# The economic impact of the New Zealand fiscal stimulus package.

1. Introduction

Like many developed economies, New Zealand moved fiscal policy to a more expansionary stance in response to the economic downturn caused by recent US and European financial crises. While there was no formal announcement of a fiscal stimulus package, the government made a series of expansionary policy announcements between October 2008 and March 2009. In this paper, we refer to the discretionary component of this expansionary trend in fiscal policy as New Zealand's fiscal stimulus package (hereafter FSP). We investigate the economic consequences of the FSP using a large-scale dynamic model of the New Zealand economy. We find that the policy generates employment gains (around 10,000 jobs) in the years 2009 and 2010. However, by increasing net foreign liabilities, these short-run employment gains depress long-run consumption. We find that the employment-stimulating effects of the FSP are largely indirect, arising through short-run terms of trade improvement in the presence of sticky wages. We examine an alternative policy that stimulates employment directly, via reduction in the employer cost of labour. This generates short-run employment gains approximately double those of the FSP, for a similar loss in long-run real consumption.

New Zealand Treasury estimates a 'fiscal impulse indicator' (hereafter FII), an estimate of the discretionary movement towards deficit expressed as a percentage of GDP. In the December 2008 publication by the Treasury of its Fiscal Forecasts (Treasury, 2008a), the FII was estimated at a cumulative 6.4% for 2009-2012. In modelling the FSP, we focus on policy measures introduced or reconfirmed between October 2008 and March 2009. In Table 1, we identify three such measures that collectively contribute 5.4% of the total 6.4% FII over the 2009 2012 period:

(1) Personal tax cuts of $1.29b in 2009, $0.54b in 2010 and $0.47b in 2011 (in FII terms, 0.7%, 0.3% and 0.2% of GDP respectively). (1)

(2) A number of business tax measures introduced in 2009, worth $0.48b over four years ($0.12b per year, or 0.1% of GDP per year in FII terms). (2)

(3) Infrastructure spending of $0.5b for three years (in FII terms, 0.3% of GDP per year).

The infrastructure spending is a temporary movement towards deficit. However, the personal and business tax measures represent permanent movements towards deficit. By 2011, the three measures push the annual budget balance permanently towards deficit by 1.6% of GDP (see Table 1). In Budget Policy Statement December 2008, the government noted that it was not comfortable with the budget position going forward (Treasury, 2008b). We interpret this to mean that the New Zealand government will eventually implement policies to return the stance of fiscal policy to its base-case path. In our modelling, we begin this process in 2013. It is the personal tax and business tax measures that cause the stance of fiscal policy to deviate permanently from its base-case path. Hence, in our simulations, we unwind these measures in five equal steps commencing 2013 (Table 1).

The remainder of this paper is structured as follows. Section 2 describes our model. In Section 2.1 we provide an overview of MONASH-NZ, the model we use to evaluate the impacts of the FSP. In Section 2.2 we present a stylised representation of this model, useful for describing the FSP's main routes of macroeconomic causation. Section 3 presents our results, beginning with a discussion in Section 3.1 of our translation of the FSP into a set of model-compatible shocks. Section 3.2 describes our simulation results via a logical sequence of cross-referenced discussions. In Section 4 we analyse an alternative FSP, more targeted to employment promotion. Section 5 concludes the paper.

2. The model

We evaluate the economic consequences of the FSP using MONASH-NZ, a large-scale dynamic CGE model of the New Zealand economy. MONASH-NZ is a New Zealand implementation of the well-known ORANI and MONASH models. The model is too large to be fully documented in a paper of this size. Full documentation of the theoretical structures of ORANI and MONASH are provided in Dixon et al. (1982) and Dixon and Rimmer (2002). However, readers of this paper need not be familiar with the details of these references. In Section 2.2 we present a 'back-of-the-envelope' (BOTE) model tailored to describe the economic mechanisms responsible for the FSP impacts discussed in Section 3. We rely on the BOTE model in Section 3 to explain the MONASH-NZ model mechanisms responsible for our main macroeconomic findings. Before proceeding to the BOTE model, we first provide an overview of MONASH-NZ.

2.1. Overview of MONASH-NZ

MONASH-NZ models production of 210 commodities by 131 industries. An initial (2003) solution to the model is calibrated from 1996 input output data and 2003 supply and use data (Statistics New Zealand, 2003). The model identifies three primary factors, labour, capital and land. (3) The model has one representative household and one central government. Optimising behaviour governs decisionmaking by firms and households. Each industry minimises unit costs subject to given input prices and a constant returns to scale (CRS) production function. (4) Household demands are modelled via a representative utility-maximising household. (5) Units of new industry-specific capital are cost minimising combinations of New Zealand and foreign commodities. (6) Imperfect substitutability between imported and domestic varieties of each commodity is modelled using the Armington CES assumption. (7) The export demand for any given New Zealand commodity is inversely related to its foreign-currency price. (8) The model recognises consumption of commodities by government, (9) and the details of direct and indirect taxation instruments. (10) It is assumed that all sectors are competitive (11) and all markets clear. (12) Purchasers' prices differ from producer prices by the value of indirect taxes and trade and transport margins. (13) Three types of dynamic adjustment are modelled: capital accumulation, net liability accumulation and lagged adjustments. Capital accumulation is industry-specific, and linked to industry-specific net investment. (14) Movements in industry-specific net investment are related to movements in industry-specific rates of return. (15) Annual changes in the national net foreign liability position are related to the annual national investment/savings imbalance. (16) In policy simulations, the labour market follows a lagged adjustment path. In the short-run, real consumer wages are sticky. Hence, short-run labour market pressures mostly manifest as changes in employment. In the long-run, employment returns to base-case, with labour market pressures reflected in real wages. (17)

To generate results with MONASH-NZ, we undertake three simulations: a side simulation, a base-case simulation, and a policy simulation. The base-case simulation produces a forecast of the economy in the absence of the policy change under investigation. We generate the base-case using the method developed by Dixon and Rimmer (2002). In particular, we calibrate our base-case paths for macroeconomic variables using independent forecasts. Our base-case macro forecasts are based on NZIER's 2009 Quarterly Predictions (see NZIER, 2009a). These forecasts include anticipated effects of the global financial crisis on macroeconomic aggregates. (18) To ensure that our base-case simulation generates macroeconomic forecasts that are identical to those in NZIER (2009a), consistent with Dixon and Rimmer (2002) we first run a side simulation in which key macroeconomic variables are exogenous and shocked equal to forecast values. These macroeconomic variables are real consumption, real investment, real public consumption, export volumes, import volumes, employment, the real wage, and the terms of trade. To accommodate exogenous determination of these macroeconomic variables in our side simulation, corresponding variables determining macroeconomic structure must be endogenous. In particular, our side simulation requires endogenous determination of: the average propensity to consume, the economy-wide relationship between rates of return and capital growth, primary factor productivity, the preference for imports relative to domestic products, foreign willingness to pay for NZ exports, and labour/capital bias in technical change. In the base-case simulation, these structural variables are exogenous and shocked equal to their side simulation values, along with all other exogenous variables. All endogenous variables in the base-case simulation reproduce their side simulation values, regardless of whether those variables were exogenously or endogenously determined in the side simulation. The policy simulation is like the base-case simulation in all respects other than the addition of movements in variables describing the direct effects of the policy under investigation. The model is solved using GEMPACK (Harrison & Pearson, 1996).

2.2. A back-of-the-envelope (BOTE) representation of MONASH-NZ

Equations (E1)-(E17) (Table 3) describe a stylised representation of the key macroeconomic relationships in MONASH-NZ relevant to the FSP simulations reported in Section 3. Hereafter we refer to these equations as the BOTE (back-of-the-envelope) model.

Equations (E1) to (E13) describe variables within any given year of a dynamic simulation. Equations (E14) to (E16) describe how key stock variables, capital and net foreign liabilities, move through time. These equations hold between any two adjoining years of a dynamic simulation. Equation (E17) describes the lagged adjustment of real wages in the policy simulation. This equation is relevant to the process of wage adjustment in the policy simulation only.

Equation (E1) describes the GDP identity in constant price terms. Equation (E2) describes an economy-wide constant returns to scale production function, relating real GDP to inputs of labour and capital and primary factor augmenting technical change. (19) Equation (E3) links real private consumption to real (CPI-deflated) household income. (20) Equations (E4) and (E5) define real household income and real government revenue respectively, while equation (E6) confirms that equations (E4) and (E5) exhaust all claims on gross national disposable income (GNDI). (21) Equation (E7) summarises the determination of import volumes. In MONASH-NZ, demands for imports are related to activity by each agent (represented in equation (E7) by Y) and the ratio of domestic to import prices (proxied in equation (E7) by the terms of trade, TOT). Commodity exports in MONASH-NZ are inversely related to foreign currency prices via constant elasticity demand functions. This is summarised by equation (E8), which relates the foreign currency price of exports (PX) to the volume of exports (X) (movements along foreign demand schedules) and a shift variable V (movements in foreign demand schedules). Equation (E9) makes investment a positive function of rates of return. Equation (E10) defines the gross capital growth rate. Since the production function is constant returns to scale, marginal product functions are homogeneous of degree 0 and thus can be expressed as functions of K/L and A. This accounts for equations (E11) and (E12). Equation (E11) relates the profit maximising capital/labour ratio to the rate of return, production taxes, technological change, and the terms of trade. (22) Equation (E12) relates the real consumer wage (W) to changes in the capital/labour ratio, technological change, the terms of trade, employer labour taxes, and production taxes. (23) Equation (E13) defines the terms of trade as the ratio of foreign currency export prices to import prices.

Equations (E14) to (E16) relate movements in three key stock variables to relevant flow variables. Equation (E14) relates changes in the capital stock to investment. Equations (E15) and (E16) relate the change in net foreign liabilities to the excess of investment over savings. (24)

Equation (E17) governs the path of real consumer wages in the policy simulation. (25) With equation (E17) activated in the policy simulation, the deviation in the real consumer wage grows (declines) as long as employment remains above (below) its base-case level. A value for [alpha] is chosen that ensures the employment effects of a shock in year t are largely eliminated by year t + 5. (26)

We now consider an appropriate closure for equations (E1)-(E17). In doing so, we must distinguish between equations that describe economic relationships within any given year (E1) (E13), equations that describe movements in stock variables between years (E14) (E16), and the equation describing sticky wage adjustment (E17). Within any given year, K, NFLG and NFLH can be considered exogenous. The movement in these variables between years depends on investment and savings within years. These accumulation relationships are described by equations (E14)-(E16). Equation (E17) governs the transition of the policy-case labour market closure from a short-run to a long-run environment. When operational in the policy simulation, equation (E17) gradually moves the labour market from a short-run situation of exogenous real wage/ endogenous employment, to a long-run situation of exogenous employment/ endogenous real wage. Thus, recognising that equations (E14)(E17) govern dynamics across years, our task of understanding model closure narrows to choosing appropriate short-run and long-run closures for equations (E1)-(E13).

Equations (E1) to (E13) comprise 13 equations in 27 unknowns. In Table 3, model closure is described by rendering exogenous variables in bold. Two closures are presented: a short-run closure and an 'effective' long-run closure. By 'effective' long-run closure, we mean that while ROR, W and L are presented as long-run exogenous, no such exogeneity is actually imposed on these variables in MONASH-NZ simulations. Rather, in year-on-year dynamic simulations, equations (E9), (E14) and (E17) lead the economy to a long-run position that can be satisfactorily described by exogenous status of ROR, [PSI] and L in BOTE. (27)

A conventional short-run closure of equations (E1)-(E13) would have Y, X, C, HINC, GINC, GNDI, M, PX, I, [PSI], ROR, L and TOT determined endogenously, given exogenous values for A, APC, G, K, NFLG, NFLH, PM, R, TD, TL, TQ, V, W and A. Under this closure, each equation can be readily associated with the determination of a specific endogenous variable. With relatively high export demand elasticities and exogenous import prices, there is little scope for significant movements in TOT. Hence, with W, K, A, TL and TQ exogenous, equation (E12) can be identified with the determination of L. Hence, with K and A exogenous, equation (E2) determines Y. With Y thus determined, equations (E4)-(E6) calculate GNDI and its distribution between households and government. With HINC determined by (E4) and APC exogenous, equation (E3) determines real private consumption. Again, leaving aside for the moment the possibility of movements in TOT, with Y, determined by equation (E2), equation (E7) determines M. With L determined by equation (E12), and K, TQ and A exogenous, equation (E11) determines ROR. This determines I via equation (E9). With I thus determined, equation (E10) calculates [PSI]. With Y, C, I, G and M explained, equation (E1) determines X. With PM exogenous, this determines PX and TOT via equations (E8) and (E13) respectively.

Our description of MONASH-NZ's long-run behaviour differs in two respects from the short-run closure described above. First, equation (E17) ensures that the policy-case level of employment is eventually returned to its base-case level via real wage adjustment. In BOTE, this is represented by long-run exogeneity of L and endogeneity of W. Second, the short-run operation of equations (E9) and (E14) gradually drive rates of return towards base-case via capital adjustment. The end point of this process can be represented by long-run exogeneity of ROR and endogeneity of K. With ROR exogenous, in the long-run, equation (E11) determines K. With L exogenous, in the long-run, equation (E12) largely determines W.

3. Simulating the New Zealand fiscal stimulus package (FSP)

3.1. Simulation design

Using BOTE to describe our modelling of the FSP, we describe below the changes made in the policy simulation, relative to the base-case forecast, to model the FSP. In Section 3.2, we report the effects of the FSP on selected variables as percentage deviations in policy simulation results away from base-case simulation results.

3.1.1. Personal tax measures

Personal tax cuts worth 0.7% of GDP, 0.3% of GDP and 0.2% of GDP are delivered in the years 2009, 2010 and 2011 respectively (row 1, Table 1). Hence, by 2011, personal tax rates are below base-case by an amount sufficient to move the government financing requirement towards annual deficit by 1.2 percentage points of GDP. Personal income tax rates stay at their 2011 level for one year, and are then returned to their base-case value in five equal steps over 2013-2017 inclusive. Hence, personal income tax rates are below base-case for the period 2009-2016 inclusive. This negative deviation in personal tax rates can be expressed in BOTE as a reduction in TD.

