<> <>If nothing is done, our credit rating will be downgraded and interest rates will rise. <> <>Listener: 12 September, 2009. <> <>Keywords: Macroeconomics & Money; <> <>When the economy plunged in 1975 as a result of the first international oil shock, the Labour Government increased public borrowing. But when the world economy recovered, the New Zealand fiscal deficit remained large, with the incoming National Government increasing spending by making (what is now) New Zealand Superannuation universal for everyone over 60. <> <>Prime Minister and Finance Minister Robert Muldoon took some fiscally prudent measures after his election in 1975 – although we are still recovering from his cutback on infrastructural spending. But these measures were insufficient, and he became timid after his party won fewer votes than Labour in the 1978 election (but more seats under the quirky winner-takes-all electoral system). <> <>So in the late 1970s, every Treasury official was faced with trying to haul back government spending and raise government revenue. What they managed to do was not enough, so Treasury scouted around the world to borrow the funds to cover the internal deficit and the external one (on the current account of the balance of payments). Big spenders and tax cutters loathed the officials, who wanted to spend small and hike taxes. In the end it was inflation, rather than political leadership, that solved the shortage of tax revenue over spending, devaluing the incomes and assets of fixed-income savers. <> <>Although committed to a career of research and teaching, rather than giving policy advice, I had a deep empathy for those Treasury economists. Like them, I knew political procrastination simply compounded the problem for the future. I – and most of them – had a deeply moral objection to piling up the costs of one’s failures onto children and the unborn. Much of the pain of the 1980s occurred as we dealt with the legacy of the Muldoon debt – although we worsened it by adopting some silly policies. <> <>Fast-forward 30 years and we find today’s economy in a similar situation – and possibly worse, for households are also not saving. Again the country has a large fiscal deficit that can be resolved only by political leadership. <> <> <>A month ago I thought gloomily that we might repeat the experiences of the late 1970s. The Government would tinker with spending cuts and revenue raising, but nowhere near enough to address the size of the deficit. Perhaps the Government – Micawber-like – would hope something turned up, or that it could at least hide the problem sufficiently to get re-elected in 2011. That would make being a Treasury official very miserable. <> <>Instead, coming to the rescue is – of all things – a credit-rating agency. The smallest of the big three, Fitch, has put us on credit watch. In time, Nos 1 and 2, Standard & Poor’s and Moody’s, may join them. We have very high overseas debt, which we are not addressing, and the ongoing fiscal deficit is making it worse. If nothing is done, our credit rating will be downgraded and interest rates will rise. <> <>The Government has already responded. In an unprecedented speech to the National Party conference, Finance Minister Bill English said there was no possibilities of tax cuts for at least five years. (He thought there might be a place for a change in the tax mix, but that’s another column.) He suggested there may be opportunities to increase revenue “without actually raising the tax burden”. We shall see. <> <>Even so, to avoid a credit downgrading we are also going to have to cut government spending. I don’t know what, and I don’t know when. But I do know that even if it is phased in, it will create difficulties for ordinary New Zealanders – which is why I favour raising taxes as part of the adjustment. <> <>Drastic measures are necessary if we are to avoid a repeat of the Muldoon years. My job here is to explain the reasons for the measures and evaluate their impact. I will be arguing for a coherent macroeconomic strategy, something we have not had for ages, and a fair sharing of the burden of adjustment. <> <>I should not be surprised if some of today’s Treasury economists agree with much of this column. The ones of 30 years ago certainly would.