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Budget 2013 Home Page Budget Economic and Fiscal Update 2013

Upside Scenario

Higher house prices…

The upside scenario is based on higher prices for existing and new houses, along with an associated increase in complementary household spending. In this scenario it is assumed that the Canterbury rebuild generates more inflationary pressures than in the central forecast. Capacity constraints, including a shortage of skilled labour, require firms to pay higher wages to attract skilled workers to Canterbury in order to complete the rebuild in a timely fashion. These higher wages spill over into the rest of the country as other regions need to retain workers and these higher wages are passed on to customers in the form of higher house-building costs. Annual growth in residential investment prices peaks around 10%, compared with the central track where productivity increases resulting from the localised and repetitive nature of the rebuild are sufficient to keep pricing pressures in check and annual growth in residential investment prices peaks around 6%.

In the upside scenario, existing house prices rise by more over the forecast period, with peak growth around 14% in 2014 compared to close to 8% in 2013 in the central forecast. House price growth also takes longer to come off its peak and prices continue increasing in real terms over the forecast period, compared to the central scenario where prices are flat in real terms by the end of the forecast period (Figures 3.4 and 3.5). The stronger house price growth is driven by higher domestic confidence resulting in increased housing demand, and the increase in building costs spilling over into existing house prices.

Figure 3.4 - House prices and private consumption in central forecast
Figure 3.4 - House prices and private consumption in central forecast.
Sources: Quotable Value Limited, Statistics New Zealand, the Treasury
Figure 3.5 - House prices and private consumption in upside scenario
Figure 3.5 - House prices and private consumption in upside scenario.
Sources: Quotable Value Limited, Statistics New Zealand, the Treasury

...boost private consumption and residential investment...

In this scenario, households resume housing equity withdrawal to finance consumption, resulting in the strong positive relationship between house prices and consumption over the 2000s reasserting itself (Figure 3.5). The resulting stronger debt-funded real consumption growth allows retailers to increase prices by more and inflation picks up considerably faster from its current subdued rate. Higher inflation results in increased short-term interest rates as the RBNZ tightens monetary policy sooner to maintain price stability. Despite higher interest rates, the exchange rate does not appreciate significantly as financial market participants see the increased activity as being unsustainable, demonstrated by the widening current account deficit.

It is also assumed that there is more complementary consumption associated with the pick up in residential investment than in the central forecast. This occurs as households buy new contents to fit out their new homes, with some of this expenditure financed out of earthquake insurance payouts. As the higher consumption is partly financed by borrowing against the increased value of housing, rather than higher incomes, the household saving rate is significantly lower than in the central forecast. The household saving rate reaches a low of -4.3% of household disposable income in the March 2016 year compared to the main forecast where it is 0.0% in 2016. This negative saving rate, along with higher interest rates at the end of the forecast period, suggests a slight adjustment to household balance sheets will be required sometime beyond the forecast period, which would likely constrain future consumption growth.

...which increases GDP and tax revenue

Stronger private consumption and residential investment result in nominal GDP being $19 billion higher over the forecast period. The increased activity drives a stronger labour market, with the unemployment rate reaching a low of 5.0% in March 2017, 0.2% points lower than in the main forecasts. The annual current account deficit is wider and reaches 7.3% of GDP in March 2017, versus 6.5% in the central forecast. The current account deficit is wider as some of the increased consumption and investment is imported goods.

Core Crown tax revenue is a cumulative $6.6 billion higher over the forecast period, mainly as a result of the higher nominal GDP. The stronger nominal consumption and residential investment boost GST revenue by $2.1 billion over the forecast period. The stronger labour market and increased competition for workers pushes up wages and salaries, boosting source deductions revenue by a cumulative $1.6 billion. The stronger economic activity allows firms to increase their margins, boosting profitability and increasing corporate tax by $1.5 billion out to June 2017. Higher short-term interest rates, needed to control rising inflation, boost tax on interest by $800 million. The increase in tax revenue is higher in the upside scenario than the fall in the downside scenario, despite the change in nominal GDP being similar. This asymmetry is because much of the decrease in GDP in the downside scenario comes from exports, which are not taxed other than to the extent to which they contribute to firm profits, while most of the gain to GDP in the upside scenario comes from consumption and residential investment which are both taxed through GST.

Core Crown expenses are slightly lower than in the central forecast as a fall in debt servicing costs more than offsets an increase in welfare payments. The increase in welfare payments is driven by higher rate adjustments to benefits and superannuation, reflecting both increased inflation and wage growth. In this scenario, the OBEGAL records a surplus of 0.6% of GDP in the June 2015 year, the same year surplus is achieved in the central forecast. Net core Crown debt as a percentage of GDP peaks at 28.0% in the June 2014 year, compared to 28.7% in the June 2015 year in the central forecast (Figure 3.6).

Figure 3.6 - Net core Crown debt
Figure 3.6 - Net core Crown debt.
Source: The Treasury
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