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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

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. In the first scenario, labelled “Stronger domestic demand”, stronger consumption and residential investment growth raises real GDP growth in the near term but also increases inflationary pressures and prevents a timelier current account adjustment. The second scenario is labelled “Lower demand for New Zealand dollar assets”. Lower demand for New Zealand dollar assets leads to a depreciation of the exchange rate while at the same time increased uncertainty and higher near-term interest rates make households more nervous about high levels of debt. The scenarios are two of a large number of possible examples, and do not represent upper or lower bounds for the central forecast, with more extreme paths possible.

Table 3.1 – Alternative scenarios: summary
  2006 2007 2008 2009 2010 2011
  Actual Forecast Forecast Forecast Forecast Forecast
Production GDP (annual average % change, year ending 31 March)            
Central forecast 2.2 1.8 2.3 3.2 3.1 3.0
Stronger domestic demand 2.2 2.0 3.3 3.4 2.6 2.8
Lower demand for NZ dollar assets 2.2 1.8 1.3 3.1 4.3 2.9
Nominal Expenditure GDP (annual average % change, year ending 31 March)            
Central forecast 4.7 3.3 4.3 5.6 5.0 4.9
Stronger domestic demand 4.7 3.6 5.8 6.2 5.1 5.0
Lower demand for NZ dollar assets 4.7 3.3 2.5 5.6 5.7 4.5
OBERAC ($ billion, year ending June)            
Central forecast 8.6 6.7 6.1 5.2 5.8 6.0
Stronger domestic demand 8.6 7.0 7.2 6.4 6.9 6.9
Lower demand for NZ dollar assets 8.6 6.7 4.9 4.5 5.5 5.5

Sources: Statistics New Zealand, The Treasury

Stronger domestic demand

In the central forecast, households are expected to limit their consumption and housing expenditure in order to slow their accumulation of debt. This translates to a relatively weak growth profile for both private consumption and residential investment. The first scenario presented below looks at the situation where households continue to accumulate debt at a faster rate than in the central forecast. Under this scenario private consumption growth reaccelerates during next year and residential investment also rebounds.

Table 3.2 – Stronger domestic demand scenario
(Annual average % change, 2006 2007 2008 2009 2010 2011
year ending 31 March) Actual Forecast Forecast Forecast Forecast Forecast
Private consumption 4.5 1.8 3.2 2.2 1.2 1.3
Residential investment -4.7 -4.9 6.3 4.8 -1.3 -1.9
Market investment 6.7 -6.2 2.6 5.2 3.6 4.3
Gross national expenditure 4.5 -0.3 3.6 3.2 2.0 2.3
Exports of goods and services -0.1 3.6 1.3 3.7 4.1 3.9
Imports of goods and services 5.0 -2.5 3.9 3.8 2.3 2.5
GDP (production measure) 2.2 2.0 3.3 3.4 2.6 2.8
Employment growth 2.6 1.7 0.4 1.7 1.4 1.2
Unemployment rate1 3.9 4.0 4.3 4.1 4.1 4.2
90-day bank bill rate2 7.6 7.6 7.7 7.3 7.0 7.0
TWI2 68.3 66.0 63.7 59.3 56.3 53.6
CPI3 3.3 2.9 2.9 3.0 2.7 2.4
Current account balance (% GDP) -9.6 -9.3 -8.9 -8.7 -8.2 -7.9
Nominal GDP (expenditure measure) 4.7 3.6 5.8 6.2 5.1 5.0

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

1 Percentage of labour force, March quarter, seasonally adjusted.

2 Average for March quarter.

3 Annual percentage change, March quarter.

With households acting in a less debt-constrained manner, private consumption growth is slightly stronger than in the central forecast in the 2007 March year before accelerating to 3.2% in the March 2008 year, 1.5% stronger than in the central forecast. The momentum in private consumption expenditure continues into the 2009 March year when consumption growth is 1.2% higher than the central forecast. After two years in which residential investment contracts by just under 5% per annum, a willingness by households to continue to accumulate debt for investment in housing sees residential investment grow by 6.3% in the March 2008 year, noticeably faster than the 0% growth predicted in the central forecast.

Figure 3.4 – Real gross national expenditure
Figure 3.3 - Real gross national expenditure.
Source: The Treasury

With signs of renewed demand from households, firms undertake a higher level of investment than in the central forecast with market investment growing by 2.6% in the March 2008 year, rather than the 1.2% contraction present in the central forecast. Employment growth is also stronger than under the central forecast, with the unemployment rate remaining just over 4% throughout most of the forecast period, compared to a March year peak of 4.8% in the central forecast. Greater job certainty reinforces households’ comfort with accumulating higher debt levels.

With stronger domestic demand and a tighter labour market, inflationary pressures are more intense than under the central forecast. This results in the need for tighter monetary policy relative to the central forecasts. In this scenario, 90-day bank bills are modestly higher in March 2007 at 7.6% rather than the 7.5% reported in the central forecast. However, under this scenario a loosening in monetary policy is not feasible during the 2008 March year, with 90-day rates edging up to 7.7% in March 2008, much higher than the 6% forecast in the central track. Even with such a response, inflation remains higher than the central forecast, with annual Consumer Price Index (CPI) inflation remaining at 3% in March 2009, 1% higher than the 2% annual inflation predicted in the central forecast.

Higher interest rates relative to the central forecast act to limit investment demand, with both residential and market investment growth weaker than the central forecast in the final two years of the forecast period.

With higher financial inflows to meet households’ continued desire to borrow, as well as higher interest rates, the exchange rate remains above the central track’s level out until the final year of the forecast. The higher exchange rate has a slight dampening effect on export volume growth, which is lower than the central forecast, most noticeably in the 2009 and 2010 March years when export growth is around 0.4% lower. With stronger domestic demand, the demand for imports also increases. This is particularly so in the March 2008 and 2009 years. Stronger import demand, as well as lower export receipts due to the higher exchange rate, sees a smaller reduction in the current account deficit than is expected in the central forecast. Under this scenario, the current account deficit remains at 8.7% of GDP in March 2009, before ending the forecast period at around 8%. A continuation of current account deficits at such a level is unsustainable, suggesting that further adjustment will be necessary in the future.

Higher real activity out until the March 2009 year, combined with higher inflationary pressures, results in nominal GDP growth being above the central forecast over the entire forecast period. The level of nominal GDP is around $4.7 billion higher than in the central forecast in the March 2011 year.

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