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Terms-of-trade adjustment

The Treasury has recently started to produce regular estimates of the terms-of-trade effect on the budget balance. This follows the methodology outlined in Treasury Working Paper 10/08.[5]

Estimating the terms-of-trade effect means calculating the approximate amount of tax revenue which is due to deviations in the terms of trade from some specified structural, or long-run, level. The main forecast has the terms of trade remaining at a relatively elevated level throughout the forecast horizon. A terms-of-trade adjustment to the fiscal balance is to understand what the underlying fiscal position may be under different assumptions (ie, scenarios) about the long-run level of the terms of trade. The purpose is to produce information which helps to make judgements about the fiscal position from a medium-term perspective, without compromising the forecasts’ role of presenting the most likely near-term outcome.

Figure 7 shows New Zealand's terms of trade and historical average levels (50-, 30- and 20-year averages) and a time-varying trend using a statistical filter.[6] The historical average and trend estimates are used as estimates of the structural level of the terms of trade. Using the statistical filter runs the risk of interpreting long cycles as structural shifts in real time, whereas using an historical average suffers from the opposite risk.

A terms-of-trade adjustment, for each alternate assumption, is reported in Table 18. The adjusted structural budget balance estimate is plotted in Figure 8. This analysis would suggest that, using an historical average, a terms-of-trade adjustment would subtract about 2% of GDP from structural tax revenues in 2011/12. This implies a larger structural budget deficit than without the terms-of-trade adjustment. Alternately, using the statistical filter, which smoothes out fluctuations around a time-varying trend, a terms-of-trade adjustment would subtract only 0.2% of GDP from the structural budget balance in 2011/12.

Figure 7 - Terms of trade with historical average and time-varying trend
Figure 7 - Terms of trade with historical average and time-varying trend.
Sources: Statistics New Zealand, The Treasury

Note: Due to data availability, this uses the goods and services terms of trade spliced with the goods terms of trade for the period prior to 1987.

Figure 8 - Cyclically-adjusted balance with terms-of-trade adjustment
Figure 8 - Cyclically-adjusted balance with terms-of-trade adjustment.
Source: The Treasury

Notes

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