Story: Spending in the economy

Page 4. Spending stabilisation

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Over time, an economy’s capacity to produce goods and services typically increases. To maintain full employment without inflation, policy makers try to keep total spending growing at close to the same rate as production. This is not easy – credit can finance sharp changes in expenditure growth.

A. W. H. (Bill) Phillips was a New Zealander who refined Keynes theories on the stabilisation of spending, and produced a model illustrating how his policies worked. After the Second World War he went to the London School of Economics. He had trained in electrical engineering, and he used the way electricity feeds back as a model for large booms and busts in an economy, so he could develop policies for moderating spending. Governments were able to see more clearly where to spend money in the economy and what the effects would be.

MONIAC

Bill Phillips designed the extraordinary MONIAC machine to illustrate how his stabilisation policies worked. It was a hydraulic model of the economy, with flows of water representing spending and money moving around different sectors in an economy. In the 2000s a working example was on display at the Reserve Bank of New Zealand in Wellington.

Reserve Bank

In the 1990s and early 2000s the Reserve Bank was largely responsible for stabilising spending growth. It did this by implementing monetary policy targeted at maintaining price stability. If inflation was expected to be too high, suggesting that total spending was moving ahead of the economy’s capacity to produce, the bank would move to slow down expenditure growth by raising the official cash rate (OCR) – the interest rate that commercial banks have to pay to borrow cash reserves. This rate fed through to all interest rates in the economy. Increased interest rates encourage businesses and households to reduce their spending.

If there were no inflationary pressures in the economy, the Reserve Bank would lower its OCR, to encourage more production. In 2008 when the world economy slowed the rate dropped dramatically.

Investment

From the late 1990s there was ongoing concern that New Zealanders did not save enough to finance domestic spending on investments, such as new factories, transport systems or broadband technologies. New Zealand borrowed overseas for some investments.

There was also concern that New Zealand workers spent too much on current consumption, and did not save enough for their retirement. The ratio of people who have retired to people in employment is expected to increase sharply over the 2010s and 2020s. The Labour government responded to this concern in the early 2000s by building up assets in the New Zealand Superannuation Fund and by encouraging workers to save through a subsidised ‘Kiwi Saver’ savings scheme.

Non-savers

People’s saving for retirement varies according to their year of birth. Those born between 1920 and 1939 save less than those born before or after. During their peak earning and saving period people born then were living in good economic times. This seemed to lessen their incentive to save.

Tax cuts

There was ongoing debate about whether the government should reduce its own spending to match any drop in revenue that would come if they lowered tax rates. Tax cuts mean people have more to spend, and can change the ratio of private- and public-consumption spending. But poorer people can find it hard to afford things like schooling and going to the doctor. In 2008 the government spent millions of dollars on education and health, but also introduced tax cuts.

Spending and social services

There has been debate about how governments can help households who are living in relative poverty. The spending power of low-income households was increased through income support, provided through the Ministry of Social Development. If people are off work due to an accident, they receive income support through the Accident Compensation Corporation.

In 2007, the government introduced the ‘Working for Families’ programme to provide tax rebates to workers in lower-paid jobs who had families, increasing their spending power.

During the decade of reforms from 1984 to 1994 the government reduced the level of transfers to people receiving income support (in the 1991 benefit cuts). Social security beneficiaries – people on the dole – were not eligible for the Working For Families programme. Critics argued that this trapped children in poverty, harming their physical and social development.

How to cite this page:

Paul Dalziel, 'Spending in the economy - Spending stabilisation', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/spending-in-the-economy/page-4 (accessed 19 November 2017)

Story by Paul Dalziel, published 11 Mar 2010, updated 16 Sep 2016