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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

3   Risks and Scenarios

Summary

  • The central forecast presented in the Economic and Tax Outlook chapter shows an economy experiencing relatively weak growth over 2007 and 2008 before recovering in the year to March 2009. Relatively weak domestic demand growth contributes to the unwinding of imbalances, such as inflationary pressures and a large current account deficit, in a fairly orderly and timely manner. However, the exact path taken by the economy is dependent on how a number of different factors evolve.
Figure 3.1 – Real GDP
Figure 3.1 - Real GDP.
Source: The Treasury
  • Some of the major risks discussed below are key judgements in the forecasts and include households’ ability and willingness to accumulate debt, the path taken by the exchange rate, the reaction of businesses to tighter trading conditions and the extent to which productivity growth rebounds. These factors will influence the extent to which inflationary pressures and a high current account deficit unwind.
  • Although we believe the central forecast presented in the Economic and Tax Outlook chapter to be the most likely outcome, two scenarios that illustrate alternative paths are presented. These scenarios are just two of a number of possible outcomes and therefore do not fully illustrate the range of possible outcomes.
  • The first scenario illustrates the impact of household expenditure and investment not slowing to the same degree as in the central forecast. In this scenario there is an increase in household indebtedness relative to the central forecasts. Stronger domestic demand generates higher real and nominal gross domestic product (GDP) but limits the extent to which inflation pressures abate and the current account deficit reduces. The second scenario reflects an environment in which there is less demand for New Zealand dollar assets leading to a faster fall in the exchange rate. The uncertainty implied by this, together with higher interest rates, reduces households’ appetite for further accumulation of debt and consequently results in lower household spending.

Introduction

The central forecast presented in the Economic and Tax Outlook chapter incorporates a number of key judgements about how various forces affecting the economy will evolve. These judgements reflect the balancing of both upside and downside risks potentially facing the economy to arrive at our best assessment of the way the economy is likely to develop. Some of these judgements are related to the cyclical drivers of activity and some relate to the structural characteristics of the economy. If actual events differ from these judgements then the path taken by the economy is likely to deviate from the central forecast.

The first part of this chapter, Economic Risks, outlines some of the risks around the economic outlook. There are both upside and downside risks – some domestically and some internationally oriented. The second part of this chapter, Economic Scenarios, presents in more detail two scenarios that could occur if a different set of events were to occur. The third part of this chapter, Fiscal Scenarios, considers the implications of the two economic scenarios on the fiscal position.

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