warranted at the moment.

        1. I agree. I’m rather sanguine about the NZ economy right now. Not good, not bad. I guess relative to other countries it’s doing fairly well, especially those with which we trade/compete – such as Australia and China. But I’m not sure that others misfortune should cause us to become too chuffed with our own performance. Indeed as you note Peter most of our growth is currently associated with population growth, Now I think population growth is good in the long run because it increases the scale of the NZ economy, but it’s not a panacea for socio-economic policy.

          My thinking is that if these other countries sorted themselves out then NZ would find itself having to fight much harder for those people.

          Key area for improvement: Land use and transport. Our land use policies are driving up the costs of living, ,while our transport policies are just a joke. The sort of pork-barreal shit that National has pulled with transport investment priorities just would not float in places like the Netherlands. I suspect it’s one reason they’re more productive: They invest in more worthwhile infrastructure.

      2. An accountant isn’t an economist. (And economists aren’t accountants, heaven knows.) It is basic theory that government borrowing should increase when interest rates are low. Public interest is long-term and it’s prudent to lock in low rates for as long as you can, and their capacity to service their debt is pretty predictable. Even a 1% rise in rates next year can vastly raise the overall cost of an investment. Also, having debt on the books at a low rate improves the creditworthiness of the government, supporting higher bond ratings and thereby lower future costs of borrowing.

        There’s a Keynesian element to this, but regardless, it still makes sense. It’s why people buy more houses – or more house – when rates are low.

  3. haha , That is a classic mistake First home buyers make… ooh interest rates a re great we can afford a bigger house (borrow more) , two years later it comes crashing down , let alone 25 years worth of fluctuations accounted for.

    1. Except with 10-year bonds the Government pays the same coupon rate for 10 years regardless of floating rates, inflation or currency changes.

      1. Exactly, its like a fixed 10 year mortgage at 3% – who wouldn’t jump at that – first home buyer or not?

        If you treated NZ as a house (- why not speculators overseas do), well your income in 10 years time will be higher because of inflation/higher rents if nothing else, while your repayments are fixed at low “pre-inflation” 3% levels.

        For an economy that inflation creep is called Fiscal Drag – inflation causes many tax payers to move up into higher tax brackets over time, so the tax take increases, and as spending rises due to inflation the $ value of the GST rises, even though its still 15% and if you’re paying off that mortgage in $NZ as NZ is for government stock/bonds then its fixed at the low level for 10 years.

        And of course, your “house” (or country in NZ Inc’s case) would be worth a lot more after 10 years than it is today, so yes, you could “cash out” after 10 years and be better off than if you never did so.

  4. And if the government hadn’t stupidly stopped contributions to the Cullen Super Fund (and borrowed cheap money to continue to do so) then as a country we would be many billions of dollars better off (that’s after the interests costs too). Could have funded more infrastructure as a result too

    1. yes. This government does seem to have an ideological barrier to implementing reasonable policy on superannuation. I actually don’t mind them not raising the age of entitlement (even though I’d prefer they did), provided that in lieu of doing that they implemented other policies to ensure superannuation was sustainable, e.g. contributions to Cullen fund.

  5. Governments tend to borrow on the never-never, such as for infrastructure that’s paid from general taxation. This is on the assumption that the investment will increase general taxation, which it rarely does (for example when project benefits are hypotheticated travel time savings that don’t increase revenue into government coffers). Instead the borrowing should be associated with an income stream, such as a rates levy or a user toll.

    Developing countries have been protected from some of these wild investments by the need to link a borrowing to an income stream. For example in China there is no fuel tax to cover road improvements, and virtually all motorways are tollways.

    1. Thanks Matthew – I really should read Reddell’s blog more frequently. I can see the sense to both Reddell’s argument about discount rates and to Miles Kimball’s, which he’s critiquing.

      My observation here is that even if we accept that bond rates (or returns in other financial markets) are a good basis for setting the government’s discount rates / opportunity cost of capital, bond rates vary substantially over the business cycle and thus the opportunity cost of government spending will also vary.

      However, that observation doesn’t release us from the obligation to do good cost-benefit analysis… it’s ridiculous to spend on projects with BCRs below one just because bond rates are currently low!

    2. Interesting post and makes some good points.

      I disagree with his assessment of the NZSF. The point of the NZSF, at least as I understand it, is to tax current generations so as to fund the future liabilities they impose via the scheme. The reason we need to do this is the demographic imbalance introduced by the babyboomers and their increases in life expectancy (both of which tend to increase liabilities in out years).

      So NZF is effectively a tax levied on current generations designed to (partly) pay for their future costs. This shifts superannuation from a PAYGO scheme to something closer to a SAYGO. In some ways you can view NZSF as a fiscal smoothing scheme designed to deliver improved intergenerational fiscal equity. Provided the proceeds from the tax are invested in such a way that it delivers returns in excess of inflation, then I think it’s achieving its stated purposes. In this context, commercial rates of capital return are irrelevant, because super is not a liability that commercial entities will bear.

      I also think that discussions of discount rates in the transport sector are somewhat unique, because revenues are hypothecated. As such it’s not competing with other investments, and arguably the most relevant metric is the social discount rate attached to transport projects. From what I know, social discount rates are lower than commercial rates, i.e. on average people seem willing to fund long-term transport investments.

      In this context I think it would be perfectly appropriate for NZTA to respond to these value-judgements (which are being made by the people on which the taxes are being levied) and subsequently apply a discount rate that was lower than the commercial discount rate.

  6. One of the implications, to me, of the government’s reluctance to borrow for infrastructure for Auckland, except for motorways, is that it is pushing the costs of these projects onto ratepayers, in the form of higher rates. Not a great move, I don’t think, to reduce household discretionary income for your largest area with a third of the population.

    My experience of the Treasury is they’re usually out by 1%. Probably more like 1.8% instead of 2.8% growth.

Leave a Reply