How the New Zealand Government Spends Money
The Roots of the Not So 'Magic Money Tree'
Introduction
A long overdue post. I hope you’ve all had a great Christmas and New Year!
Let’s start by talking about how the government spends money and where it comes from. Understanding the banking operations at the centre of government expenditure in New Zealand operates upends the idea that the government is financially constrained by tax and bond ‘revenue’. When understood, it is clear that the New Zealand Government cannot run out of money as it is self-financing.
What is the Crown Settlement Account?
How the government spends money is an institutionally complex tapestry of exchanges between the Government’s and Westpac’s bank accounts at the Reserve Bank.
At the centre of it all is the Crown Settlement Account (CSA). The CSA is at the root of the ‘magic money tree’ and is, as its name suggests, a settlement account operated by the Reserve Bank for the Government. The CSA ‘serves as the Crown’s central ‘disbursement account’’,[1] where ‘all flows between the government and the private sector and the government and the Bank end up flowing through this account’.[2] At the end of every day, ‘the amounts held in all of the Crown and departmental bank accounts are ‘swept’ into the Crown Settlement Account with the Reserve Bank of New Zealand [which] permits the centralised management of the Crown’s cash position by the NZ Debt Management Office [DMO - a part of the Treasury]’.[3]
Despite the importance of the CSA in the government expenditure process, there is very little mention of it anywhere. There are four different papers published by the Reserve Bank that mention it and a superseded one from the Treasury. The Treasury’s new paper doesn’t mention it. The CSA is mentioned in the Reserve Bank’s annual reports, but these are just copy-pasted from report to report after 2014. There is no mention of the CSA in any academic literature or journalism on New Zealand’s fiscal policy.
The operational elements of pre-2020 CSA literature are currently irrelevant due to changes in the Monetary Policy Implementation framework, where the Reserve Bank moved from a ‘corridor’ to the ‘floor’ system. Simply, instead of targeting the OCR within a corridor, the Reserve Bank pays the OCR on balances within the settlement cash system (including on balances within the CSA – the balance of the CSA is not counted as settlement cash). Settlement cash is the money held by commercial banks in their accounts in the Exchange Settlement Account Service (ESAS) at the Reserve Bank. Moving to the floor system changed the game for the relevance of bond issuance and cash management on interest rates. The floor system means that the quantity of settlement cash is ‘largely irrelevant to the achievement of the short-term interest rate target and, as such, any necessary operational link between quantities of debt issued and the net balance of the Exchequer's spending [in the UK context] and taxation flows is broken’.[4]
The CSA has a $5 billion overdraft facility, which was extended to $10 billion temporarily between March and June of 2020.[5] The CSA had an end of day balance in overdraft for 24 days in 2020, where the highest overdrawn balance was $2.36 billion.[6] Use of the CSA overdraft facility merely indicates insufficient cash management by the Treasury (NZDMO) required to maintain a positive balance in the CSA.[7] This was offset by quantitative easing (the LSAP in NZ), where the Reserve Bank created settlement cash to acquire government bonds to control interest rates. This increased the settlement cash level and the CSA balance. According to mainstream economic logic, the Government literally did run out of money but could still meet its payment obligations. The Reserve Bank can ensure that any government payment obligation (wages, benefit payments etc) can be made no matter what the balance of the CSA is. This is the operational reality at the core of the self-financing state.
How Does the Government Spend Money from the Crown Settlement Account?
The CSA is the source of all government expenditure in New Zealand. Upon approval of government expenditure by Parliament during the Budget process, the Reserve Bank ensures that the government is able to fulfil expenditure operations when they are due to occur.
When the New Zealand government spends money, it flows from the CSA to Westpac’s settlement cash account with the Reserve Bank. This adds to the amount of settlement cash as the government creates new money (in the form of settlement cash) when it spends. While government spending impacts on the level of settlement cash, ‘the amount of settlement cash is determined by the Reserve Bank’.[8] The Reserve Bank has unlimited capacity to do this.[9] Crucially, ‘the government ultimately insists on being paid in Reserve Bank settlement cash’,[10] where ‘transactions between the government and individuals and firms need to be settled, and the [Reserve] Bank requires that settlement cash is used’.[11] In other words, the Government insists on settling (i.e., making and receiving) payments in money that is created/determined by the Reserve Bank.
