Fiscal strategy
Fiscal consolidation - unwinding structural deficits and reducing public debt - is necessary for medium- to long-term fiscal sustainability and critical for stable economic growth. The Government is currently spending more than it is collecting in revenue, which is boosting aggregate demand. This is not a sustainable way to support the economy as deficits must be funded by borrowing. By withdrawing this support over time, fiscal consolidation allows monetary policy to respond. In that event, interest rates are set lower than would otherwise have been the case, which helps offset the negative impacts of reduced government consumption on short-term economic growth. Fiscal consolidation will also support the rebuilding of fiscal buffers over time, allowing the government to absorb and respond to future shocks and economic cycles.[1]
There is a choice about how fast to undertake fiscal consolidation. As stated in the FSR 2024, the Government is taking a deliberate, medium-term approach to fiscal consolidation. The alternative approach - a more severe, short-term consolidation - comes with risks: that sharp spending reductions could impact front-line public services New Zealanders rely on; or that significant revenue increases could constrain growth, especially as the economy comes out of recession. That would be contrary to the Government's other goals for its term of office. Alongside its fiscal objectives, the Government has goals of building a stronger, more productive economy and delivering more efficient, effective and responsive public services. These are both themes of Budget 2025.
The key elements of the Government's fiscal strategy, as first set out in the FSR 2024, are to:
- reduce core Crown expenses towards 30 per cent of GDP over time
- return the headline operating balance measure to surplus by 2027/28, and
- put net core Crown debt as a percentage of GDP on a downward trajectory towards 40 per cent and in the longer term keep it below that percentage.
The only change made to this strategy since the FSR 2024 has been to the headline operating balance definition, with OBEGALx replacing the operating balance before gains and losses (OBEGAL).[2]
Forecasts invariably change at each update. Having a medium-term approach to fiscal consolidation means the Government will not over‑react to these changes. Downside revenue surprises will not necessitate a sharp spending reduction. Upside revenue surprises will contribute to reducing the deficit.
The last few updates have seen downward revisions to forecasts, making the Government's fiscal goals more challenging to achieve. The Treasury has progressively unwound several economic forecasting assumptions it made during the term of the last Government, precipitating downward revisions to GDP forecasts (Figure 4). These revisions have had a negative impact on forecasts of tax revenue and therefore on forecasts of the operating balance and net debt.
Figure 4 - Revisions to real GDP forecasts
Source: The Treasury
While the latest fiscal forecasts for 2024/25 show a deterioration compared to a year ago, they also indicate there is a feasible path to achieving the fiscal goals. The fiscal performance of the Government, in the period from 1 July 2024 to the present, is therefore consistent with that anticipated in the FSR 2024.