3.1.2. Business tax measures

As discussed in Section 1, business tax measures worth 0.1% of GDP in foregone revenue are delivered in 2009, and retained until 2012 (row 2, Table 1). In modelling the business tax measures, we treat them as reductions in net production taxes. (28) In BOTE these are represented by TQ. Consistent with our discussion in Section 1, we assume these tax cuts are removed in five equal instalments over 2013-2017.

3.1.3. Infrastructure spending

The FSP includes an increase in public infrastructure spending equal to 0.3% of GDP in each year 2009-2011 (row 3, Table 1). We identify and model two effects arising from this spending. First, government spending on construction services rises relative to base-case. In terms of BOTE, the increase in infrastructure spending can be represented by a rise in G. In the MONASH-NZ results, this is reflected in Figure 6, later, as a positive deviation in public consumption of just over 1.4% for the three years 2009-2011. (29) Second, we assume the public capital produced by the infrastructure spending generates benefits. The literature on returns from public infrastructure, in the context of a CGE modelling exercise, is reviewed by Giesecke, Dixon and Rimmer (2008). Like Giesecke et al., we assume that each additional dollar of infrastructure spending provides an annuity of 0.15 dollars, (30) and that this benefit is delivered via a rise in economy-wide primary factor productivity. In terms of BOTE, this is represented by a rise in A. We assume that the typical infrastructure project financed by the FSP takes one year to construct, and that the productivity benefits of the new infrastructure commence in the year following construction.

3.2. Simulation results

Figures 1-11 present the macroeconomic consequences of the full FSP. The effects of the full package can be understood as the sum of the individual effects of the components of the package. Hence Figures 1-11 decompose the FSP's total impact on each macroeconomic aggregate into the individual contributions made by each of the three components of the FSP. (31) In the remainder of Section 3 we explain results via a sequence of cross-referenced explanations, relying on BOTE at each point of our discussion. We conjecture that a chief policy aim of the FSP is employment promotion. We find that the package does promote employment over 2009-2011, largely through infrastructure spending and personal tax cuts (Figure 1). However the employment gain, at an average of 0.5% over 2009-2010, or approximately 10,000 jobs, is modest. In Section 4 we examine an alternative policy combination that promotes a higher short-term employment deviation with the same discretionary movement towards deficit. However, we first explore in detail the core FSP, using BOTE to explain MONASH-NZ results for the FSP's three components: personal tax cuts, business tax cuts, and infrastructure spending.

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3.2.1. The FSP generates a short-run positive deviation in employment The employment deviation is positive for the first three years of the simulation period, peaking in the first year at 0.5% (Figure 1). As Figure 1 makes clear, all three components of the FSP make positive contributions to the short-run employment deviation. The FSP contributes to short-run employment promotion through two routes: directly, via a decrease in business taxation; and indirectly, via a positive deviation in the terms of trade. We expand on these two employment-promoting effects below.

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All three components of the FSP contribute to a short-run positive deviation in the terms of trade (see Figure 10 and Section 3.2.10 below). Our labour market is characterised by stickiness in the short-run real (CPI-deflated) wage. In BOTE we express this as short-run rigidity in W (see Section 2.2 above). The capital stock (in BOTE, K) adjusts slowly to the FSP (see Figure 2 and Section 3.2.4 below). In the presence of short-run stickiness in W and K, the initial positive deviation in the terms of trade (in BOTE, TOT) promotes a positive deviation in employment via equation (E12).

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In BOTE, the business tax measures can be expressed as a reduction in TQ (see Section 3.1 above). Via equation (E12), in the presence of sticky short-run real consumer wages (W) and capital stocks (K), a reduction in TQ relative to base-case generates a positive deviation in employment. The peak year of contribution to the employment deviation by the business tax measures is 2009 (Figure 1). This is so for two reasons. First, the full extent of the business tax reductions is delivered in the first year of the policy. Second, with employment above base-case, via equation (E17) the real wage deviation steadily increases to return employment towards base-case (see Section 3.2.2 below). Over 2010 to 2012, this accounts for the growing contribution by business tax measures to the wage deviation (Figure 4) and declining contribution by business tax measures to the employment deviation (Figure 1).

3.2.2. The short-run real wage rises relative to base-case

Our short-run labour market is characterised by sticky real wages, allowing short-run labour market pressures to be largely expressed as changes in employment (see Section 3.2.1 above). In BOTE, we represent this by short-run exogeneity of W in Section (E11) (see Table 3, column 1). In the long-run, New Zealand employment returns to base-case, with labour market pressures expressed as changes in real wages. In BOTE, we represent this by long-run exogeneity of L in equation (E11) (see Table 3, column 2). As discussed in Section 2.2, the transition in the policy simulation from short-run wage stickiness to long-run wage flexibility is governed by equation (E17). This equation ensures that the real wage deviation grows as long as employment is above base-case. This accounts for the growing real wage deviation in the first three years of the simulation (Figure 4).

3.2.3. Employment exhibits a shallow path of trough and recovery over 2012-2022

The last year of expanded infrastructure spending is 2011 (see Section 3.1.3 above). With infrastructure spending returning to base-case in 2012, and the remaining elements of the FSP steadily unwound over 2013-2017, the real wage deviation is left too high in the central years of the simulation (Figure 4) to maintain employment at its base-case level (Figure 1). The infrastructure component of the FSP makes a particularly large contribution to this effect over 2012-2014 (Figure 1). Via equation (E17), over 2009--2011 the positive deviation in employment caused by infrastructure spending (Figure 1) generates a growing positive wage deviation to return employment towards base-case (Figure 4). However, 2011 is the last year of elevated public spending on infrastructure development (Figure 6). In 2012, with past infrastructure spending having contributed to the growth in the real wage deviation (Figure 4), but public infrastructure spending returning to its base-case level (Figure 6), the real wage is left too high for employment to remain above base-case. This accounts for infrastructure's large negative contribution to the employment deviation in 2012. From 2013, the personal and business tax measures are steadily returned to base-case (see Table 1 and Sections 3.1.1 and 3.1.2. above). This requires a steady decline in the real wage deviation in the latter years of the simulation (Figure 4) to return employment to its base-case level (Figure 1). This accounts for the pattern of trough and recovery in employment between 2012 and 2022 (Figure 1).

3.2.4. The short-run positive investment deviation generates a positive capital deviation

Over the first six years of the simulation period, each of the FSP's three components contributes to the positive deviation in real investment (Figure 7). This positive investment deviation accounts for the growing positive capital deviation over the same period (Figure 2). The FSP generates a short-run positive deviation in real investment via four routes:

(1) a positive short-run employment deviation (see Section 3.2.1 above);

(2) a positive short-run terms of trade deviation (see Section 3.2.10 below);

(3) a negative deviation in taxation of production (see Section 3.1.2 above); and

(4) a positive deviation in productivity (see Section 3.1.3 above).

In terms of short-run BOTE (see column 1, Table 3), these four routes can be represented by increases in L, TOT and A, and a fall in TQ. In the short-run, capital stocks are slow to adjust (Figure 2). In terms of short-run BOTE, we express this via exogeneity of K. Via equation (Ell), with employment (L), the terms of trade (TOT), and productivity (A) above base-case in the short-run, and with business taxation (TQ) below base-case in the short-run, the deviation in rates of return (ROR) must be positive. With investment (I), a positive function of rates of return (via equation (E9)) the initial deviation in investment must be positive (Figure 7). With investment above base-case over 2009-2014, via equation (E14) the capital stock deviation must be positive and growing over the same period (Figure 2).

3.2.5. The short-run real GDP deviation is positive, peaking over 2011-2013

Over the first three years of the simulation, all three components of the FSP contribute to a positive deviation in employment (see Section 3.2.1 above). Over the same period, the capital deviation is positive and growing (see Section 3.2.4 above). As discussed in Section 3.1.3, we express the returns from infrastructure spending as a rise in productivity. Hence, via BOTE equation (E2), with L, K and A above base-case, so too must be real GDP (Figure 3).

3.2.6. The capital deviation is positive but declining from 2014-2022

All components of the FSP are gradually returned to base-case over 2013-2017 (see Section 3.1 above). As such, all but one of the four factors contributing to the short-run positive capital deviation (see Section 3.2.4 above) gradually return to base-case. This accounts for the gradual decline in the capital deviation from 2014 (Figure 2). The one factor that does not return to base-case is productivity. The infrastructure developed by the FSP's infrastructure spending over 2009--2011 continues to provide benefits, in the form of a positive deviation in economy-wide productivity (see Section 3.1.3 above). Via equation (E11) (see column 2, Table 1), with productivity (A) higher in the long-run, ceteris paribus, the long-run capital deviation must be positive. This accounts for the persistent long-run positive contribution to the capital deviation made by the infrastructure program (Figure 2).

3.2.7. The real GDP deviation is' positive but declining from 2013-2022

The employment deviation gradually returns to zero over the latter part of the simulation period (see Section 3.2.3 above). The capital deviation declines steadily over the same period (see Section 3.2.6 above). Nevertheless, a permanent positive deviation in real GDP is supported by the productivity-enhancing effect of the infrastructure component of the FSP (see Section 3.1.3 above). The rise in productivity (A in BOTE) generates a positive deviation in real GDP via two routes. First, the positive deviation in A contributes directly to a long-run positive deviation in real GDP via equation (E2). (32) Second, via equation (E11), with A higher, and L returning to base-case, K must rise relative to base-case (see Section 3.2.6 above). This positive deviation in K contributes to a positive deviation in real GDP via equation (E2).

3.2.8. The private consumption deviation is positive in the short-run

The FSP contributes to a positive short-run real consumption deviation by:

(1) lowering taxation of household income;

(2) increasing national income via promotion of employment and capital accumulation;

(3) increasing national income via a short-run positive terms of trade deviation.

All three components of the FSP contribute to the real consumption deviation via (2) and (3). Only the personal and business tax measures contribute to real consumption via (1).

Both the personal and business tax measures contribute to a positive short-run deviation in real consumption via (1) above. In terms of BOTE, these measures can be represented by short-run reductions in TD and TQ (see Section 3.1 above). Via Section (E4), reductions in TD and TQ directly increase HINC by increasing post-tax factor income. The real consumption deviation peaks in 2011 at approximately 3.5%. By 2011, the direct contribution to the consumption deviation made by the two tax measures is approximately 2.2 percentage points. (33) However in Figure 5, we see that the contribution made by the personal and business tax measures to the 2011 real consumption deviation is higher, at 3.1 percentage points. Infrastructure spending, while not directly affecting household disposable income, contributes an additional 0.3 percentage points to the 2011 real consumption deviation. The 1 percentage point (34) of 2011 consumption deviation not directly related to taxation reduction is due to the fact that all three components of the FSP generate short-run positive deviations in real GDP (see Section 3.2.5 above) and the terms of trade (see Section 3.2.10 below). Via equations (E3) and (E4) of BOTE, the positive deviations in both real GDP and the terms of trade lift real private consumption relative to base-case.

3.2.9. The real balance of trade moves towards deficit in the short-run

The FSP promotes short-run positive deviations in real private consumption (see Section 3.2.8 above), real public consumption (see Section 3.1.3 above) and real investment (see Section 3.2.4 above). Together, these movements generate a short-run positive deviation in real GNE that exceeds the deviation in real GDP. Via BOTE equation (El), this positive deviation in real GNE relative to real GDP requires a movement towards balance of trade deficit. This accounts for the short-run negative deviation in export volumes (Figure 8) and short-run positive deviation in import volumes (Figure 9).

3.2.10. The terms of trade deviation is positive in the short-run

Export volumes are below base-case between 2009 and 2014 (see Section 3.2.9 above). Via equation (E8), New Zealand export prices must rise relative to base-case. Via equation (E13), this accounts for the positive deviation in the terms of trade between 2009 and 2014 (Figure 10).

3.2.11. The deviation in net foreign liabilities grows until 2017

With the real balance of trade moving towards deficit in the first six years of the simulation period (see Section 3.2.9 above), New Zealand's net foreign liabilities must rise relative to the base-case over the same period. The bulk of this increase in net foreign liabilities is attributable to the movement towards fiscal deficit. In BOTE, this can be seen by noting that via equations (E5) and (E16), with G above base-case (see Section 3.1.3 above) and TD and TQ below base-case throughout the period 2009--2016 (see Sections 3.1.1 and 3.1.2 above), the bulk of the increase in net foreign liabilities depicted in Figure 11 can be viewed as an increase in the long-run value of NFLG.

Figure 11 plots two indicators of the change in New Zealand's net foreign liabilities: the ratio of net foreign liabilities to GNDI, and the cumulative FII. (35) Initially, the cumulative FII lies above the deviation in the ratio of debt to GNDI because the FSP generates a positive deviation in real GNDI via short-run positive deviations in real GDP (see Section 3.2.5 above) and the terms of trade (see Section 3.2.10 above). Relative to their direct contribution to the cumulative FII, the business tax measures and infrastructure program are strongly investment-promoting (see Section 3.2.4 above). This accounts for the increase in the ratio of net foreign liabilities to GNDI, relative to the cumulative FII, over the middle years of the simulation period (Figure 11). The cumulative FII stops rising in 2017, the year in which all policy components of the FSP have returned to base-case (see Table 1 and Section 3.1 above). With the deviation in the cumulative FII steady from 2017, the ratio of debt to GNDI falls from 2017 onwards, reflecting base-case growth in GNDI.

