Welcome to Reality
Not So Magic Money Trees: The Mechanics of Government Spending in New Zealand
Welcome to my first foray into the ‘Substackosphere’. What better way to get started than by dispelling the mythology surrounding government spending.
On Sunday August 11, a 15-minute interview with Australian Economist Steven Hail on Q&A signalled the emergence of Modern Monetary Theory (MMT) into serious public conversation in New Zealand. Yes, there have been commentaries on MMT in New Zealand in the past, but these are so far removed from ‘actual’ MMT that they aren’t worth paying attention to. It would be like me commenting on fashion. I know nothing about fashion.
The MMT position is this: all government expenditure comes from the government itself. The state is self-financing.
There are no magic money trees. The self-financing state operates through keyboards marking up bank accounts.
For a government that doesn’t have a fixed exchange rate (like New Zealand) and doesn’t allow the currency to be convertible into other commodities like gold (again, like New Zealand), government is constrained only by the resources (like wood, nurses, pipes, engineers) available in the currency it issues and self-imposed rules. We call governments that meet these criteria ‘currency issuers’ and others ‘currency users’. Here’s a useful graphic to help you understand the constraints on government spending.
As an introduction to MMT, it is important to understand how government spending works and what the impacts of government fiscal policy are on the non-government sector. This is what we’ll be looking at today.
Nothing that will be described here is new. Rather, this merely explains the government expenditure process as it exists currently. This is the ‘Jedi mind trick’ of MMT. MMT merely explains how government expenditure operates in a modern economy. It really turns everything the right way up, as economics has kept everything upside down. Moreover, we do not shift to MMT. Nicola Willis isn’t going to wake up tomorrow morning and proclaim, ‘I’m going to turn NZ into an MMT economy!’. MMT is an analytical lens we apply to government expenditure for economies that do not have a fixed exchange rate or where their currencies are convertible into commodities like gold.
Yes, it is technical. However, like many other technical things, it reflects reality. The simple assumption that ‘government spends like a household’ is just plain wrong. Government creates money when it spends, and now I will explain how.
The Mechanics of Government Spending in New Zealand
At the moment, there is no detailed description of how the government spending process operates in New Zealand.
Let that sink in for a second.
The account given here is merely a ‘first look under the hood’. It is a taste tester of a significantly more complex description to come.
Shameless self-promotion incoming: my Doctoral research aims to remove the opacity surrounding the mechanics of government finance in New Zealand. Watch this space.
There just simply isn’t enough information in the public domain to understand the complexities of the mechanics of government finance. For example, there is no formal legislative basis for the Government’s bank account at the Reserve Bank – the Crown Settlement Account (CSA). The Reserve Bank Act 2021 states that the Reserve Bank can provide ‘settlement accounts for persons approved by the Bank’ (s116(e) RBNZ Act 2021), but that is really it. There is also very little institutional literature on the CSA, save for a few mentions of it in RBNZ Bulletins (which are very useful sources of information). Confusingly, the RBNZ ‘Analytical Accounts Data’ refers to the Crown Settlement Accounts (plural!). It’ll come as no surprise that there is no academic literature whatsoever on the CSA.
Pretty incredible that this is the case for the bank account that all government expenditure comes from.
Before we get too far into it, it is really important to recognise that the Reserve Bank is a creature of government. In other words, it is a part of government. The RBNZ and the rest of government (namely Treasury) are strongly interdependent, which is integral for government spending.
On to our taste tester overview.
The following graphic shows a stylisation of the government spending process in New Zealand.
Many thanks to the Reserve Bank (Knowles et al 2023 – Money Creation in New Zealand) for this graphic (with Morgan amendments, of course). I’d really like to thank them for including the wee infinity sign under the Reserve Bank of New Zealand.
The government spending process begins with the Appropriation Process. You may know this as ‘the Budget’. The Parliament authorises this expenditure after some debate and Select Committee hearings. This is shown with the blue line coming from the box at the top.
