Monday, 28 June 2021

Another case for Cat Bonds

This week's column in the Dom draws on the joint RBNZ-Treasury workshop on post-Covid macroeconomic policy that preceded last week's Covid-truncated NZ Association of Economists conference. 

A snippet:

Overall, the workshop felt designed to warm the economic policy community to higher public debt levels for a longer period. The risks of the approach were noted: interest rates can rise, and there will be problems if they do.

And the approach only makes sense if projects funded by that debt really do pass cost-benefit assessment. That conventional cost-benefit assessment processes ensuring value for money seem out of fashion was not noted as any substantial constraint.

Higher levels of government debt bring risk not only in case of interest rate increases, but also in case of natural disaster. Maintaining headroom to take on a lot of debt in a crisis has been important. If public debt is higher for longer, and global credit conditions become less friendly, the Alpine Fault becomes even riskier.

If the public sector is determined to encourage politicians’ imprudent pursuit of higher debt levels, it should encourage that some of that debt be funded more prudently: through catastrophe bonds.

Catastrophe bonds pay investors more during normal times but void most or all of the bond if a triggering event happens. If an earthquake required substantial government funding, existing catastrophe bonds would void and would provide some necessary headroom.

They may be a more prudent approach in imprudent times.

Nightmare scenarios do still exist

There were other interesting bits on the day. One presentation went through some simulations of different paths for fiscal consolidation (getting debt back down); the least costly approach, which also yielded long-run benefits, was through increased consumption tax - GST - and/or reduced transfer spending. The worst approaches were increased taxes on capital, and/or reduced government investment spending (on the assumption that that investment spending is on stuff with positive BCRs, which is a bit heroic). 

One option put up by that paper's discussant, which hadn't come up in the paper, was to use migration settings. You can drive down net debt to GDP by increasing population size - though you'd have to be careful on how the necessary infrastructure were financed.  

Michael Reddell has a good run-down on the macro session

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