3.2.12. The long-run real private consumption deviation is negative

Personal income tax and business tax rates (in BOTE, TD and TQ) are progressively returned to their base-case levels over 2013-2017 (see Sections 3.1.1 and 3.1.2 above). This accounts for the steady decline in the contributions made by the personal and business tax measures to the aggregate real consumption deviation over this period (Figure 5). With personal and business taxes returned to base-case by 2017, we might expect the contributions made by these measures to the real consumption deviation to be zero thereafter. However, we find both measures make negative contributions to long-run real consumption (Figure 5). This is so for two reasons. First, both the personal and business tax measures make negative contributions to the terms of trade deviation in the long-run (see Section 3.2.15 below). In terms of BOTE, this long-run negative deviation in the terms of trade contributes to negative real consumption deviation via equations (E4) and (E3). Second, both tax measures promote a positive deviation in government liabilities (see Section 3.2.11 above). The cumulative FII stops rising in 2017 (Figure 11). In terms of BOTE, such an outcome requires [DELTA]NFLG = from 2017. Via equation (E16), this requires GINC = G from 2017. Note that G remains on its base-case value from 2012 onwards (Figure 6). Hence, from 2017, the requirement that government debt accumulation ceases means that GINC must also return to its base-base path. But with NFLG now above base-case, via equation (E5) the requirement that GINC returns to base-case requires that the long-run value of TD be above base-case. Via equations (E4) and (E3), this contributes to a long-run negative deviation in real consumption.

3.2.13. The real investment deviation is negative from 2015

The capital deviation is positive but declining in the latter part of the simulation period (see Section 3.2.6 above). For the capital deviation to decline, the investment deviation must be negative in the latter part of the simulation period (Figure 7). Post 2017, the one enduring feature of the FSP is a positive deviation in productivity (see Section 3.1.3 above). This induces a permanent positive capital stock deviation (see Section 3.2.6 above). Via equation (E10) (see column 2, Table 3), this induces a permanent positive deviation in investment. This accounts for the steady positive contribution to the long-run investment deviation made by the infrastructure component of the FSP (Figure 7). However the net real investment deviation is negative because the two tax measures make negative contributions to the long-run real investment deviation. With the two tax measures returned to base-case by 2017, they no longer provide any direct impetus to capital formation, requiring their contribution to the short-run capital deviation to move towards zero (see Section 3.2.6 above). This requires the long-run contributions to the real investment deviation made by the two tax measures to become negative (Figure 7). A further damping influence on the long-run real investment deviation is the long-run negative deviation in the terms of trade (see Section 3.2.15 below). Via equation (Ell) (see column 2, Table 3), the negative deviation in the long-run terms of trade lowers the long-run capital/labour ratio relative to base-case. With employment tending towards base-case in the long-run (see Section 3.2.3 above), this is equivalent to a long-run damping influence on the capital deviation. Via equation (E10) (see column 2, Table 3), this exerts a long-run damping influence on the investment deviation.

3.2.14. The real balance of trade moves towards" surplus in the long-run

The real GDP deviation is positive over the latter part of the simulation period (see Section 3.2.7 above). At the same time, the deviations in real private consumption and real investment are negative (see Sections 3.2.12 and 3.2.13 respectively). Hence, via equation (E1), with the deviation in real GNE below the deviation in real GDP, the real balance of trade must move towards surplus. This accounts for the positive deviation in export volumes (Figure 8) and negative deviation in import volumes (Figure 9) over the latter part of the simulation period.

3.2.15. The long-run terms of trade deviation is negative

The export volume deviation is positive over the latter part of the simulation period (see Sections 3.2.14 above). Via equation (E8) (see column 2, Table 3), the positive export volume deviation causes a negative export price deviation, which in turn causes a negative deviation in the terms of trade via equation (E13) (Figure 10).

4. Stimulating short-run employment via lower employer labour taxes

We investigate a variant of the policy investigated in Section 3. The variant involves one change: in 2009, we direct 0.3 percentage points of the FII away from personal income tax cuts and towards a net cut to employer labour taxes. In BOTE, this is represented by a reduction in TL. A policy of this type has been advocated by Dixon (2009) for Australia's response to the global financial crisis. In the Australian context, Dixon (2009) argues that a temporary reduction in the producer wage might be secured via a wage-tax bargain in which labour is persuaded to moderate short-run demands for nominal wage growth through a compensating cut to the personal income tax rate. With its more market-oriented wage setting institutions, such an arrangement might be more difficult for New Zealand. Australia also possesses indirect labour taxes in the form of payroll tax levied on employers by state governments. Explicit employer labour taxes of this kind are largely absent in New Zealand. However, the ACC Workplace Cover, Residual Claims and Health and Safety in Employment levies are effectively payroll taxes. These taxes are levied on New Zealand employers to cover work-related personal injury costs, the on-going costs of historical injuries, and the cost of the Occupational Health and Safety Department of the Department of Labour. The ACC 2008 Annual Report estimates that the revenue from the Workplace and Residual Claims levies totalled $1.2b in 2008. The alternative FSP scenario we investigate in this section might be interpreted as either direct government funding of ACC levies, or payment of an employer labour subsidy.

At 0.3 percentage points of the FII, our employer labour tax cut is calibrated to reduce the employer cost of labour by 1 percentage point in the first year of the policy. The lower employer tax is retained for two years. Then, like all elements of the FSP, it is steadily removed over 2011 to 2017. Table 2 reports the annual contributions of the components of the alternative FSP to the FII. Note that, by 2017, the policy involves the same cumulative movement towards deficit as the core FSP (Table 1, row 5). (36)

Figure 12 reports real (CPI-deflated) post-tax wages, as perceived by employers and employees. Our labour tax cut is calibrated to 1 percentage point of the employer cost of labour. In Figure 12, this is exactly the vertical distance between the 2009 deviations in the real employee and employer wages. Recall from Section 2 that our labour market is characterised by short-run stickiness in the real employee wage, via equation (E17). In the first year of the employer labour tax cut, via equation (E12) the real effective wage as viewed by the employer falls relative to the base-case, causing a positive deviation in employment. However, the positive employment deviation immediately causes the real employee wage to begin rising relative to the base-case via equation (E17). (37) Hence, we see in 2009 approximately two-thirds of the employer labour tax cut is received by workers as a higher pre-tax wage (Figure 12).

Figure 13 compares employment and real consumption deviations under the core FSP and our alternative FSP. Both FSPs are financed by a movement towards fiscal deficit. Since both FSPs involve a cumulative movement towards fiscal deficit of 8 percentage points of GDP, the long-run costs of financing the resulting net increase in foreign liabilities are similar. By 2022, real private consumption spending is 0.83% below base-case under the core FSP, and 0.88% below base-case under the alternative FSP. However, the 2009 and 2010 employment deviations under the alternative FSP are approximately double those of the core FSP. In Figure 13, the 2009 and 2010 employment deviations under the core FSP are 0.52 and 0.42% respectively. Under the alternative FSP these figures rise to 1.0 and 0.79%. Short-run employment promotion is higher under the alternative FSP because part of the stimulus package is targeted directly at reducing the employer cost of labour. In contrast, under the core FSP, more of the impetus to short-run employment promotion is via indirect routes. As discussed in Section 3.2.1, by pushing the balance of trade towards deficit (via equation (E1)), the core FSP generates transient real producer wage reduction (in equation (E12)) through a positive terms of trade deviation in the presence of short-run real consumer wage stickiness. In contrast, by reducing TL, the alternative FSP targets the post-tax real producer wage, directly stimulating employment via equation (E12).

[FIGURE 12 OMITTED]

[FIGURE 13 OMITTED]

5. Conclusions

Like many other countries, New Zealand has responded to the global financial crises by making a discretionary movement towards fiscal deficit. By examining policy announcements between October 2008 and March 2009, we infer a cumulative movement in the discretionary component of the fiscal deficit of 5.4 percentage points of GDP by 2012. We assume this movement towards deficit will be gradually reversed by 2017. By 2017, the accumulated value of the discretionary movement towards deficit is 8% of GDP. Financing the increase in net foreign liabilities that this implies is worth 0.83% of real private consumption by 2022. Our paper discusses outcomes for a range of macroeconomic variables. However, we conjecture that a chief aim of the discretionary movement towards deficit is mitigation of short-run job losses during the present period of macroeconomic uncertainty. We find that, relative to the base-case, the employment gains from the policy package are modest: 0.5% and 0.4% in 2009 and 2010, or around 11,000 and 9000 jobs respectively. Hence we consider an alternative policy package, more targeted at employment promotion. Under the alternative package, part of the personal income tax component of the fiscal stimulus package is directed at reducing employer labour taxes. Relative to the base-case, this stimulates employment in 2009 and 2010 by 22,000 and 17,000 jobs respectively (1.0 and 0.8%). The long-run financing cost of the alternative package, at 0.89% of long-run real consumption, is comparable to that of the package of measures announced between October 2008 and March 2009.

DOI: 10.1080/00779954.2010.522162

Acknowledgements

The authors thank John Ballingall, Peter Dixon, John Janssen, John Madden, Jean-Pierre de Raad, Nhi Tran, Louise Roos and two anonymous referees for helpful comments and suggestions. The views expressed in this paper are those of the authors alone.

References

Benes, J., Binning, A., Fukac, M., Lees, K., & Matheson, T. (2009). K.I.T.T.: Kiwi Inflation Targeting Technology. Reserve Bank of New Zealand, http://www.rbnz.govt.nz/research/kitt/3715912.pdf

Colmar Brunton (2005). Measuring the tax compliance costs of small and medium-sized businesses--a benchmark survey. Available from http://www.taxpolicy.ird.govt.nz/ publications/files/smecompliancecosts.pdf

Demetriades, P.O., & Mamuneas, T.P. (2000). Intertemporal output and employment effects of public infrastructure capital: evidence from 12 OECD economies. The Economic Journal, 110, 687-712.

Dixon, P.B. (2009). Stimulating the Australian economy: comments to the Senate Standing Committee on Finance and Public Administration. Centre of Policy Studies, 9 February 2009, http://www.monash.edu.au/policy/Senate_Dixon_090209.pdf

Dixon, P.B., & Rimmer, M.T. (2001). Explanation of the MONASH equations in TABLO code. http://www.monash.edu.au/policy/ftp/monbookl/m1-chap5.pdf

Dixon, P.B., & Rimmer, M.T. (2002). Dynamic general equilibrium modelling for forecasting and policy: A practical guide and documentation of MONASH. Contributions to Economic Analysis, 256. Amsterdam: North Holland.

Dixon, P.B., Parmenter, B.R., Sutton, J., & Vincent, D.P. (1982). ORANI: A multisectoral model of the Australian economy. Contributions to Economic Analysis. Amsterdam: North Holland.

English, B., & Dunne, P. (2009). Government delivers April 1 tax cuts, SME changes. 29 March 2009. http//beehivegovtnz/release/ government+delivers+april+l+tax+cuts+sine+changes

Giesecke, J.A., Dixon, P.B., & Rimmer, M.T. (2008). Regional macroeconomic outcomes under alternative arrangements for the financing of public infrastructure. Papers in Regional Science, 87(1), 3-31.

Harrison, W.J., & Pearson, K.R. (1996). Computing solutions for large general equilibrium models using GEMPACK. Computational Economics, 9, 83-127.

New Zealand Institute for Economic Research (NZIER) (2009a). Quarterly predictions, March 2009. Wellington, New Zealand: NZIER.

New Zealand Institute for Economic Research (NZIER) (2009b). Consensus forecasts, March 2009. Wellington, New Zealand: NZIER.

Sandford, C.T., & Hasseldine, J. (1992). The compliance costs of business taxes in New Zealand. Wellington, New Zealand: Institute of Policy Studies, Victoria University of Wellington.

Statistics New Zealand (2003). Supply and use tables, March 2003. http://www.stats.govt.nz/tables/supply-and-use-tables.htm

Treasury (2008a). Additional information for economic fiscal forecasts, December 2008. 18 December 2008. http://www.treasury.govt.nz/budget/forecasts/eff2008/eff08-add.pdf

Treasury (2008b). Budget Policy Statement 2008. http://www.treasury.govt.nz/budget/2008/bps/bps08.pdf

Notes

(1.) While personal income tax cuts were announced prior to October 2008, they were reaffirmed after the global financial crisis. We include them in the fiscal stimulus package since, under more benign macroeconomic conditions, these tax cuts may have been revoked.

(2.) The business tax measures are described in English and Dunne (2009). These measures can be broadly classified into two groups: (1) changes in thresholds, limits and tax penalty interest rates, having the effect of permanently lowering the value of tax paid by SMEs. Examples include: increasing the GST payments threshold, increasing the GST registration threshold, increasing the minor FBT limit, and provision for tax-expensing of business-related legal costs. (2) Changes in tax thresholds and tax clauses that have the effect of delaying the payment of tax. Examples include removal of the 5% uplift rate that businesses pay in advance on provisional tax, and increasing the PAYE once-a-month filing and payment threshold from $100,000 to $500,000. These measures do not directly affect legislated 'tax rates'. They do, however, lower effective tax rates, by lower tax collected off a given tax base. As we discuss in Section 3.1.2, we model the business tax measures as a temporary reduction in production tax rates costing $0.12b of revenue over four years.

(3.) Capital and land are specific to each industry. Labour is occupation-specific, but free to move between industries.

(4.) The 131 industry-specific production functions are nested constant returns to scale. The top level of the nested production functions are fixed proportions in 210 composite commodities and a primary factor composite. Each of the 210 x 131 composite commodities is a CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The primary factor composite is a CES composite of land, labour and capital. The model thus has 55,413 (= 210 x 131 x 2 + 131 x 3) cost-minimising input demand functions over source-specific commodities and primary factor inputs. See Dixon et al. (1982, p. 76-90).

(5.) The representative household maximises a Klein-Rubin or Stone-Geary utility function in current-year consumption of 210 composite commodities subject to current-year income. Each of the 210 composite commodities is a cost-minimising CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The household optimisation problem thus produces 420 (= 210 x 2) utility maximising demand functions over source-specific commodities. See Dixon et al. (1982, pp. 96-103).