The Parliamentary authorisation of Appropriations and Imprest Supply Acts legislates the creation of money by the Reserve Bank. When necessary. the money created by the Reserve Bank is placed into the Crown Settlement Account (CSA). This is shown by the black line going from the RBNZ to the Beehive. The CSA is the Government’s bank account at the Reserve Bank. An RBNZ Bulletin from 2004 notes that, ‘all [monetary] flows between the government and the private sector and the government and the Bank end up flowing through this account’ (Frazer 2004, p. 5).
Moving on, the money from the CSA is spent into the banking system - Westpac bank accounts to be specific. Westpac is the Government’s bank for ‘non-government’ interactions (for instance, benefit payments, paying employees). Here, the Reserve Bank has to understand how much money is going to have to be created to fulfil the operations of the government. From the RBNZ Bulletin mentioned above:
The [Reserve] Bank needs to know the value of the payments the government and the Bank expect to receive and pay out on any given day. The Bank does this by forecasting liquidity based on information provided to it by the NZDMO and the larger government departments (such as the Ministry of Social Development, the Ministry of Health, and the Ministry of Education). (Frazer 2004, p. 8).
After this, the money is within the banking system ready to be used.
In a nutshell:
1.       The ability to spend public money is authorised by the New Zealand Parliament after the completion of the Appropriation Process.
2.       The money is created by the Reserve Bank when the spending is due.
3.       The money is placed into the CSA.
4.       The money is spent into the banking system.
5.       Money appears in bank accounts
What about Taxes and Bonds?
There’s no mention of taxes and bonds in the preceding description. Why? Taxes and bonds are not a component of the process of government spending. Taxation and bond issuance is independent of government spending.
Tax dollars make their way back into the CSA through a daily settlement process but are not used for future expenditure. However, taxes are still a very important part of government economic policy. Taxes are used to influence spending either giving (allowing us to keep more of our income) or taking away money. Taxes also determine the policy space available to government. Finally, the payment of taxes also cements the government atop the monetary hierarchy as people must have money to pay taxes in the currency the government has chosen. You’ll get in trouble if you don’t pay them. Don’t think for a second that taxes aren’t important.
Bonds, or what you may know as government debt, are a bit different. Bonds are assets created by government that enable their holders to earn interest. They’re a great asset for savers because the Government can’t run out of money. Nowadays, they aren’t necessary for government spending. They used to play an important role in the liquidity management process (the management of money in the settlement cash system), but not anymore.
The Impact of Fiscal Policy
Now that we understand the government expenditure process, we can turn to understanding what the impacts of the government’s fiscal position is on the rest of the economy.
The reality is this: someone’s surplus is someone else’s deficit. When we are talking about government finance, a government (fiscal) surplus is a non-governmental sector (household and business) deficit. This is called the sectoral balances logic. Â
Here’s the sectoral balances for the government (in blue) and households (in red) between 1987 and 2022.
The ‘responsible fiscal management’ (i.e., running government surpluses) of successive New Zealand Governments has eroded the financial wellbeing of the non-governmental sector.
As the state is self-financing, the government doesn’t save for new bass guitars (or anything else, for that matter). A government surplus is a flow of money out of the non-government sector. Conversely, a government deficit is a flow of money into the non-governmental sector.
My own surpluses are being used to save for a new bass guitar. But, I am not a money creator like the government, so I have to run surpluses in order to buy a new bass. I am a user of the government’s currency, not an issuer.
Conclusion
Everything that has been explained here is how the mechanics of government finance are currently. These processes have been created by people and represent reality for how government expenditure is conducted in this country.
In other words, this is not an ideological perspective. We apply our ideologies to the mechanics of government finance. If a government wants to attain a surplus or limit the size of government, then that is reasonable from an ideological perspective. That Government had better explain why it wants to destroy non-governmental sector wealth.  Conversely, using the MMT lens doesn’t give politicians the ability to spend on everything they like. New Zealand still faces significant resource constraints, and if government spending is to outpace resource capacity, then inflation (rising prices) is bound to occur.
