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Budget 2017 Home Page Budget Economic and Fiscal Update 2017

Risks and Uncertainties Affecting the Economic and Fiscal Outlook

The main forecasts are based on a range of assumptions about the evolution of some variables, including the exchange rate, the terms of trade and population growth (see Key judgements and assumptions, page 25) and judgements about how developments in one part of the economy will affect others. One way of showing the extent of uncertainty surrounding the main economic forecasts is to present confidence intervals based on historical forecast errors.

In this chapter we also consider the consequences that different judgements and assumptions may have for the forecasts and discuss possible outcomes based on events occurring that are not part of the main forecasts. We consider two alternative paths, or scenarios, for the economic outlook, to illustrate the sensitivity of fiscal outcomes to economic developments.[12]

Economic forecast uncertainty

Figure 3.1 shows a fan chart of nominal expenditure on GDP.[13] The width of the fan increases further into the forecast period, meaning our forecasts are less accurate the longer the forecast horizon. In other words, the further away from the present the more uncertain the future is. The outermost edges of the fan chart show that, 90% of the time, nominal GDP will be within +/-8% of the main forecast at the end of the forecast period (ie, five years). The boundaries of the darker, innermost fan show that, 70% of the time, nominal GDP will be within +/-5% of the main forecast at the end of the forecast period. Over the forecast period, the cumulative impact of nominal GDP outcomes that are persistently on the 70% percentile boundary is to raise/lower the main forecast by $50 billion.

Figure 3.1 - Fan chart of nominal expenditure on GDP
Figure 3.1 - Fan chart of nominal expenditure on GDP.
Sources: Statistics New Zealand, the Treasury

The cumulative impact on nominal GDP of the scenarios we consider in this chapter lie well within the 70th percentile of the fan. The box in this chapter reviewing recent scenarios of weaker terms of trade shows that even the most extreme terms of trade scenario produces nominal GDP outcomes that lie close to the 70th percentile. That is, a number of coincident shocks are needed to push economic outcomes significantly beyond the 70th percentile.

Fiscal forecast uncertainty

The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy. For example, a fall in dairy export prices reduces farm incomes, which impacts on investment and consumption spending. Government tax revenue is affected through a number of channels including taxes on wages and salaries and corporate profits, and via indirect taxes on sales of goods and services.

Figure 3.2 shows the uncertainty surrounding the main tax revenue forecast based on historical tax forecast variances and the assumption of an even balance of risks around the main forecast.[14] The outermost shaded area captures the range of approximately +/- $7.6 billion in the June 2021 year, within which actual tax outturns are expected to fall 80% of the time.[15]The innermost shaded area captures the range of approximately +/- $4.0 billion in the June 2021 year, within which actual tax outturns are expected to fall 50% of the time.

Figure 3.2 - Fan chart of tax revenue
Figure 3.2 - Fan chart of tax revenue.
Source: The Treasury

Government expenses may also be impacted by economic developments. One channel is through changes in labour market conditions that affect the demand for working-age benefits. Another channel is through the indexation of a range of welfare benefits to wage and price movements. Government tax expenditures, including Working for Families, may also be affected by labour market conditions. Changes in net migration flows may also impact on the demand for central government services, particularly health and education. Over the longer-term, current policies imply population growth and population ageing will place increasing pressure on public expenditure, particularly in the areas of health and superannuation.[16]

Changes in the valuation of long-term liabilities, such as the ACC claims liability and the GSF retirement plan, caused by changes in inflation and long-term interest rates, may also affect the Crown operating balance.

One-off and unexpected expenditures can also have a large impact on the Crown's fiscal position. In recent years, earthquakes have demonstrated the inherent exposure of the Crown’s fiscal position to unexpected events. More generally, uncertainty is inherent in forecasting the fiscal impacts of new policy initiatives.


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