Government Size, Government Debt and Economic Performance with particular application to New Zealand

In: https://ir.library.carleton.ca/pub/417

Abstract

Many countries have been concerned recently whether government size and government debt have become large enough to encroach excessively on their private economic performance. New Zealand, in contradistinction, has undergone a period of reversal over the past two decades in which both government size and the ratio of government debt to GDP have been reduced substantially. This paper examines whether there has been a cost to government debt and government size in New Zealand and thus whether a policy of deliberate contraction would have been associated with an output premium. The analysis suggests that in the long run government size and private per capita output have had an inverted U-shaped relationship with the positive effect of government size peaking at close to thirty percent of GDP. In addition larger government debt is found to be associated with lower levels of private output. Hence the contraction in government size and the debt ratio in New Zealand would have resulted in an output premium. After accounting for the process of convergence to the long run, the short run analysis suggests that the inverse relationship found between changes in government size and economic growth may be attributable more to the response of fiscal expenditure policy to unanticipated changes in growth than to the perverse effect of government expenditures on growth and output. This reinforces the traditional expenditure role of fiscal policy while at the same time cautioning against any longer run spillover into larger government size and debt.