In the 1980's New Zealand had a poor macroeconomic record. A central macroeconomic problem was that political pressure at crucial junctures tended to force the Central Bank to relax its dedication to price stability and accommodate lax fiscal policy. Thus the Central Bank lacked credibility in pursuing its goal of price stability.

New Zealand adopted two pieces of legislation to improve macroeconomic policy credibility. The Reserve Bank Act of 1989 strengthened the Central Bank's independence under a charter that required it to achieve and maintain price stability. Price stability was defined as an inflation target between 0-2 percent per year, as agreed in a policy targets agreement.

A second piece of legislation designed to enhance policy credibility was the Fiscal Responsibility Act of 1994. The Hon. Ruth Richardson, the Minister of Finance of New Zealand from 1990 to 1993, noted, "The fiscal responsibility code has a very heavy emphasis on transparency. New Zealand is the first sovereign state in the world to subject itself to comprehensive accrual accounting. Combined with the availability of high quality financial information, the frequent and full disclosure of the fiscal position acts as a natural check and balance against bad fiscal behaviour."

The Fiscal Responsibility Act also set out five principles to govern fiscal policy.

1. Government debt will be reduced to a prudent level.
   This principle acknowledged that the existing level of government debt was too high, and that the government needed to run operating budget surpluses for a period of time to reduce outstanding debt.
2. Once debt is reduced to a prudent level, the government will seek to maintain a balanced budget on average over the medium to long term.
   This principle meant that the government could pursue counter-cyclical spending policies, but that over time deficits and surpluses were required to balance out.
3. The government will achieve and maintain a level of net worth that provides some buffer against unforseen future factors.
   This principle recognized that factors other than explicit government debt, such public service pension liabilities or bank deposit insurance, affect the fiscal position.
4. The government will manage fiscal risks prudently.
   This principle called for attention to fiscal risks, such as shifts in the demographic structure of the population and off-balance sheet state guarantees.
5. The government will pursue policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years.
   This principle recognized the importance of tax stability for private sector planning and growth.

While credibility cannot be established by decree, stating these macroeconomic principles through explicit legislation increases the political cost of deviating from them. Clearly and formally articulating these principles helps to coordinate upon a standard to which successive New Zealand governments should be held. Having agreement on such a standard helps to foster macroeconomic policy credibility.

Policy Credibility Learning Module