Impact Of Expansionary Fiscal And Monetary Policy On The New Zealand Economy

Recession in economics is essentially a general slowdown in economic activity in a country over a sustained period of time. During recessions, many macroeconomic indicators vary in a similar way. Production as measured by Gross Domestic Product (GDP), employment, investment spending, household incomes and business profits all fall during recessions.

The primary indicator for determining whether a country is in recession is by its GDP. Recession can be simply defined as two consecutive quarters of negative growth i.e. Negative GDP, thus based on an assessment by the New Zealand Treasury, New Zealand has officially been in recession since the second quarter of 2008. [2]

Recession leads to expansionary fiscal policies by the Government accompanied by similar monetary policies by the respective Reserve (Central) Banks as is the case with New Zealand as well, where in an effort to stimulate demand and restore the economy the Government and the Reserve Bank have embarked on expansionary fiscal and monetary policies respectively. This can further be seen in the figure below that outlines the current recessionary state of the New Zealand economy as well as the impact that the expansionary fiscal and monetary policy aims to achieve in terms of stimulating demand that will consequently lead to putting New Zealand on the path of recovery.  

Figure 1: Business Cycle [10]

Fiscal Policy refers to government expenditure undertaken to provide goods and services and they way by which the government finances these expenditures. There are two primary methods for achieving this i.e. Taxation and borrowing. [8, 24]  

Expansionary Fiscal Policy relates to Increasing Government expenditure and reducing taxes. An expansionary policy is financed by budgets surpluses in previous years and / or by borrowing that consequently results in a fiscal deficit.

Monetary policy on the other hand is defined as the policy used by the Reserve bank (Central Bank) to maintain price stability i.e. Keep inflation in check. E.g. The Governor of the Reserve Bank of New Zealand has a policy target agreement with New Zealand Government to keep inflation within 0 – 3%. The Reserve bank implements monetary policy by adjusting the reserve requirements i.e. allowing banks to hold a lower portion of their total assets in reserve or changing the Official Cash Rate (OCR). The OCR is an interest rate set by the Reserve bank on the cash settlement balances on the commercial banks that gets reviewed on a frequent basis E.g. in New Zealand it gets reviewed about 9 times in a year. OCR also indirectly influences short – term interest rates and floating mortgage interest rates. [19]  

Expansionary Monetary policy is monetary policy that aims to increase the size of the money supply. This can be achieved either by reducing the reserve requirement or by reducing the OCR. The latter is the primary policy instrument used by the Reserve Bank of New Zealand (RBNZ) Governor as is evident in the current recessionary state of the New Zealand economy resulting in the RBNZ Governor – Allan Bollard cutting interest rates by as much as 5.25% (overall) from last July to leave it currently at 3%. [12]

Fiscal and Monetary policies come with their own set of set of Pro’s and Con’s with the major argument against its implementation is the substantial lag that accompanies both these policies i.e. the time from when the policy has been implemented till the time its impact is felt in the economy.

The lines below describe the impact of the consequent expansionary Fiscal and monetary policies pursued by New Zealand Government and RBNZ respectively and the impact that this would have on the macroeconomic goals of the Government of New Zealand, the possible changes it would bring to the New Zealand economy (in terms of supply and demand) if the policies have the desired effect as well as its impact on exchange rates and the balance of payments.

The Five Macroeconomic objectives / goals of New Zealand along with how they would be impacted by the expansionary Fiscal and Monetary Policies mentioned above are described below:

Join now!
  • Economic Growth – more GDP

The recessionary state of New Zealand’s economy has resulted in an increase in Government expenditure that has been financed primarily by borrowing with an aim to increase growth (GDP) / reducing the negative growth.

The reasoning behind this policy relates to Keynesian theories developed during the Great Depression of the 1930’s that states essentially the only way to come out of a recessionary climate “is to run a budget deficit by increasing government expenditures in excess of current tax receipts. The increase in government expenditures should be sufficient to cause the aggregate demand curve ...

This is a preview of the whole essay