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Domestic Factors

Domestic outlook is dominated by a number of negative factors …

As well as external events, the future path of the economy will be determined by some developments in the domestic economy. Domestic demand was expected to slow in the Half Year Update as a result of restrictive monetary conditions combined with high debt levels for households, slowing housing activity and a fall in net migration inflows. These factors are now expected to have a greater influence on domestic demand as monetary conditions are tighter than expected owing to global credit constraints, housing activity has slowed by more than expected and net migration inflows have tracked slightly below forecast. Additional factors have emerged since the Half Year Update, particularly higher fuel and food costs, general financial uncertainty and lower farm incomes than previously forecast owing to drought.

These factors will be offset to some degree by supportive factors such as personal income tax cuts and continuing momentum in the labour market, both of which will support private consumption. The net effect on the domestic economy is that growth in domestic demand (ie, real Gross National Expenditure) will fall from 5.0% in the year to March 2008 to around 2.0% the following year and 1.4% in the year to March 2010, picking up slightly to over 2% in the final year of the forecasts.

… as households are affected by high interest rates and declining house prices …

Figure 1.10 – Consumption and house prices
Figure 1.10 – Consumption and house prices.
Source: Statistics New Zealand, Quotable Value New Zealand, The Treasury

Real private consumption growth is fairly subdued over the forecast period (Figure 1.10). Growth in consumer spending slows sharply from 4.3% in the calendar year 2007 to 1.9% in the years to March 2009 and 2010. The main factors dampening this growth are higher mortgage servicing costs, higher fuel and food prices, a lower exchange rate making imports more expensive, and falling house values lowering wealth. Whereas no decline was forecast in the Half Year Update, house prices are now expected to fall 7% over the year to March 2009 and this fall already appears to be underway. A gradual recovery in house prices is expected from late 2009.

… but personal tax cuts provide some upside support to consumer spending …

The forecasts contain the personal tax cut in Budget 2008. Households will benefit from higher disposable incomes of $1.5 billion in 2008/09, $2.3 billion in 2009/10, $3.1 billion in 2010/11 and $3.8 billion in 2011/12 (June years). See Personal Income Tax Cuts box below for more details. This is larger than the assumption used in the Half Year Update, where the increase in disposable incomes was around $1.5 billion per annum from April 2009, rising to $1.7 billion in the year to June 2012. The boost to incomes helps support consumer spending growth of just under 2% in the years to March 2009 and 2010 during a time in which consumers face pressure from factors such as high interest rates and falling house prices.

Personal Income Tax Cuts

Personal income taxes will be reduced over the forecast period. Personal income tax rates and thresholds will be adjusted over the forecast period as per Table 1.2.

Table 1.2 –Personal income tax rates and thresholds

Personal income tax rates and thresholds
For 1 April 2008 From 1 October 2008 From 1 April 2010 From 1 April 2011
Income over… is taxed at… Income over… is taxed at… Income over… is taxed at… Income over… is taxed at…
$0 15% $0 12.5% $0 12.5% $0 12.5%
$9,500 21% $14,000 21% $17,500 21% $20,000 21%
$38,000 33% $40,000 33% $40,000 33% $42,500 33%
$60,000 39% $70,000 39% $75,000 39% $80,000 39%

The Budget Update incorporates the actual policy change, whereas the HalfYear Update incorporated a revenue reduction contingency assumption of $1.5 billion per annum from April 2009, rising to $1.7 billion in the year to June 2012. The personal income tax cuts will deliver an increase in disposable income to New Zealand households of $1.5 billion in 2008/09, $2.3 billion in 2009/10, $3.1 billion in 2010/11 and $3.8 billion in 2011/12 (June years).

In terms of fiscal cost, the increase in disposable income for households represents the headline reduction in Crown revenue, adjusted for the consequential changes in Crown expenditure on benefits and superannuation. These changes are explained on page 92 of the Fiscal Outlook chapter.

The impact of personal income tax cuts on the economic forecasts is mainly through higher private consumption as a result of higher disposable income. The cut in personal taxes raises growth in real GDP by about 0.3% over the year to March 2009. Although the personal income tax cuts do not come into effect until the December 2008 quarter, they impact on consumer spending from the previous quarter as we assume workers anticipate an increase in discretionary income and spend more accordingly. Consumer spending is boosted further when tax cuts are realised from the December 2008 quarter onwards. We assume the tax cuts will only impact on the labour market via increased employment (ie, higher consumer spending boosts the demand for labour) as we have not assumed any change in the supply of labour from the tax cuts.

The exact nature of the response to personal tax cuts is uncertain. The effect could be smaller if the weaker economic environment encourages households to save more of the tax cuts than we expect. However, the effect could be greater as the percentage increases in take-home pay are highest for people at the lower end of the income scale, who tend to spend more of a given increase in income.

… while non-market investment and public consumption are expected to increase …

Government consumption and investment are expected to support overall economic growth in the years to March 2009 and March 2010. Non-market investment (ie, central government and Crown entities) is forecast to grow strongly over this period as the Government expands infrastructure. The Government's current expenditure is also forecast to increase throughout the forecast period, averaging growth of around 3.5% per annum in real terms.

… and the labour market is expected to weaken but remain relatively tight

Figure 1.11 – Unemployment rate
Figure 1.11 – Unemployment rate.
Source: Statistics New Zealand, The Treasury

The labour market is fairly robust throughout the forecast period but the weak patch in economic growth does affect employment growth with a lag. While employment growth is not expected to be as strong as in recent years, firms are expected to be reluctant to shed staff for fear of not being able to hire people when growth begins to pick up, given recent difficulty attracting labour. Lower employment growth means the unemployment rate rises to 4.5% in the March 2011 quarter, higher than in the Half Year Update (Figure 1.11). This rise comes from a lower starting point than assumed in the Half Year Update, and is expected to be muted by slower labour force growth (as a result of lower net migration inflows).

Figure 1.12 – Average hourly earnings
Figure 1.12 – Average hourly earnings.
Source: Statistics New Zealand, The Treasury

With earlier lower unemployment and continuing difficulties for firms in recruiting staff, as well as higher inflation, nominal wage growth is expected to be slightly higher than in the Half Year Update over the forecast period (albeit lower in the short term). Annual growth in average ordinary-time hourly earnings is forecast to rise to 4.7% at March 2010 before falling back towards 4% per annum (Figure 1.12). Ongoing wage growth is expected to keep growth in labour income near or above 5% per annum over the forecast period.

Real wage growth (ie, adjusted for inflation) averages around 1.5% per annum in the forecast period, supported by growth in labour productivity (output per work hour). On an economy-wide basis, labour productivity growth rose to a 7-year high of 2.6% in the calendar year 2007, partly reflecting the upturn in the economy and previous business investment. Although it eases in the short term as firms hoard labour amidst a slowing economy, labour productivity growth is expected to average 1.8% per annum over the forecast period.[1]

Notes

  • [1]For more discussion on productivity, see the recent Treasury Productivity Papers: http://www.treasury.govt.nz/publications/research-policy/tprp
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