In the corridor system prior to 2020, the Reserve Bank and DMO sought to offset the impact of government spending. This was to maintain the level of settlement cash which would support the Official Cash Rate (OCR). The lower the amount of settlement cash, the higher interbank interest rates would go above the OCR as banks would be willing to pay more to get it.
With the unwinding of the LSAP, the settlement cash level will move from ‘abundant’ to ‘ample’.[12] When the settlement cash level returns to an ‘ample’ level, the Reserve Bank will inject money ‘to compensate for net payments from the banking system to the government (eg tax payments) on any given day, and it withdraws liquidity to compensate for net payments from the government to the banking system (eg pension payments) on any given day’.[13] The size of the intervention depends on the scale of government expenditure on that day.
What Does Understanding the Crown Settlement Account Mean for Fiscal Policy As We Currently See It?
The notion of fiscal responsibility, as legislated in section 26G of the Public Finance Act, relate only to the transactional side of government expenditure. This has no bearing on the ability of the government to make payments, as this is determined by the Reserve Bank.
Crucially, the Public Finance Act 1989 and its provisions relating to Crown Bank Accounts and departmental bank accounts do not apply to the operation of the CSA. The legislative basis of the CSA is section 116(e) of the Reserve Bank of New Zealand Act 2021, allowings the Reserve Bank to ‘provide settlement accounts for persons approved by the Reserve Bank’.[14] This is peculiar in in the context of government finance internationally, as the establishment and operations of government bank accounts at the central bank are often legislated. Examples of this include section 53(3) of the Public Governance, Performance and Accountability Act (PGPA Act) 2013 in Australia and the Audit and Exchequer Departments Act 1866 (the 1866 Act) in the UK.
Section 53(3) of the PGPA Act 2013 states that ‘the Finance Minister must, on behalf of the Commonwealth, open and maintain a central bank account with the Reserve Bank of Australia’. The 1866 Act governs the operations of the Consolidated Fund, which is equivalent to the CSA in the UK context.
Conclusion
There is a lot we still don’t know about the CSA. Its exact structure, namely whether it is one account or several, is unknown to the public.[15] The exact operations which surround it are also something of a mystery. There is likely a daily settlement account similar to the Consolidated Fund which ends the day on a nil balance, from which all Government transactions are settled daily. However, it is clear from Reserve Bank literature and knowledge of how the system operates that the CSA is the source of all government expenditure. The balance of the CSA is irrelevant to the ability of the government to spend money.
This pierces the veil of the myth that the government is like a household and has to pursue cuts to crucial public services to maintain its ‘financial stability’.
[1] Reserve Bank of New Zealand, 2020, Annual Report: 2019-2020, p. 117
[2] Jan Frazer, 2004, Liquidity Management in the New Zealand Banking System, Reserve Bank Bulletin Vol. 67, No. 4, p. 5
[3] The Treasury, 2011, Putting it Together, p. 60
[4] Berkeley et al., 2022, The Self-Financing State, UCL IIPP Working Paper
[5] Reserve Bank of New Zealand, 2020, p. 121
[6] Ibid
[7] As noted by Berkeley et al. (2022) in their paper ‘The Self-Financing State’, in the absence of adequete cash management, expenditure from the Consolidated Fund (the UK’s CSA) will ‘result in a W&M advance [i.e., an overdraft] at the end of the day by default. Such an outcome is entirely within the discretion of HM Treasury and explains how and why any spending authorised by Parliament happens without constraint in all circumstances’ (p. 15).
[8] Callaghan, Hawthorn and Poskitt, 2023, How the Reserve Bank Implements Monetary Policy, Reserve Bank Bulletin Vol. 86, No. 3, p. 4
[9] Knowles, Austin and Kerr, 2023, Money Creation in New Zealand, Reserve Bank Bulletin Vol. 86, No. 1, p. 3
[10] Huxley and Reddell, 1996, Implementing Monetary Policy in New Zealand, Reserve Bank Bulletin Vol. 59 No.4, p. 309
[11] Archer, Brookes and Reddell, 1999, A Cash Rate System for Implementing Monetary Policy, Reserve bank Bulletin Vol. 62 No. 1, p. 5
[12] Karen Silk, 2024, Liquidity Management: Principles for Liquidity Provision and the End of an Abundant Era, Reserve Bank of New Zealand, p. 6
[13] Frazer 2004, pp. 5-6
[14] Reserve Bank of New Zealand Act 2021
[15] For instance, the Reserve Bank’s analytical accounts data refers to the Crown Settlement Accounts (plural).