(6.) Units of new industry-specific capital are produced via industry-specific nested constant returns to scale production functions. The top levels of the nested production functions are fixed proportions in 210 composite commodities. Each commodity composite is in turn a cost-minimising CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The model thus has 55,020 (= 131 x 210 x 2) cost-minimising demand equations relating to inputs to capital formation. See Dixon et al. (1982, pp. 94-96).

(7.) That is, each of the 210 commodity composites demanded by each of the model's agents is a cost-minimising CES (constant elasticity of substitution) composite of imported and domestic varieties of the commodity. See Dixon et al. (1982, p. 69).

(8.) Commodity-specific export demand functions are constant elasticity of demand. See Dixon et al. (1982, pp. 104-105).

(9.) With 210 commodities and two sources of supply, the model recognises 420 source-specific government commodity demands. These demands are modelled as either exogenous or indexed to aggregate public consumption spending. See Dixon et al. (1982, p. 105).

(10.) Direct taxes are levied on labour and capital income. Indirect taxes are potentially payable on every source-specific commodity flow to each agent (= 210 x 2 x (131 + 131 + 1 + 1) indirect taxes), production by industry (= 131 indirect taxes), imports by commodity (= 210 indirect taxes), and exports by commodity (= 210 indirect taxes). However, indirect taxes on most sales are zero. Given New Zealand's VAT system, the bulk of the indirect tax burden falls on commodity-specific flows to household consumption. See Dixon et al. (1982, pp. 108-117).

(11.) We calculate the average unit cost of production for each of the model's 131 industries. Given the constant returns to scale technology that characterises each industry's production function, the average unit cost is also the marginal cost. The competitive zero pure profits condition that output price is equal to marginal cost is enforced via an assumption that the average cost of each industry's output is equal to the average price received on the commodities sold by each industry. See Dixon et al. (1982, pp. 108-110).

(12.) In both the short-run and long-run, imports are available in elastic supply at given world prices. Short-run market clearing is imposed on sales of domestic commodities and industry-specific physical capital markets. As discussed in Section 2.1, short-run labour markets are characterised by stickiness of the real consumer wage (see Dixon & Rimmer, 2002, pp. 204-210). Long-run market clearing is imposed on all markets other than commodity-specific import markets, where, again, import supply is assumed to be elastic at given world prices. See Dixon et al. (1982, pp. 122-125).

(13.) Five types of margin are modelled: wholesale trade, retail trade, road freight, other road transport services, and rail and sea transport services. In the absence of exogenous movements in technical change, demands for margin services are assumed to be a fixed proportion of the physical commodity flows that they facilitate. See Dixon et al. (1982, pp. 106-108).

(14.) Industry-specific capital accumulation follows the stock-flow accounting rule that capital in year t is equal to depreciated capital in year t-1 plus gross fixed capital formation in year t-1. See Dixon and Rimmer (2002, pp. 4-5, 154-155).

(15.) See Dixon and Rimmer (2002, pp. 190-195).

(16.) See Dixon and Rimmer (2002, p. 158).

(17.) See Dixon and Rimmer (2002, pp. 204-210).

(18.) NZIER (2009a) forecast annual average growth in real GDP of -1.5% in the year to March 2009, the lowest since 1991. NZIER (2009a) anticipates growth to remain sub-trend at 1.1% in 2010 before stabilising in 2011 and 2012 at rates of 2.8% and 3.0% respectively. Forecasts for the other macro aggregates similarly reflect likely impacts of the global financial crisis. The NZIER (2009a) forecasts are broadly in line with consensus forecasts from other major forecasters around New Zealand (see NZIER, 2009b).

(19.) We exclude land from BOTE equation (E2) since the stock of land (which is unchanged in both our base-case and policy simulations) exerts little influence on our FSP simulation results.

(20.) In linking current-year consumption to current-year disposable income via equation (E3) we have: (a) excluded the possibility of Ricardian-equivalence in short-run savings behaviour; and (b) assumed households adjust consumption to current income. We think (a) is justified on two grounds. First, empirical studies have yet to reach a consensus on the existence or size of Richardian-equivalence savings effects. Secondly, we do not find the microeconomic assumptions required for Ricardian-equivalence, such as household adjustment of current savings to anticipated future tax liabilities, to be compelling descriptions of actual behaviour. We justify (b) on the grounds that since our model is annual, rather than quarterly, we expect much of household consumption adjustment to changes in post-tax income to occur within-period.

(21.) Adding equations (E4) and (E5), the tax terms cancel, giving HINC + GINC = Y x q(TOT)--[NFLG + NFLH] x R = GNP. BOTE does not include autonomous net foreign transfers (MONASH-NZ does). Hence in BOTE, GNP is the same as GNDI. The basis of equations (E4) and (E5) is the nominal GNDI identity NGNDI = NGDP--[NNFLG + NNFLH] x R, where NGNDI is nominal gross national disposable income, NGDP is nominal GDP, R is the rate of interest on net foreign liabilities, and NNFLG and NNFLH are the nominal net foreign liabilities of the public and private sectors respectively. Dividing through by the deflator for consumption, PC, we have: GNDI = Y x PY/PC--[NFLG + NFLH] x R, where PY is the GDP deflator and all other variables are as defined in Table 3. PY/PC is a positive function of the terms of trade, q(TOT). With inclusion of tax terms, this identity can be split into two components: claims on GNDI by the household sector (HINC) and the public sector (GINC), being equations (E4) and (E5) respectively.

(22.) Equation (El0) is based on the profit maximising first order condition that the value of the marginal product of capital equals the rental price of capital, noting that the production function is constant returns to scale. See Dixon and Rimmer (2002, p. 244).

(23.) Equation (E11) is based on the profit maximising first-order condition that the value of the marginal product of labour equals the wage, noting that the production function is homogeneous of degree 1.

(24.) Adding equations (El5) and (El6) provides ANFLH + ANFLG = I--HINC + APC HINC + G--INC. Via equation (E3), ANFLH + [DELTA]NFLG = I--[HINC + GINC--C--G]. From Note 21 above we know HINC + GINC = GNDI. Hence ANFLH + ANFLG = I--[GNDI--C--G]. GNDI--C--G is national savings, S. Hence equations (E3), (E4), (E5), (E15) and (E16) imply that the change in national net foreign liabilities equals I--S.

(25.) Further details on the model's labour market adjustment mechanism are available in Dixon and Rimmer 2002 (pp. 205--210).

(26.) We base this on the speed of employment adjustment in KITT, the Reserve Bank of New Zealand's quarterly macro-econometric model. This model displays an employment adjustment path in which employment deviations are largely eliminated over 20 quarters. See Benes et al. (2009).

(27.) In equation (E9), A can be interpreted as a normal rate of return. Hence, via equation (E9), investment will be above (below) base-case so long as current rates of return (ROR) are above (below) normal rates of return. The annual capital accumulation process is described by equation (El4). Capital accumulation (depreciation) gradually drives convergence of actual and normal rates of return. In column (2) of Table 3, row (E9), we describe the long-run outcome of this process as effective exogeneity of ROR. Long-run movements in capital require long-run adjustment of investment to maintain the capital. We describe this via long-run exogenous status of [PSI] in equation (E10). Equation (E17) ensures that wage rates in the policy-case will rise (fall) relative to the base-case so long as employment in the policy case is above (below) base-case employment. This process continues until policy-case employment returns to its base-case level. While in the MONASH-NZ simulation employment (L) remains formally endogenous at all times, by driving L back to base-case, equation (E17) makes L act like a long-run exogenous variable. Hence, in column (2) of Table 3, we describe L as exogenous.

(28.) A potential source of gain from the business tax measures, not modelled in our paper, is a lowering of the compliance cost burden related to New Zealand's business taxation. A further study, one focused on the compliance cost consequences of the 2009 business tax measures, might use studies such as Colmar Brunton (2005) and Sandford and Hasseldine (1992) as starting points for the construction of plausible estimates of efficiency gains arising from a lower compliance burden under the new tax arrangements.

(29.) We model the rise in public infrastructure spending as an increase in public consumption of output of non-dwellings construction services. Hence, in our macroeconomic indicators, we see a positive deviation in public consumption spending (see Figure 6). From a national accounting perspective, the additional infrastructure spending might be assigned to economy-wide gross fixed capital formation rather than public consumption. Beyond this national accounting matter, the assignment of the additional infrastructure spending to one national accounts demand aggregate or another has no implications for our modelling.

(30.) As Giesecke et al. (2008) note, this is consistent with rates of return on Australian public infrastructure capital found by Demetriades and Mamuneas (2000).

(31.) The decomposition is calculated by running four simulations: the personal tax measures alone, the business tax measures alone, the infrastructure spending alone and the combined simulation. Since the model is non-linear, the sum of the impacts of the three shocks alone is slightly different from the joint effect of the three shocks considered simultaneously. We report the (small) difference as 'residual' in Figures 1-11.

(32.) The returns on the new infrastructure contribute approximately 0.14 (= 0.9 x 0.15) percentage points of the long-run real GDP deviation. That is, 0.9 percentage points of GDP (representing the size of the infrastructure spending) generating an annuity of 15 cents in the dollar (see Section 3.1.3).

(33.) Real consumption is approximately 60% of New Zealand's GDP. By 2011, the two tax measures are worth 1.3% of GDP (Table 1). Hence the two tax measures directly contribute approximately 2.2 percentage points (= 1.3 / 0.60) to the 2011 real private consumption deviation.

(34.) =3.5-2.2-0.3.

(35.) Fiscal impulse indicator: see Section 1.

(36.) Compare the year 2017 outcomes for the cumulative FII: final row of Tables 1 and 2.

(37.) With employment returning to the base-case in the long-run, the long-run incidence of the tax is borne by employees. If we were to leave the employer labour tax cut permanently in place, the real pre-tax wage would rise by the full amount of the tax cut, returning employment to the base-case. The start of this process is apparent in the wage and employment results for the first three years of the simulation period (Figure 12).

James A. Giesecke (a) * and Chris Schilling (b)

(a) Centre of Policy Studies and the Impact Project, Building II, Monash University, Clayton, Victoria 3800, Australia; (b) New Zealand Institute for Economic Research, 8 Halswell Street, Thorndon, PO Box 3479, Wellington, New Zealand

Received 12 March 2009; final version received 23 March 2010)

* Corresponding author. Email: James.Giesecke@buseco.monash.edu.au

Like many developed economies, New Zealand moved fiscal policy to a more expansionary stance in response to the economic downturn caused by recent US and European financial crises. While there was no formal announcement of a fiscal stimulus package, the government made a series of expansionary policy announcements between October 2008 and March 2009. In this paper, we refer to the discretionary component of this expansionary trend in fiscal policy as New Zealand's fiscal stimulus package (hereafter FSP). We investigate the economic consequences of the FSP using a large-scale dynamic model of the New Zealand economy. We find that the policy generates employment gains (around 10,000 jobs) in the years 2009 and 2010. However, by increasing net foreign liabilities, these short-run employment gains depress long-run consumption. We find that the employment-stimulating effects of the FSP are largely indirect, arising through short-run terms of trade improvement in the presence of sticky wages. We examine an alternative policy that stimulates employment directly, via reduction in the employer cost of labour. This generates short-run employment gains approximately double those of the FSP, for a similar loss in long-run real consumption.

New Zealand Treasury estimates a 'fiscal impulse indicator' (hereafter FII), an estimate of the discretionary movement towards deficit expressed as a percentage of GDP. In the December 2008 publication by the Treasury of its Fiscal Forecasts (Treasury, 2008a), the FII was estimated at a cumulative 6.4% for 2009-2012. In modelling the FSP, we focus on policy measures introduced or reconfirmed between October 2008 and March 2009. In Table 1, we identify three such measures that collectively contribute 5.4% of the total 6.4% FII over the 2009 2012 period:

(1) Personal tax cuts of $1.29b in 2009, $0.54b in 2010 and $0.47b in 2011 (in FII terms, 0.7%, 0.3% and 0.2% of GDP respectively). (1)

(2) A number of business tax measures introduced in 2009, worth $0.48b over four years ($0.12b per year, or 0.1% of GDP per year in FII terms). (2)

(3) Infrastructure spending of $0.5b for three years (in FII terms, 0.3% of GDP per year).

The infrastructure spending is a temporary movement towards deficit. However, the personal and business tax measures represent permanent movements towards deficit. By 2011, the three measures push the annual budget balance permanently towards deficit by 1.6% of GDP (see Table 1). In Budget Policy Statement December 2008, the government noted that it was not comfortable with the budget position going forward (Treasury, 2008b). We interpret this to mean that the New Zealand government will eventually implement policies to return the stance of fiscal policy to its base-case path. In our modelling, we begin this process in 2013. It is the personal tax and business tax measures that cause the stance of fiscal policy to deviate permanently from its base-case path. Hence, in our simulations, we unwind these measures in five equal steps commencing 2013 (Table 1).

The remainder of this paper is structured as follows. Section 2 describes our model. In Section 2.1 we provide an overview of MONASH-NZ, the model we use to evaluate the impacts of the FSP. In Section 2.2 we present a stylised representation of this model, useful for describing the FSP's main routes of macroeconomic causation. Section 3 presents our results, beginning with a discussion in Section 3.1 of our translation of the FSP into a set of model-compatible shocks. Section 3.2 describes our simulation results via a logical sequence of cross-referenced discussions. In Section 4 we analyse an alternative FSP, more targeted to employment promotion. Section 5 concludes the paper.

2. The model

We evaluate the economic consequences of the FSP using MONASH-NZ, a large-scale dynamic CGE model of the New Zealand economy. MONASH-NZ is a New Zealand implementation of the well-known ORANI and MONASH models. The model is too large to be fully documented in a paper of this size. Full documentation of the theoretical structures of ORANI and MONASH are provided in Dixon et al. (1982) and Dixon and Rimmer (2002). However, readers of this paper need not be familiar with the details of these references. In Section 2.2 we present a 'back-of-the-envelope' (BOTE) model tailored to describe the economic mechanisms responsible for the FSP impacts discussed in Section 3. We rely on the BOTE model in Section 3 to explain the MONASH-NZ model mechanisms responsible for our main macroeconomic findings. Before proceeding to the BOTE model, we first provide an overview of MONASH-NZ.

