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Budget 2007 Home Page Budget Economic and Fiscal Update [2007]

3 Risks and Scenarios

Summary

  • The central forecast presented in the Economic and Tax Outlook chapter is for the current recovery in domestic demand to be sustained through most of 2007. Tight monetary conditions are expected to slow its quarterly growth from late 2007 and the high exchange rate will constrain export growth, leading to low growth overall in the March 2009 year, before it recovers in the final two years of the forecasts. However, the course taken by the economy depends on a number of different factors.
Figure 3.1 – Real GDP
Figure 3.1 – Real GDP
Source: Statistics New Zealand, The Treasury
  • A key judgement is the strength of domestic demand in the near term, particularly private consumption. There is also uncertainty about the path of the exchange rate and the strength of the world economy. The investment and employment responses of firms to increasing costs and weak profit growth are also key judgements, as are the underlying assumptions concerning population growth, labour market participation and productivity growth.
  • Although we believe the central forecast presented in the Economic and Tax Outlook chapter is the most likely outcome, two scenarios that illustrate different paths for the economy are presented in this chapter. These scenarios are only two of a number of possible outcomes and therefore do not fully illustrate the range of possibilities, but they represent key risks.
  • The first scenario illustrates the impact of higher terms of trade and stronger domestic demand in the short term. Gross domestic product (GDP) is higher in both real and nominal terms, but inflation pressures abate more slowly and the current account deficit reduces less. The second scenario assumes that the exchange rate falls sooner and that domestic demand is weaker than in the central forecast, leading to lower growth in GDP and an increase in tradables inflation. Subsequently, inflation is weaker, interest rates are lowered and the current account adjusts sooner than in the central forecast.

Introduction

The central forecast presented in the Economic and Tax Outlook chapter incorporates a number of key judgements about how various forces affecting the economy will evolve. These judgements reflect the balancing of both positive and negative risks facing the economy to arrive at our best assessment of how it is likely to develop. Some of these judgements are related to the cyclical drivers of activity and some relate to the structural characteristics of the economy. If events turn out differently from our assessment, the path taken by the economy is also likely to deviate from the central forecast.

The first part of this chapter, Economic Risks, outlines some of the risks associated with the economic outlook. There are both positive and negative risks – some domestically and some internationally oriented. The second part of this chapter, Economic Scenarios, presents in more detail two scenarios that could occur if events were to unfold differently. The third part of this chapter, Fiscal Scenarios, considers the implications of the two economic scenarios on the fiscal position.

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