There is a whole lot more that will be written about this, and many more topics, in New Economic Management in the coming weeks and months.
Bass of the Week
The first bass of the week – a bass that has captured my attention over the past week – comes to us from a seller in the United States. A beautiful, pretty much brand-new Wal Mk 2. Was are the top of the pack for me. They’re absolutely brilliant instruments. Having played a few Wals, I can tell you that it is quite an experience having a bass the price of a new car hanging off of you. Nothing can beat the tone and feel of a Wal. The price isn’t a typo either. Tone is priceless they say.
From a sunny, mild Dunedin, see you next week.
Cheers!
Morgan
Further Reading
If you’re interested, here are some reads related to this post.
The Self Financing State: An Institutional Analysis
https://www.ucl.ac.uk/bartlett/public-purpose/publications/2022/may/self-financing-state-institutional-analysis
Money Creation in New Zealand
https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/bulletins/2023/money-creation-in-new-zealand.pdf
Liquidity Management in the New Zealand Banking System
https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/bulletins/2004/2004dec67-4frazer.pdf
Note that some of this isn’t particularly relevant given the changes in the ‘Monetary Policy Implementation framework’. We’ll go through this at a later date.
Excellent article. Taxes do not change the fiscal space though. Not with an MMT lens.
I appreciate the focus here was on Government spending, but introducing that banks loans create deposits may have been informative.
Welcome to Substack, Morgan. Yours is a very timely entry into the debate on government finance- to bring observations that are specific to the NZ scene.
As a MMT-familiar person, much of the general points are already known to me. One NZ specific that interests me is: "The Reserve Bank Act 2021 states that the Reserve Bank can provide ‘settlement accounts for persons approved by the Bank". I understand that 'cash' has certain properties that make is similar in status to 'reserves' (which I take to mean settlement funds held at the RB) Does this mean that the way is already clear legally for the introduction of CBDC to the general public? What about Bond-backed interest bearing savings accounts held at the RB too? The reason I'm keen on these ideas is because IMO there's a necessity to eliminate the 'too big to fail' hubris of commercial banks, and the capacity to bank with the RB creates that opportunity.
I feel like the bond interest issue is the real 'elephant in the room', and it's the one thing that Richard Murphy in the UK gets constantly dissed for on the comments to his frequent and popular Youtube videos. Perhaps you could address it in a post one day? I asked the same question of Steve Keen recently, and his reply was: "I don't mind banks getting interest on bonds--it partly finances the payments system they provide as a public service*. But I do mind them being able to sell as many bonds as they like to NBFIs and the private sector, which undermines the government's money creation. There were rules restricting this in my youth in Australia, and they need to be reintroduced". Steven Hail, at the MML seminar, gave another set of reasons, including "guide to long term interest rates"I, and the obvious "the private sector like to hold them" (of course they do ffs- that doesn't mean they should!). In my view there's something else going on that's driving the conversion of almost all (rather than just some) Treasury 'debt' (or negative balance if you prefer not to use the 'D'-word) at the RB into Bonds- maybe a consensus to maintain the illusion to the public that money is, for the government, a scarce and expensive commodity to be used sparingly- just as it is for households. Maybe it is simply a conveyor-belt of income from the public purse into private pockets- literally institutionalised usury of the public purse that's a hangover from the gold-standard that no-one has the balls to call-out as such? For those of us working at the coalface trying to persuade the 'great unwashed' voting public of NZ that this isn't an idiotic fantasy or communist plot, this is the core stumbling block.
Good luck with the 'Stack!
*IMO the cost of the payments system should be up front and on the customers' monthly charge, making it subject to competitive forces- not hidden away from view in some arrangement between the RB and the commercial banks.