2.1. Overview of MONASH-NZ

MONASH-NZ models production of 210 commodities by 131 industries. An initial (2003) solution to the model is calibrated from 1996 input output data and 2003 supply and use data (Statistics New Zealand, 2003). The model identifies three primary factors, labour, capital and land. (3) The model has one representative household and one central government. Optimising behaviour governs decisionmaking by firms and households. Each industry minimises unit costs subject to given input prices and a constant returns to scale (CRS) production function. (4) Household demands are modelled via a representative utility-maximising household. (5) Units of new industry-specific capital are cost minimising combinations of New Zealand and foreign commodities. (6) Imperfect substitutability between imported and domestic varieties of each commodity is modelled using the Armington CES assumption. (7) The export demand for any given New Zealand commodity is inversely related to its foreign-currency price. (8) The model recognises consumption of commodities by government, (9) and the details of direct and indirect taxation instruments. (10) It is assumed that all sectors are competitive (11) and all markets clear. (12) Purchasers' prices differ from producer prices by the value of indirect taxes and trade and transport margins. (13) Three types of dynamic adjustment are modelled: capital accumulation, net liability accumulation and lagged adjustments. Capital accumulation is industry-specific, and linked to industry-specific net investment. (14) Movements in industry-specific net investment are related to movements in industry-specific rates of return. (15) Annual changes in the national net foreign liability position are related to the annual national investment/savings imbalance. (16) In policy simulations, the labour market follows a lagged adjustment path. In the short-run, real consumer wages are sticky. Hence, short-run labour market pressures mostly manifest as changes in employment. In the long-run, employment returns to base-case, with labour market pressures reflected in real wages. (17)

To generate results with MONASH-NZ, we undertake three simulations: a side simulation, a base-case simulation, and a policy simulation. The base-case simulation produces a forecast of the economy in the absence of the policy change under investigation. We generate the base-case using the method developed by Dixon and Rimmer (2002). In particular, we calibrate our base-case paths for macroeconomic variables using independent forecasts. Our base-case macro forecasts are based on NZIER's 2009 Quarterly Predictions (see NZIER, 2009a). These forecasts include anticipated effects of the global financial crisis on macroeconomic aggregates. (18) To ensure that our base-case simulation generates macroeconomic forecasts that are identical to those in NZIER (2009a), consistent with Dixon and Rimmer (2002) we first run a side simulation in which key macroeconomic variables are exogenous and shocked equal to forecast values. These macroeconomic variables are real consumption, real investment, real public consumption, export volumes, import volumes, employment, the real wage, and the terms of trade. To accommodate exogenous determination of these macroeconomic variables in our side simulation, corresponding variables determining macroeconomic structure must be endogenous. In particular, our side simulation requires endogenous determination of: the average propensity to consume, the economy-wide relationship between rates of return and capital growth, primary factor productivity, the preference for imports relative to domestic products, foreign willingness to pay for NZ exports, and labour/capital bias in technical change. In the base-case simulation, these structural variables are exogenous and shocked equal to their side simulation values, along with all other exogenous variables. All endogenous variables in the base-case simulation reproduce their side simulation values, regardless of whether those variables were exogenously or endogenously determined in the side simulation. The policy simulation is like the base-case simulation in all respects other than the addition of movements in variables describing the direct effects of the policy under investigation. The model is solved using GEMPACK (Harrison & Pearson, 1996).

2.2. A back-of-the-envelope (BOTE) representation of MONASH-NZ

Equations (E1)-(E17) (Table 3) describe a stylised representation of the key macroeconomic relationships in MONASH-NZ relevant to the FSP simulations reported in Section 3. Hereafter we refer to these equations as the BOTE (back-of-the-envelope) model.

Equations (E1) to (E13) describe variables within any given year of a dynamic simulation. Equations (E14) to (E16) describe how key stock variables, capital and net foreign liabilities, move through time. These equations hold between any two adjoining years of a dynamic simulation. Equation (E17) describes the lagged adjustment of real wages in the policy simulation. This equation is relevant to the process of wage adjustment in the policy simulation only.

Equation (E1) describes the GDP identity in constant price terms. Equation (E2) describes an economy-wide constant returns to scale production function, relating real GDP to inputs of labour and capital and primary factor augmenting technical change. (19) Equation (E3) links real private consumption to real (CPI-deflated) household income. (20) Equations (E4) and (E5) define real household income and real government revenue respectively, while equation (E6) confirms that equations (E4) and (E5) exhaust all claims on gross national disposable income (GNDI). (21) Equation (E7) summarises the determination of import volumes. In MONASH-NZ, demands for imports are related to activity by each agent (represented in equation (E7) by Y) and the ratio of domestic to import prices (proxied in equation (E7) by the terms of trade, TOT). Commodity exports in MONASH-NZ are inversely related to foreign currency prices via constant elasticity demand functions. This is summarised by equation (E8), which relates the foreign currency price of exports (PX) to the volume of exports (X) (movements along foreign demand schedules) and a shift variable V (movements in foreign demand schedules). Equation (E9) makes investment a positive function of rates of return. Equation (E10) defines the gross capital growth rate. Since the production function is constant returns to scale, marginal product functions are homogeneous of degree 0 and thus can be expressed as functions of K/L and A. This accounts for equations (E11) and (E12). Equation (E11) relates the profit maximising capital/labour ratio to the rate of return, production taxes, technological change, and the terms of trade. (22) Equation (E12) relates the real consumer wage (W) to changes in the capital/labour ratio, technological change, the terms of trade, employer labour taxes, and production taxes. (23) Equation (E13) defines the terms of trade as the ratio of foreign currency export prices to import prices.

Equations (E14) to (E16) relate movements in three key stock variables to relevant flow variables. Equation (E14) relates changes in the capital stock to investment. Equations (E15) and (E16) relate the change in net foreign liabilities to the excess of investment over savings. (24)

Equation (E17) governs the path of real consumer wages in the policy simulation. (25) With equation (E17) activated in the policy simulation, the deviation in the real consumer wage grows (declines) as long as employment remains above (below) its base-case level. A value for [alpha] is chosen that ensures the employment effects of a shock in year t are largely eliminated by year t + 5. (26)

We now consider an appropriate closure for equations (E1)-(E17). In doing so, we must distinguish between equations that describe economic relationships within any given year (E1) (E13), equations that describe movements in stock variables between years (E14) (E16), and the equation describing sticky wage adjustment (E17). Within any given year, K, NFLG and NFLH can be considered exogenous. The movement in these variables between years depends on investment and savings within years. These accumulation relationships are described by equations (E14)-(E16). Equation (E17) governs the transition of the policy-case labour market closure from a short-run to a long-run environment. When operational in the policy simulation, equation (E17) gradually moves the labour market from a short-run situation of exogenous real wage/ endogenous employment, to a long-run situation of exogenous employment/ endogenous real wage. Thus, recognising that equations (E14)(E17) govern dynamics across years, our task of understanding model closure narrows to choosing appropriate short-run and long-run closures for equations (E1)-(E13).

Equations (E1) to (E13) comprise 13 equations in 27 unknowns. In Table 3, model closure is described by rendering exogenous variables in bold. Two closures are presented: a short-run closure and an 'effective' long-run closure. By 'effective' long-run closure, we mean that while ROR, W and L are presented as long-run exogenous, no such exogeneity is actually imposed on these variables in MONASH-NZ simulations. Rather, in year-on-year dynamic simulations, equations (E9), (E14) and (E17) lead the economy to a long-run position that can be satisfactorily described by exogenous status of ROR, [PSI] and L in BOTE. (27)

A conventional short-run closure of equations (E1)-(E13) would have Y, X, C, HINC, GINC, GNDI, M, PX, I, [PSI], ROR, L and TOT determined endogenously, given exogenous values for A, APC, G, K, NFLG, NFLH, PM, R, TD, TL, TQ, V, W and A. Under this closure, each equation can be readily associated with the determination of a specific endogenous variable. With relatively high export demand elasticities and exogenous import prices, there is little scope for significant movements in TOT. Hence, with W, K, A, TL and TQ exogenous, equation (E12) can be identified with the determination of L. Hence, with K and A exogenous, equation (E2) determines Y. With Y thus determined, equations (E4)-(E6) calculate GNDI and its distribution between households and government. With HINC determined by (E4) and APC exogenous, equation (E3) determines real private consumption. Again, leaving aside for the moment the possibility of movements in TOT, with Y, determined by equation (E2), equation (E7) determines M. With L determined by equation (E12), and K, TQ and A exogenous, equation (E11) determines ROR. This determines I via equation (E9). With I thus determined, equation (E10) calculates [PSI]. With Y, C, I, G and M explained, equation (E1) determines X. With PM exogenous, this determines PX and TOT via equations (E8) and (E13) respectively.

Our description of MONASH-NZ's long-run behaviour differs in two respects from the short-run closure described above. First, equation (E17) ensures that the policy-case level of employment is eventually returned to its base-case level via real wage adjustment. In BOTE, this is represented by long-run exogeneity of L and endogeneity of W. Second, the short-run operation of equations (E9) and (E14) gradually drive rates of return towards base-case via capital adjustment. The end point of this process can be represented by long-run exogeneity of ROR and endogeneity of K. With ROR exogenous, in the long-run, equation (E11) determines K. With L exogenous, in the long-run, equation (E12) largely determines W.

3. Simulating the New Zealand fiscal stimulus package (FSP)

3.1. Simulation design

Using BOTE to describe our modelling of the FSP, we describe below the changes made in the policy simulation, relative to the base-case forecast, to model the FSP. In Section 3.2, we report the effects of the FSP on selected variables as percentage deviations in policy simulation results away from base-case simulation results.

3.1.1. Personal tax measures

Personal tax cuts worth 0.7% of GDP, 0.3% of GDP and 0.2% of GDP are delivered in the years 2009, 2010 and 2011 respectively (row 1, Table 1). Hence, by 2011, personal tax rates are below base-case by an amount sufficient to move the government financing requirement towards annual deficit by 1.2 percentage points of GDP. Personal income tax rates stay at their 2011 level for one year, and are then returned to their base-case value in five equal steps over 2013-2017 inclusive. Hence, personal income tax rates are below base-case for the period 2009-2016 inclusive. This negative deviation in personal tax rates can be expressed in BOTE as a reduction in TD.

3.1.2. Business tax measures

As discussed in Section 1, business tax measures worth 0.1% of GDP in foregone revenue are delivered in 2009, and retained until 2012 (row 2, Table 1). In modelling the business tax measures, we treat them as reductions in net production taxes. (28) In BOTE these are represented by TQ. Consistent with our discussion in Section 1, we assume these tax cuts are removed in five equal instalments over 2013-2017.

3.1.3. Infrastructure spending

The FSP includes an increase in public infrastructure spending equal to 0.3% of GDP in each year 2009-2011 (row 3, Table 1). We identify and model two effects arising from this spending. First, government spending on construction services rises relative to base-case. In terms of BOTE, the increase in infrastructure spending can be represented by a rise in G. In the MONASH-NZ results, this is reflected in Figure 6, later, as a positive deviation in public consumption of just over 1.4% for the three years 2009-2011. (29) Second, we assume the public capital produced by the infrastructure spending generates benefits. The literature on returns from public infrastructure, in the context of a CGE modelling exercise, is reviewed by Giesecke, Dixon and Rimmer (2008). Like Giesecke et al., we assume that each additional dollar of infrastructure spending provides an annuity of 0.15 dollars, (30) and that this benefit is delivered via a rise in economy-wide primary factor productivity. In terms of BOTE, this is represented by a rise in A. We assume that the typical infrastructure project financed by the FSP takes one year to construct, and that the productivity benefits of the new infrastructure commence in the year following construction.

3.2. Simulation results

Figures 1-11 present the macroeconomic consequences of the full FSP. The effects of the full package can be understood as the sum of the individual effects of the components of the package. Hence Figures 1-11 decompose the FSP's total impact on each macroeconomic aggregate into the individual contributions made by each of the three components of the FSP. (31) In the remainder of Section 3 we explain results via a sequence of cross-referenced explanations, relying on BOTE at each point of our discussion. We conjecture that a chief policy aim of the FSP is employment promotion. We find that the package does promote employment over 2009-2011, largely through infrastructure spending and personal tax cuts (Figure 1). However the employment gain, at an average of 0.5% over 2009-2010, or approximately 10,000 jobs, is modest. In Section 4 we examine an alternative policy combination that promotes a higher short-term employment deviation with the same discretionary movement towards deficit. However, we first explore in detail the core FSP, using BOTE to explain MONASH-NZ results for the FSP's three components: personal tax cuts, business tax cuts, and infrastructure spending.

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3.2.1. The FSP generates a short-run positive deviation in employment The employment deviation is positive for the first three years of the simulation period, peaking in the first year at 0.5% (Figure 1). As Figure 1 makes clear, all three components of the FSP make positive contributions to the short-run employment deviation. The FSP contributes to short-run employment promotion through two routes: directly, via a decrease in business taxation; and indirectly, via a positive deviation in the terms of trade. We expand on these two employment-promoting effects below.

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All three components of the FSP contribute to a short-run positive deviation in the terms of trade (see Figure 10 and Section 3.2.10 below). Our labour market is characterised by stickiness in the short-run real (CPI-deflated) wage. In BOTE we express this as short-run rigidity in W (see Section 2.2 above). The capital stock (in BOTE, K) adjusts slowly to the FSP (see Figure 2 and Section 3.2.4 below). In the presence of short-run stickiness in W and K, the initial positive deviation in the terms of trade (in BOTE, TOT) promotes a positive deviation in employment via equation (E12).

