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Budget 2005 Home Page Half-Year Economic & Fiscal Update 2005

Economic Scenarios

The following scenarios present two possible growth paths for the economy when some of the key judgements underlying the central forecast are altered.

  1. Generalised weakness - a harder landing scenario - This scenario involves households reducing their spending relative to the central forecast and exports also being weaker.
  2. More rapid exchange rate led adjustment - This scenario illustrates the implications for the economy if the exchange rate depreciates more rapidly than in the central scenario.

The scenarios are two of a large number of possible outcomes, and do not represent upper or lower bounds for the central forecast, with more extreme paths being possible.

Table 3.1 – Alternative scenarios: summary
  2005 2006 2007 2008 2009 2010
  Actual Forecast Forecast Forecast Forecast Forecast
Production GDP (annual average % change, year ending 31 March )            
Central forecast 3.8 2.9 1.7 2.5 3.8 3.1
Generalised weakness 3.8 2.7 0.7 2.6 4.4 3.3
More rapid exchange rate led adjustment 3.8 2.9 2.0 3.1 3.1 2.6
Nominal Expenditure GDP (annual average % change, year ending 31 March )            
Central forecast 7.5 5.6 2.9 3.7 5.2 5.1
Generalised weakness 7.5 5.4 1.5 2.9 5.2 5.0
More rapid exchange rate led adjustment 7.5 5.5 2.7 5.2 5.4 5.0
OBERAC ($ billion, year ending June)            
Central forecast 8.9 5.9 5.9 4.1 3.4 5.1
Generalised weakness 8.9 5.8 4.9 2.4 2.0 3.8
More rapid exchange rate led adjustment 8.9 6.0 6.1 4.5 3.5 5.2

Sources: Statistics New Zealand, The Treasury

Generalised weakness – a harder landing scenario

The generalised weakness scenario illustrates an alternative path for the economy in the event that households reduce spending relative to the central forecast and exports are also weaker. Lower household spending on both consumption items and housing could occur due to households displaying a greater responsiveness to interest rates and debt levels than is incorporated in the central forecast. Weaker export growth could stem from the recent high level of the exchange rate having a larger negative impact on export volumes than is incorporated in the central forecast or could reflect weaker agricultural production or weaker trading partner growth.

Figure 3.2 – Total exports
Figure 3.2 - Total exports.
Source: The Treasury

In the central forecast, real GDP growth is expected to slow over the course of 2006 to 1.7% in the year to March 2007 and 2.5% in the year to March 2008. In this scenario, growth is slightly lower in the 2006 March year as household concern about debt levels and the associated servicing costs sees them begin to reduce their rate of expenditure growth. The trough in real GDP growth in the year to March 2007 is deeper with growth slowing to 0.7% prior to stronger growth in the year to March 2009 of 4.4% as households and businesses respond to lower interest rates.

Under this scenario, private consumption growth is particularly weak in the year to March 2007 with growth of only 0.5%. In addition residential investment is a little weaker than the central forecast, contracting 11.3% in the 2007 March year. The impact of the recent high level of the exchange rate has a longer-lasting impact on export volumes making the recovery in export volumes in the March 2007 year weaker than in the central forecast.

With slower domestic demand and falling demand for New Zealand exports, businesses cut back on employment plans and annual average employment growth falls to 0.1% in each of the 2007 and 2008 March years, pushing the unemployment rate to 4.8% by the end of the forecast period. With weaker demand pressures and a less-tight labour market, both general price and wage inflation are lower than in the central forecast.

Figure 3.3 – Private consumption
Figure 3.3 - Private Consumption.
Source: The Treasury

With less inflationary pressure, an easing in monetary policy is possible with 90-day bill rates lower from the end of 2006. Lower interest rates eventually encourage households to increase their spending growth and also contribute to stronger residential and business investment growth in the March 2009 year relative to the central forecast.

Under the generalised weakness scenario, the negative impact of lower exports on the current account more than offsets the lower demand for imports stemming from weaker domestic demand, resulting in a slight widening of the current account deficit relative to the central forecast.

Table 3.2 – Generalised weakness
(Annual average % change, 2005 2006 2007 2008 2009 2010
Year ending 31 March ) Actual Forecast Forecast Forecast Forecast Forecast
Private consumption 5.9 4.2 0.5 0.9 2.7 2.5
Residential investment 2.0 -4.4 -11.3 -2.5 8.9 5.9
Business investment 12.9 11.1 -1.7 0.2 4.9 3.7
Gross national expenditure 6.8 5.6 0.0 1.0 3.5 2.7
Exports of goods and services 3.8 -1.6 0.9 4.8 5.0 5.1
Imports of goods and services 12.9 7.7 -0.2 -0.6 2.5 3.4
GDP (production measure) 3.8 2.7 0.7 2.6 4.4 3.3
Employment growth 3.6 2.8 0.1 0.1 1.0 1.4
Unemployment rate[1] 3.9 3.4 4.1 4.6 4.7 4.8
90-day bank bill rate[2] 6.9 7.5 5.8 5.5 5.5 5.5
TWI[2] 69.6 67.8 61.3 59.6 59.2 59.1
CPI[3] 2.8 3.4 2.6 1.5 1.7 1.8
Current account balance (% GDP) -7.4 -9.2 -8.7 -7.4 -6.7 -5.9

Nominal GDP

(expenditure measure)

7.5 5.4 1.5 2.9 5.2 5.0

Sources: Statistics New Zealand, Reserve Bank of New Zealand, The Treasury

By the end of the forecast period real economic activity is around $450 million lower than the central forecast. The effect of the lower price inflation accumulates so that by the end of the forecast period, nominal GDP is approximately $4.6 billion lower than in the central forecast. This has a negative impact on the size of the OBERAC.

Notes

  • 1 Percentage of labour force, March quarter, seasonally adjusted.[1]
  • 2 Average for March quarter.[2]
  • 3 Annual percentage change, March quarter.[3]
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