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In BOTE, the business tax measures can be expressed as a reduction in TQ (see Section 3.1 above). Via equation (E12), in the presence of sticky short-run real consumer wages (W) and capital stocks (K), a reduction in TQ relative to base-case generates a positive deviation in employment. The peak year of contribution to the employment deviation by the business tax measures is 2009 (Figure 1). This is so for two reasons. First, the full extent of the business tax reductions is delivered in the first year of the policy. Second, with employment above base-case, via equation (E17) the real wage deviation steadily increases to return employment towards base-case (see Section 3.2.2 below). Over 2010 to 2012, this accounts for the growing contribution by business tax measures to the wage deviation (Figure 4) and declining contribution by business tax measures to the employment deviation (Figure 1).

3.2.2. The short-run real wage rises relative to base-case

Our short-run labour market is characterised by sticky real wages, allowing short-run labour market pressures to be largely expressed as changes in employment (see Section 3.2.1 above). In BOTE, we represent this by short-run exogeneity of W in Section (E11) (see Table 3, column 1). In the long-run, New Zealand employment returns to base-case, with labour market pressures expressed as changes in real wages. In BOTE, we represent this by long-run exogeneity of L in equation (E11) (see Table 3, column 2). As discussed in Section 2.2, the transition in the policy simulation from short-run wage stickiness to long-run wage flexibility is governed by equation (E17). This equation ensures that the real wage deviation grows as long as employment is above base-case. This accounts for the growing real wage deviation in the first three years of the simulation (Figure 4).

3.2.3. Employment exhibits a shallow path of trough and recovery over 2012-2022

The last year of expanded infrastructure spending is 2011 (see Section 3.1.3 above). With infrastructure spending returning to base-case in 2012, and the remaining elements of the FSP steadily unwound over 2013-2017, the real wage deviation is left too high in the central years of the simulation (Figure 4) to maintain employment at its base-case level (Figure 1). The infrastructure component of the FSP makes a particularly large contribution to this effect over 2012-2014 (Figure 1). Via equation (E17), over 2009--2011 the positive deviation in employment caused by infrastructure spending (Figure 1) generates a growing positive wage deviation to return employment towards base-case (Figure 4). However, 2011 is the last year of elevated public spending on infrastructure development (Figure 6). In 2012, with past infrastructure spending having contributed to the growth in the real wage deviation (Figure 4), but public infrastructure spending returning to its base-case level (Figure 6), the real wage is left too high for employment to remain above base-case. This accounts for infrastructure's large negative contribution to the employment deviation in 2012. From 2013, the personal and business tax measures are steadily returned to base-case (see Table 1 and Sections 3.1.1 and 3.1.2. above). This requires a steady decline in the real wage deviation in the latter years of the simulation (Figure 4) to return employment to its base-case level (Figure 1). This accounts for the pattern of trough and recovery in employment between 2012 and 2022 (Figure 1).

3.2.4. The short-run positive investment deviation generates a positive capital deviation

Over the first six years of the simulation period, each of the FSP's three components contributes to the positive deviation in real investment (Figure 7). This positive investment deviation accounts for the growing positive capital deviation over the same period (Figure 2). The FSP generates a short-run positive deviation in real investment via four routes:

(1) a positive short-run employment deviation (see Section 3.2.1 above);

(2) a positive short-run terms of trade deviation (see Section 3.2.10 below);

(3) a negative deviation in taxation of production (see Section 3.1.2 above); and

(4) a positive deviation in productivity (see Section 3.1.3 above).

In terms of short-run BOTE (see column 1, Table 3), these four routes can be represented by increases in L, TOT and A, and a fall in TQ. In the short-run, capital stocks are slow to adjust (Figure 2). In terms of short-run BOTE, we express this via exogeneity of K. Via equation (Ell), with employment (L), the terms of trade (TOT), and productivity (A) above base-case in the short-run, and with business taxation (TQ) below base-case in the short-run, the deviation in rates of return (ROR) must be positive. With investment (I), a positive function of rates of return (via equation (E9)) the initial deviation in investment must be positive (Figure 7). With investment above base-case over 2009-2014, via equation (E14) the capital stock deviation must be positive and growing over the same period (Figure 2).

3.2.5. The short-run real GDP deviation is positive, peaking over 2011-2013

Over the first three years of the simulation, all three components of the FSP contribute to a positive deviation in employment (see Section 3.2.1 above). Over the same period, the capital deviation is positive and growing (see Section 3.2.4 above). As discussed in Section 3.1.3, we express the returns from infrastructure spending as a rise in productivity. Hence, via BOTE equation (E2), with L, K and A above base-case, so too must be real GDP (Figure 3).

3.2.6. The capital deviation is positive but declining from 2014-2022

All components of the FSP are gradually returned to base-case over 2013-2017 (see Section 3.1 above). As such, all but one of the four factors contributing to the short-run positive capital deviation (see Section 3.2.4 above) gradually return to base-case. This accounts for the gradual decline in the capital deviation from 2014 (Figure 2). The one factor that does not return to base-case is productivity. The infrastructure developed by the FSP's infrastructure spending over 2009--2011 continues to provide benefits, in the form of a positive deviation in economy-wide productivity (see Section 3.1.3 above). Via equation (E11) (see column 2, Table 1), with productivity (A) higher in the long-run, ceteris paribus, the long-run capital deviation must be positive. This accounts for the persistent long-run positive contribution to the capital deviation made by the infrastructure program (Figure 2).

3.2.7. The real GDP deviation is' positive but declining from 2013-2022

The employment deviation gradually returns to zero over the latter part of the simulation period (see Section 3.2.3 above). The capital deviation declines steadily over the same period (see Section 3.2.6 above). Nevertheless, a permanent positive deviation in real GDP is supported by the productivity-enhancing effect of the infrastructure component of the FSP (see Section 3.1.3 above). The rise in productivity (A in BOTE) generates a positive deviation in real GDP via two routes. First, the positive deviation in A contributes directly to a long-run positive deviation in real GDP via equation (E2). (32) Second, via equation (E11), with A higher, and L returning to base-case, K must rise relative to base-case (see Section 3.2.6 above). This positive deviation in K contributes to a positive deviation in real GDP via equation (E2).

3.2.8. The private consumption deviation is positive in the short-run

The FSP contributes to a positive short-run real consumption deviation by:

(1) lowering taxation of household income;

(2) increasing national income via promotion of employment and capital accumulation;

(3) increasing national income via a short-run positive terms of trade deviation.

All three components of the FSP contribute to the real consumption deviation via (2) and (3). Only the personal and business tax measures contribute to real consumption via (1).

Both the personal and business tax measures contribute to a positive short-run deviation in real consumption via (1) above. In terms of BOTE, these measures can be represented by short-run reductions in TD and TQ (see Section 3.1 above). Via Section (E4), reductions in TD and TQ directly increase HINC by increasing post-tax factor income. The real consumption deviation peaks in 2011 at approximately 3.5%. By 2011, the direct contribution to the consumption deviation made by the two tax measures is approximately 2.2 percentage points. (33) However in Figure 5, we see that the contribution made by the personal and business tax measures to the 2011 real consumption deviation is higher, at 3.1 percentage points. Infrastructure spending, while not directly affecting household disposable income, contributes an additional 0.3 percentage points to the 2011 real consumption deviation. The 1 percentage point (34) of 2011 consumption deviation not directly related to taxation reduction is due to the fact that all three components of the FSP generate short-run positive deviations in real GDP (see Section 3.2.5 above) and the terms of trade (see Section 3.2.10 below). Via equations (E3) and (E4) of BOTE, the positive deviations in both real GDP and the terms of trade lift real private consumption relative to base-case.

3.2.9. The real balance of trade moves towards deficit in the short-run

The FSP promotes short-run positive deviations in real private consumption (see Section 3.2.8 above), real public consumption (see Section 3.1.3 above) and real investment (see Section 3.2.4 above). Together, these movements generate a short-run positive deviation in real GNE that exceeds the deviation in real GDP. Via BOTE equation (El), this positive deviation in real GNE relative to real GDP requires a movement towards balance of trade deficit. This accounts for the short-run negative deviation in export volumes (Figure 8) and short-run positive deviation in import volumes (Figure 9).

3.2.10. The terms of trade deviation is positive in the short-run

Export volumes are below base-case between 2009 and 2014 (see Section 3.2.9 above). Via equation (E8), New Zealand export prices must rise relative to base-case. Via equation (E13), this accounts for the positive deviation in the terms of trade between 2009 and 2014 (Figure 10).

3.2.11. The deviation in net foreign liabilities grows until 2017

With the real balance of trade moving towards deficit in the first six years of the simulation period (see Section 3.2.9 above), New Zealand's net foreign liabilities must rise relative to the base-case over the same period. The bulk of this increase in net foreign liabilities is attributable to the movement towards fiscal deficit. In BOTE, this can be seen by noting that via equations (E5) and (E16), with G above base-case (see Section 3.1.3 above) and TD and TQ below base-case throughout the period 2009--2016 (see Sections 3.1.1 and 3.1.2 above), the bulk of the increase in net foreign liabilities depicted in Figure 11 can be viewed as an increase in the long-run value of NFLG.

Figure 11 plots two indicators of the change in New Zealand's net foreign liabilities: the ratio of net foreign liabilities to GNDI, and the cumulative FII. (35) Initially, the cumulative FII lies above the deviation in the ratio of debt to GNDI because the FSP generates a positive deviation in real GNDI via short-run positive deviations in real GDP (see Section 3.2.5 above) and the terms of trade (see Section 3.2.10 above). Relative to their direct contribution to the cumulative FII, the business tax measures and infrastructure program are strongly investment-promoting (see Section 3.2.4 above). This accounts for the increase in the ratio of net foreign liabilities to GNDI, relative to the cumulative FII, over the middle years of the simulation period (Figure 11). The cumulative FII stops rising in 2017, the year in which all policy components of the FSP have returned to base-case (see Table 1 and Section 3.1 above). With the deviation in the cumulative FII steady from 2017, the ratio of debt to GNDI falls from 2017 onwards, reflecting base-case growth in GNDI.

3.2.12. The long-run real private consumption deviation is negative

Personal income tax and business tax rates (in BOTE, TD and TQ) are progressively returned to their base-case levels over 2013-2017 (see Sections 3.1.1 and 3.1.2 above). This accounts for the steady decline in the contributions made by the personal and business tax measures to the aggregate real consumption deviation over this period (Figure 5). With personal and business taxes returned to base-case by 2017, we might expect the contributions made by these measures to the real consumption deviation to be zero thereafter. However, we find both measures make negative contributions to long-run real consumption (Figure 5). This is so for two reasons. First, both the personal and business tax measures make negative contributions to the terms of trade deviation in the long-run (see Section 3.2.15 below). In terms of BOTE, this long-run negative deviation in the terms of trade contributes to negative real consumption deviation via equations (E4) and (E3). Second, both tax measures promote a positive deviation in government liabilities (see Section 3.2.11 above). The cumulative FII stops rising in 2017 (Figure 11). In terms of BOTE, such an outcome requires [DELTA]NFLG = from 2017. Via equation (E16), this requires GINC = G from 2017. Note that G remains on its base-case value from 2012 onwards (Figure 6). Hence, from 2017, the requirement that government debt accumulation ceases means that GINC must also return to its base-base path. But with NFLG now above base-case, via equation (E5) the requirement that GINC returns to base-case requires that the long-run value of TD be above base-case. Via equations (E4) and (E3), this contributes to a long-run negative deviation in real consumption.

3.2.13. The real investment deviation is negative from 2015

The capital deviation is positive but declining in the latter part of the simulation period (see Section 3.2.6 above). For the capital deviation to decline, the investment deviation must be negative in the latter part of the simulation period (Figure 7). Post 2017, the one enduring feature of the FSP is a positive deviation in productivity (see Section 3.1.3 above). This induces a permanent positive capital stock deviation (see Section 3.2.6 above). Via equation (E10) (see column 2, Table 3), this induces a permanent positive deviation in investment. This accounts for the steady positive contribution to the long-run investment deviation made by the infrastructure component of the FSP (Figure 7). However the net real investment deviation is negative because the two tax measures make negative contributions to the long-run real investment deviation. With the two tax measures returned to base-case by 2017, they no longer provide any direct impetus to capital formation, requiring their contribution to the short-run capital deviation to move towards zero (see Section 3.2.6 above). This requires the long-run contributions to the real investment deviation made by the two tax measures to become negative (Figure 7). A further damping influence on the long-run real investment deviation is the long-run negative deviation in the terms of trade (see Section 3.2.15 below). Via equation (Ell) (see column 2, Table 3), the negative deviation in the long-run terms of trade lowers the long-run capital/labour ratio relative to base-case. With employment tending towards base-case in the long-run (see Section 3.2.3 above), this is equivalent to a long-run damping influence on the capital deviation. Via equation (E10) (see column 2, Table 3), this exerts a long-run damping influence on the investment deviation.

3.2.14. The real balance of trade moves towards" surplus in the long-run

The real GDP deviation is positive over the latter part of the simulation period (see Section 3.2.7 above). At the same time, the deviations in real private consumption and real investment are negative (see Sections 3.2.12 and 3.2.13 respectively). Hence, via equation (E1), with the deviation in real GNE below the deviation in real GDP, the real balance of trade must move towards surplus. This accounts for the positive deviation in export volumes (Figure 8) and negative deviation in import volumes (Figure 9) over the latter part of the simulation period.

3.2.15. The long-run terms of trade deviation is negative

The export volume deviation is positive over the latter part of the simulation period (see Sections 3.2.14 above). Via equation (E8) (see column 2, Table 3), the positive export volume deviation causes a negative export price deviation, which in turn causes a negative deviation in the terms of trade via equation (E13) (Figure 10).

4. Stimulating short-run employment via lower employer labour taxes

We investigate a variant of the policy investigated in Section 3. The variant involves one change: in 2009, we direct 0.3 percentage points of the FII away from personal income tax cuts and towards a net cut to employer labour taxes. In BOTE, this is represented by a reduction in TL. A policy of this type has been advocated by Dixon (2009) for Australia's response to the global financial crisis. In the Australian context, Dixon (2009) argues that a temporary reduction in the producer wage might be secured via a wage-tax bargain in which labour is persuaded to moderate short-run demands for nominal wage growth through a compensating cut to the personal income tax rate. With its more market-oriented wage setting institutions, such an arrangement might be more difficult for New Zealand. Australia also possesses indirect labour taxes in the form of payroll tax levied on employers by state governments. Explicit employer labour taxes of this kind are largely absent in New Zealand. However, the ACC Workplace Cover, Residual Claims and Health and Safety in Employment levies are effectively payroll taxes. These taxes are levied on New Zealand employers to cover work-related personal injury costs, the on-going costs of historical injuries, and the cost of the Occupational Health and Safety Department of the Department of Labour. The ACC 2008 Annual Report estimates that the revenue from the Workplace and Residual Claims levies totalled $1.2b in 2008. The alternative FSP scenario we investigate in this section might be interpreted as either direct government funding of ACC levies, or payment of an employer labour subsidy.

At 0.3 percentage points of the FII, our employer labour tax cut is calibrated to reduce the employer cost of labour by 1 percentage point in the first year of the policy. The lower employer tax is retained for two years. Then, like all elements of the FSP, it is steadily removed over 2011 to 2017. Table 2 reports the annual contributions of the components of the alternative FSP to the FII. Note that, by 2017, the policy involves the same cumulative movement towards deficit as the core FSP (Table 1, row 5). (36)

Figure 12 reports real (CPI-deflated) post-tax wages, as perceived by employers and employees. Our labour tax cut is calibrated to 1 percentage point of the employer cost of labour. In Figure 12, this is exactly the vertical distance between the 2009 deviations in the real employee and employer wages. Recall from Section 2 that our labour market is characterised by short-run stickiness in the real employee wage, via equation (E17). In the first year of the employer labour tax cut, via equation (E12) the real effective wage as viewed by the employer falls relative to the base-case, causing a positive deviation in employment. However, the positive employment deviation immediately causes the real employee wage to begin rising relative to the base-case via equation (E17). (37) Hence, we see in 2009 approximately two-thirds of the employer labour tax cut is received by workers as a higher pre-tax wage (Figure 12).

Figure 13 compares employment and real consumption deviations under the core FSP and our alternative FSP. Both FSPs are financed by a movement towards fiscal deficit. Since both FSPs involve a cumulative movement towards fiscal deficit of 8 percentage points of GDP, the long-run costs of financing the resulting net increase in foreign liabilities are similar. By 2022, real private consumption spending is 0.83% below base-case under the core FSP, and 0.88% below base-case under the alternative FSP. However, the 2009 and 2010 employment deviations under the alternative FSP are approximately double those of the core FSP. In Figure 13, the 2009 and 2010 employment deviations under the core FSP are 0.52 and 0.42% respectively. Under the alternative FSP these figures rise to 1.0 and 0.79%. Short-run employment promotion is higher under the alternative FSP because part of the stimulus package is targeted directly at reducing the employer cost of labour. In contrast, under the core FSP, more of the impetus to short-run employment promotion is via indirect routes. As discussed in Section 3.2.1, by pushing the balance of trade towards deficit (via equation (E1)), the core FSP generates transient real producer wage reduction (in equation (E12)) through a positive terms of trade deviation in the presence of short-run real consumer wage stickiness. In contrast, by reducing TL, the alternative FSP targets the post-tax real producer wage, directly stimulating employment via equation (E12).

[FIGURE 12 OMITTED]

[FIGURE 13 OMITTED]

5. Conclusions

Like many other countries, New Zealand has responded to the global financial crises by making a discretionary movement towards fiscal deficit. By examining policy announcements between October 2008 and March 2009, we infer a cumulative movement in the discretionary component of the fiscal deficit of 5.4 percentage points of GDP by 2012. We assume this movement towards deficit will be gradually reversed by 2017. By 2017, the accumulated value of the discretionary movement towards deficit is 8% of GDP. Financing the increase in net foreign liabilities that this implies is worth 0.83% of real private consumption by 2022. Our paper discusses outcomes for a range of macroeconomic variables. However, we conjecture that a chief aim of the discretionary movement towards deficit is mitigation of short-run job losses during the present period of macroeconomic uncertainty. We find that, relative to the base-case, the employment gains from the policy package are modest: 0.5% and 0.4% in 2009 and 2010, or around 11,000 and 9000 jobs respectively. Hence we consider an alternative policy package, more targeted at employment promotion. Under the alternative package, part of the personal income tax component of the fiscal stimulus package is directed at reducing employer labour taxes. Relative to the base-case, this stimulates employment in 2009 and 2010 by 22,000 and 17,000 jobs respectively (1.0 and 0.8%). The long-run financing cost of the alternative package, at 0.89% of long-run real consumption, is comparable to that of the package of measures announced between October 2008 and March 2009.

DOI: 10.1080/00779954.2010.522162

Acknowledgements

The authors thank John Ballingall, Peter Dixon, John Janssen, John Madden, Jean-Pierre de Raad, Nhi Tran, Louise Roos and two anonymous referees for helpful comments and suggestions. The views expressed in this paper are those of the authors alone.

References

Benes, J., Binning, A., Fukac, M., Lees, K., & Matheson, T. (2009). K.I.T.T.: Kiwi Inflation Targeting Technology. Reserve Bank of New Zealand, http://www.rbnz.govt.nz/research/kitt/3715912.pdf

Colmar Brunton (2005). Measuring the tax compliance costs of small and medium-sized businesses--a benchmark survey. Available from http://www.taxpolicy.ird.govt.nz/ publications/files/smecompliancecosts.pdf

Demetriades, P.O., & Mamuneas, T.P. (2000). Intertemporal output and employment effects of public infrastructure capital: evidence from 12 OECD economies. The Economic Journal, 110, 687-712.

Dixon, P.B. (2009). Stimulating the Australian economy: comments to the Senate Standing Committee on Finance and Public Administration. Centre of Policy Studies, 9 February 2009, http://www.monash.edu.au/policy/Senate_Dixon_090209.pdf

Dixon, P.B., & Rimmer, M.T. (2001). Explanation of the MONASH equations in TABLO code. http://www.monash.edu.au/policy/ftp/monbookl/m1-chap5.pdf

Dixon, P.B., & Rimmer, M.T. (2002). Dynamic general equilibrium modelling for forecasting and policy: A practical guide and documentation of MONASH. Contributions to Economic Analysis, 256. Amsterdam: North Holland.

Dixon, P.B., Parmenter, B.R., Sutton, J., & Vincent, D.P. (1982). ORANI: A multisectoral model of the Australian economy. Contributions to Economic Analysis. Amsterdam: North Holland.

English, B., & Dunne, P. (2009). Government delivers April 1 tax cuts, SME changes. 29 March 2009. http//beehivegovtnz/release/ government+delivers+april+l+tax+cuts+sine+changes

Giesecke, J.A., Dixon, P.B., & Rimmer, M.T. (2008). Regional macroeconomic outcomes under alternative arrangements for the financing of public infrastructure. Papers in Regional Science, 87(1), 3-31.

Harrison, W.J., & Pearson, K.R. (1996). Computing solutions for large general equilibrium models using GEMPACK. Computational Economics, 9, 83-127.

New Zealand Institute for Economic Research (NZIER) (2009a). Quarterly predictions, March 2009. Wellington, New Zealand: NZIER.

New Zealand Institute for Economic Research (NZIER) (2009b). Consensus forecasts, March 2009. Wellington, New Zealand: NZIER.

Sandford, C.T., & Hasseldine, J. (1992). The compliance costs of business taxes in New Zealand. Wellington, New Zealand: Institute of Policy Studies, Victoria University of Wellington.

Statistics New Zealand (2003). Supply and use tables, March 2003. http://www.stats.govt.nz/tables/supply-and-use-tables.htm

Treasury (2008a). Additional information for economic fiscal forecasts, December 2008. 18 December 2008. http://www.treasury.govt.nz/budget/forecasts/eff2008/eff08-add.pdf

Treasury (2008b). Budget Policy Statement 2008. http://www.treasury.govt.nz/budget/2008/bps/bps08.pdf

Notes

(1.) While personal income tax cuts were announced prior to October 2008, they were reaffirmed after the global financial crisis. We include them in the fiscal stimulus package since, under more benign macroeconomic conditions, these tax cuts may have been revoked.

(2.) The business tax measures are described in English and Dunne (2009). These measures can be broadly classified into two groups: (1) changes in thresholds, limits and tax penalty interest rates, having the effect of permanently lowering the value of tax paid by SMEs. Examples include: increasing the GST payments threshold, increasing the GST registration threshold, increasing the minor FBT limit, and provision for tax-expensing of business-related legal costs. (2) Changes in tax thresholds and tax clauses that have the effect of delaying the payment of tax. Examples include removal of the 5% uplift rate that businesses pay in advance on provisional tax, and increasing the PAYE once-a-month filing and payment threshold from $100,000 to $500,000. These measures do not directly affect legislated 'tax rates'. They do, however, lower effective tax rates, by lower tax collected off a given tax base. As we discuss in Section 3.1.2, we model the business tax measures as a temporary reduction in production tax rates costing $0.12b of revenue over four years.

(3.) Capital and land are specific to each industry. Labour is occupation-specific, but free to move between industries.

(4.) The 131 industry-specific production functions are nested constant returns to scale. The top level of the nested production functions are fixed proportions in 210 composite commodities and a primary factor composite. Each of the 210 x 131 composite commodities is a CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The primary factor composite is a CES composite of land, labour and capital. The model thus has 55,413 (= 210 x 131 x 2 + 131 x 3) cost-minimising input demand functions over source-specific commodities and primary factor inputs. See Dixon et al. (1982, p. 76-90).

(5.) The representative household maximises a Klein-Rubin or Stone-Geary utility function in current-year consumption of 210 composite commodities subject to current-year income. Each of the 210 composite commodities is a cost-minimising CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The household optimisation problem thus produces 420 (= 210 x 2) utility maximising demand functions over source-specific commodities. See Dixon et al. (1982, pp. 96-103).

(6.) Units of new industry-specific capital are produced via industry-specific nested constant returns to scale production functions. The top levels of the nested production functions are fixed proportions in 210 composite commodities. Each commodity composite is in turn a cost-minimising CES (constant elasticity of substitution) composite of source-specific varieties of the commodity. Two commodity sources are identified: New Zealand and foreign. The model thus has 55,020 (= 131 x 210 x 2) cost-minimising demand equations relating to inputs to capital formation. See Dixon et al. (1982, pp. 94-96).

(7.) That is, each of the 210 commodity composites demanded by each of the model's agents is a cost-minimising CES (constant elasticity of substitution) composite of imported and domestic varieties of the commodity. See Dixon et al. (1982, p. 69).

(8.) Commodity-specific export demand functions are constant elasticity of demand. See Dixon et al. (1982, pp. 104-105).

(9.) With 210 commodities and two sources of supply, the model recognises 420 source-specific government commodity demands. These demands are modelled as either exogenous or indexed to aggregate public consumption spending. See Dixon et al. (1982, p. 105).

(10.) Direct taxes are levied on labour and capital income. Indirect taxes are potentially payable on every source-specific commodity flow to each agent (= 210 x 2 x (131 + 131 + 1 + 1) indirect taxes), production by industry (= 131 indirect taxes), imports by commodity (= 210 indirect taxes), and exports by commodity (= 210 indirect taxes). However, indirect taxes on most sales are zero. Given New Zealand's VAT system, the bulk of the indirect tax burden falls on commodity-specific flows to household consumption. See Dixon et al. (1982, pp. 108-117).

(11.) We calculate the average unit cost of production for each of the model's 131 industries. Given the constant returns to scale technology that characterises each industry's production function, the average unit cost is also the marginal cost. The competitive zero pure profits condition that output price is equal to marginal cost is enforced via an assumption that the average cost of each industry's output is equal to the average price received on the commodities sold by each industry. See Dixon et al. (1982, pp. 108-110).

(12.) In both the short-run and long-run, imports are available in elastic supply at given world prices. Short-run market clearing is imposed on sales of domestic commodities and industry-specific physical capital markets. As discussed in Section 2.1, short-run labour markets are characterised by stickiness of the real consumer wage (see Dixon & Rimmer, 2002, pp. 204-210). Long-run market clearing is imposed on all markets other than commodity-specific import markets, where, again, import supply is assumed to be elastic at given world prices. See Dixon et al. (1982, pp. 122-125).

(13.) Five types of margin are modelled: wholesale trade, retail trade, road freight, other road transport services, and rail and sea transport services. In the absence of exogenous movements in technical change, demands for margin services are assumed to be a fixed proportion of the physical commodity flows that they facilitate. See Dixon et al. (1982, pp. 106-108).

(14.) Industry-specific capital accumulation follows the stock-flow accounting rule that capital in year t is equal to depreciated capital in year t-1 plus gross fixed capital formation in year t-1. See Dixon and Rimmer (2002, pp. 4-5, 154-155).

(15.) See Dixon and Rimmer (2002, pp. 190-195).

(16.) See Dixon and Rimmer (2002, p. 158).

(17.) See Dixon and Rimmer (2002, pp. 204-210).

(18.) NZIER (2009a) forecast annual average growth in real GDP of -1.5% in the year to March 2009, the lowest since 1991. NZIER (2009a) anticipates growth to remain sub-trend at 1.1% in 2010 before stabilising in 2011 and 2012 at rates of 2.8% and 3.0% respectively. Forecasts for the other macro aggregates similarly reflect likely impacts of the global financial crisis. The NZIER (2009a) forecasts are broadly in line with consensus forecasts from other major forecasters around New Zealand (see NZIER, 2009b).

(19.) We exclude land from BOTE equation (E2) since the stock of land (which is unchanged in both our base-case and policy simulations) exerts little influence on our FSP simulation results.

(20.) In linking current-year consumption to current-year disposable income via equation (E3) we have: (a) excluded the possibility of Ricardian-equivalence in short-run savings behaviour; and (b) assumed households adjust consumption to current income. We think (a) is justified on two grounds. First, empirical studies have yet to reach a consensus on the existence or size of Richardian-equivalence savings effects. Secondly, we do not find the microeconomic assumptions required for Ricardian-equivalence, such as household adjustment of current savings to anticipated future tax liabilities, to be compelling descriptions of actual behaviour. We justify (b) on the grounds that since our model is annual, rather than quarterly, we expect much of household consumption adjustment to changes in post-tax income to occur within-period.

(21.) Adding equations (E4) and (E5), the tax terms cancel, giving HINC + GINC = Y x q(TOT)--[NFLG + NFLH] x R = GNP. BOTE does not include autonomous net foreign transfers (MONASH-NZ does). Hence in BOTE, GNP is the same as GNDI. The basis of equations (E4) and (E5) is the nominal GNDI identity NGNDI = NGDP--[NNFLG + NNFLH] x R, where NGNDI is nominal gross national disposable income, NGDP is nominal GDP, R is the rate of interest on net foreign liabilities, and NNFLG and NNFLH are the nominal net foreign liabilities of the public and private sectors respectively. Dividing through by the deflator for consumption, PC, we have: GNDI = Y x PY/PC--[NFLG + NFLH] x R, where PY is the GDP deflator and all other variables are as defined in Table 3. PY/PC is a positive function of the terms of trade, q(TOT). With inclusion of tax terms, this identity can be split into two components: claims on GNDI by the household sector (HINC) and the public sector (GINC), being equations (E4) and (E5) respectively.

(22.) Equation (El0) is based on the profit maximising first order condition that the value of the marginal product of capital equals the rental price of capital, noting that the production function is constant returns to scale. See Dixon and Rimmer (2002, p. 244).

(23.) Equation (E11) is based on the profit maximising first-order condition that the value of the marginal product of labour equals the wage, noting that the production function is homogeneous of degree 1.

(24.) Adding equations (El5) and (El6) provides ANFLH + ANFLG = I--HINC + APC HINC + G--INC. Via equation (E3), ANFLH + [DELTA]NFLG = I--[HINC + GINC--C--G]. From Note 21 above we know HINC + GINC = GNDI. Hence ANFLH + ANFLG = I--[GNDI--C--G]. GNDI--C--G is national savings, S. Hence equations (E3), (E4), (E5), (E15) and (E16) imply that the change in national net foreign liabilities equals I--S.

(25.) Further details on the model's labour market adjustment mechanism are available in Dixon and Rimmer 2002 (pp. 205--210).

(26.) We base this on the speed of employment adjustment in KITT, the Reserve Bank of New Zealand's quarterly macro-econometric model. This model displays an employment adjustment path in which employment deviations are largely eliminated over 20 quarters. See Benes et al. (2009).

(27.) In equation (E9), A can be interpreted as a normal rate of return. Hence, via equation (E9), investment will be above (below) base-case so long as current rates of return (ROR) are above (below) normal rates of return. The annual capital accumulation process is described by equation (El4). Capital accumulation (depreciation) gradually drives convergence of actual and normal rates of return. In column (2) of Table 3, row (E9), we describe the long-run outcome of this process as effective exogeneity of ROR. Long-run movements in capital require long-run adjustment of investment to maintain the capital. We describe this via long-run exogenous status of [PSI] in equation (E10). Equation (E17) ensures that wage rates in the policy-case will rise (fall) relative to the base-case so long as employment in the policy case is above (below) base-case employment. This process continues until policy-case employment returns to its base-case level. While in the MONASH-NZ simulation employment (L) remains formally endogenous at all times, by driving L back to base-case, equation (E17) makes L act like a long-run exogenous variable. Hence, in column (2) of Table 3, we describe L as exogenous.

(28.) A potential source of gain from the business tax measures, not modelled in our paper, is a lowering of the compliance cost burden related to New Zealand's business taxation. A further study, one focused on the compliance cost consequences of the 2009 business tax measures, might use studies such as Colmar Brunton (2005) and Sandford and Hasseldine (1992) as starting points for the construction of plausible estimates of efficiency gains arising from a lower compliance burden under the new tax arrangements.

(29.) We model the rise in public infrastructure spending as an increase in public consumption of output of non-dwellings construction services. Hence, in our macroeconomic indicators, we see a positive deviation in public consumption spending (see Figure 6). From a national accounting perspective, the additional infrastructure spending might be assigned to economy-wide gross fixed capital formation rather than public consumption. Beyond this national accounting matter, the assignment of the additional infrastructure spending to one national accounts demand aggregate or another has no implications for our modelling.

(30.) As Giesecke et al. (2008) note, this is consistent with rates of return on Australian public infrastructure capital found by Demetriades and Mamuneas (2000).

(31.) The decomposition is calculated by running four simulations: the personal tax measures alone, the business tax measures alone, the infrastructure spending alone and the combined simulation. Since the model is non-linear, the sum of the impacts of the three shocks alone is slightly different from the joint effect of the three shocks considered simultaneously. We report the (small) difference as 'residual' in Figures 1-11.

(32.) The returns on the new infrastructure contribute approximately 0.14 (= 0.9 x 0.15) percentage points of the long-run real GDP deviation. That is, 0.9 percentage points of GDP (representing the size of the infrastructure spending) generating an annuity of 15 cents in the dollar (see Section 3.1.3).

(33.) Real consumption is approximately 60% of New Zealand's GDP. By 2011, the two tax measures are worth 1.3% of GDP (Table 1). Hence the two tax measures directly contribute approximately 2.2 percentage points (= 1.3 / 0.60) to the 2011 real private consumption deviation.

(34.) =3.5-2.2-0.3.

(35.) Fiscal impulse indicator: see Section 1.

(36.) Compare the year 2017 outcomes for the cumulative FII: final row of Tables 1 and 2.

(37.) With employment returning to the base-case in the long-run, the long-run incidence of the tax is borne by employees. If we were to leave the employer labour tax cut permanently in place, the real pre-tax wage would rise by the full amount of the tax cut, returning employment to the base-case. The start of this process is apparent in the wage and employment results for the first three years of the simulation period (Figure 12).

James A. Giesecke (a) * and Chris Schilling (b)

(a) Centre of Policy Studies and the Impact Project, Building II, Monash University, Clayton, Victoria 3800, Australia; (b) New Zealand Institute for Economic Research, 8 Halswell Street, Thorndon, PO Box 3479, Wellington, New Zealand

Received 12 March 2009; final version received 23 March 2010)

* Corresponding author. Email: James.Giesecke@buseco.monash.edu.au

Table 1. Annual contributions to F11 under the government's FSP (percentage of GDP). 2008 (a) 2009 (a) 2010 (a) 1. Personal tax cut 0.0 0.70 1.00 2. Business tax cuts 0.0 0.10 0.10 3. Infrastructure spending 0.0 0.30 0.30 4. Fiscal impulse indicator (FII) 0.0 1.10 1.40 5. Cumulative FII 0.0 1.10 2.50 2011 (a) 2012 (a) 2013 (b) 1. Personal tax cut 1.20 1.20 0.96 2. Business tax cuts 0.10 0.10 0.08 3. Infrastructure spending 0.30 0.00 0.00 4. Fiscal impulse indicator (FII) 1.60 1.30 1.04 5. Cumulative FII 4.10 5.40 6.44 2014 (b) 2015 (b) 2016 (b) 1. Personal tax cut 0.72 0.48 0.24 2. Business tax cuts 0.06 0.04 0.02 3. Infrastructure spending 0.00 0.00 0.00 4. Fiscal impulse indicator (FII) 0.78 0.52 0.26 5. Cumulative FII 7.22 7.74 8.00 2017 (b) BOTE (c) 1. Personal tax cut 0.00 TD 2. Business tax cuts 0.00 TQ 3. Infrastructure spending 0.00 G 4. Fiscal impulse indicator (FII) 0.00 [DELTA]NFLG 5. Cumulative FII 8.00 NFLG Notes: (a) 2008-2012 values inferred by authors from Treasury (2008a). (b) We assume that the discretionary movements towards deficit is steadily unwound over 2013-2017. See Section 1 for details. (c) Relevant variable in the back-of-the-envelope (BOTE) model. See Table 3. Table 2. Annual contributions to FII under the Alternative FSP (percentage of GDP). 2008 (a) 2009 (a) 2010 (a) 1. Personal tax cut 0.0 0.37 0.67 2. Employer labour tax cut 0.0 0.33 0.33 3. Business tax cuts 0.0 0.10 0.10 4. Infrastructure spending 0.0 0.30 0.30 5. Fiscal impulse indicator (FII) 0.0 1.10 1.40 6. Cumulative FII 0.0 1.10 2.50 2011 (a) 2012 (a) 2013 (a) 1. Personal tax cut 0.92 0.97 0.77 2. Employer labour tax cut 0.28 0.23 0.19 3. Business tax cuts 0.10 0.10 0.08 4. Infrastructure spending 0.30 0.00 0.00 5. Fiscal impulse indicator (FII) 1.60 1.30 1.04 6. Cumulative FII 4.10 5.40 6.44 2014 (a) 2015 (a) 2016 (a) 1. Personal tax cut 0.58 0.39 0.19 2. Employer labour tax cut 0.14 0.09 0.05 3. Business tax cuts 0.06 0.04 0.02 4. Infrastructure spending 0.00 0.00 0.00 5. Fiscal impulse indicator (FII) 0.78 0.52 0.26 6. Cumulative FII 7.22 7.74 8.00 2017 (a) BOTE (b) 1. Personal tax cut 0.00 TD 2. Employer labour tax cut 0.00 TL 3. Business tax cuts 0.00 TQ 4. Infrastructure spending 0.00 G 5. Fiscal impulse indicator (FII) 0.00 [DELTA]NFLG 6. Cumulative FII 8.00 NFLG Notes: (a) Authors' values. See Section 4 for details. (b) Relevant variable in the back-of-the-envelope (BOTE) model. See Table 3. Table 3. BOTE: a stylised representation of the main macroeconomic relationships of MONASH-NZ. Equations holding within any given year of the year-on-year base-case and policy simulations (1) Short-run closure (2) 'Effective' long-run closure (E1) Y = C + I# + G# + X - M Y = C + I + G# + X - M (E2) Y = A f(K#, L) Y = A# f(K, L#) (E3) C = APC# x HINC C = APC# x HINC (E4) HINC = [Y x q(TOT) x {1 -TQ#} HINC = [Y x q(TOT) x {1 -TQ#} - L x W# x TL# - NFLH# x R#] - L x W x TL# - NFLH# x R#] x {1 - TD] x {1 - TD] (E5) GINC = [Y x q(TOT) x {1 - TQ#} GINC# = [Y x q(TOT) x {1 - - L x W# x TL# -NFLH# x R#] x TQ#} - L x W x T# - NFLH# x TD# + Y x q(TOT) x TQ# - NFLG# R#] x TD + Y x q (TOT) x TQ# x R# + L x W# x TL# - NFLG# x R# + L x W x TL# (E6) GNDI = HINC + GINC GNDI = HINC + GINC# (E7) M = h(Y, TOT) M = h(Y, TOT) (E8) PX = j(X, V#) PX = j(X, V) (E9) I = u(ROR/[LAMBDA]#) I = u(ROR#/[LAMBDA]) (E10) [PSI] = I#/K# [PSI] = I/K (E11) K#/L = n(ROR, TQ#, A#, TOT) K/L = n(ROR#, TQ#, A#, TOT) (E12) W# = z(K#/L, A#, TOT, TL#, W = z(K/L#, A#, TOT, TL#, TQ#) TQ#) (E13) TOT = PX/PM# TOT = PX/PM# Equations holding between any two adjacent years of the year-on-year base-case and policy simulations (E14) [DELTA]K = I [DELTA]K = I (E15) [DELTA]NFLH = I (1 - APC#) x [DELTA]NFLH = I - (1 - APC#) HINC x HINC (E16) [DELTA]NFLG = G# - GINC [DELTA]NFLG = G# - GINC# Lagged wage adjustment in the policy simulation (E17) ([W.sup.Policy.sub.t]/[W#.sup.Basecase#.sub.t#] -1) = ([W#.sup.Policy#.sub.t# - 1#]/[W#.sup.Basecase#.sub.t# - 1#] - 1) + [alpha] ([L.sup.Policy.sub.t]/[L#.sup.Basecase#.sub.t#] - 1) Variables of the BOTE model A Primary factor augmenting technical change APC Average propensity to consume C Real private consumption G Real public consumption GINC Real (CPI-deflated) government income GNDI Gross national disposable income HINC Real (CPI-deflated) household income I Real investment K Capital stock L Employment M Import volumes NFLG Real (CPI-deflated) government net foreign liabilities NFLH Real (CPI-deflated) household net foreign liabilities PM Foreign currency import price PX Foreign currency export price wt Real (CPI-deflated) wage at time t in simulation s. R Rate of interest on net foreign liabilities ROR Rate of return on capital TD Direct tax rate TL Labour tax rate TQ Production tax rate TOT Terms of trade V Shift in export demand schedule W Real (CPI-deflated) wage X Export volumes Y Real GDP [LAMBDA] Shift in investment/rate of return schedule [PSI] Investment/capital ratio [DELTA]K Change in K between years t and t + 1 [DELTA]NFLG Change in NFLG between years t and t + 1 [DELTA]NFLH Change in NFLH stock between years t and t + 1 [L.sup.s.sub.t] Employment at time t in simulation s. Bold text denotes exogenous variable. Note: Bold text denotes exogenous variable is indicated with #.

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Title Annotation: | RESEARCH ARTICLE |
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Author: | Giesecke, James A.; Schilling, Chris |

Publication: | New Zealand Economic Papers |

Article Type: | Report |

Geographic Code: | 8NEWZ |

Date: | Dec 1, 2010 |

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