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Budget 2007 Home Page Half Year Economic & Fiscal Update 2007

Domestic stimulus and momentum offset by some constraints

Positive and negative factors balanced in the domestic setting

Some key developments in the domestic economy will also be important in determining the path of the economy over the forecast period. The main supportive factors are an assumed reduction in personal income taxes and continuing momentum in the labour market, both of which will support private consumption, and continuing capacity constraints for firms which will encourage them to invest. These positive factors will be offset to some degree by continuing restrictive monetary conditions (combined with high debt levels for households), slower population growth as a result of lower net migration inflows, continuing high fuel costs and moderating house price growth.

Figure 1.10 – Real GNE
Figure 1.10 – Real GNE.
Sources:  Statistics New Zealand, The Treasury

Growth in real Gross National Expenditure (GNE) is estimated to be relatively high at 4.7% in the year to March 2008 as a result of the resurgence in consumption and residential investment in the first half of 2007 and higher market investment in the second half of 2007. In the 2009 and 2010 March years, growth in GNE is forecast to ease to 2.7% and 2.6% respectively, and then to ease further to 1.8% in the following year as the negative influences predominate, picking up slightly to 2.0% in the final year of the forecasts (Figure 1.10).

Assumed reduction in personal taxes stimulates private consumption

The forecast incorporates the implications of a reduction in tax revenue of around $1.5 billion per annum from April 2009, which is discussed in the Budget Policy Statement and the Fiscal Outlook chapter. It has been assumed that the revenue reduction will be applied to personal income taxes, thus supporting private consumption with some flow-through to higher imports, especially in the year to March 2010. The higher level of consumption will continue in subsequent years as net incomes will be higher than they would otherwise be. No assumptions have been made about the nature of the tax revenue reduction, apart from its aggregate value, and no response has been assumed in labour supply.

Continuing momentum in labour market …

Figure 1.11 – Full-time equivalent employment
Figure 1.11 – Full-time equivalent employment.
Sources:  Statistics New Zealand, The Treasury

Labour income growth was slightly higher in the first half of 2007 than our Budget Update forecasts, with higher employment growth offsetting lower wage growth. This increased momentum in the labour market is expected to continue in the forecast period as capacity constraints and high employment intentions point to continued robust employment growth. We expect full-time equivalent employment growth of 1.4% in the year to March 2008, but averaging just below 1% per annum over the following four years (Figure 1.11).

With a lower starting point for the unemployment rate than assumed in the Budget Update and slower labour force growth (as a result of lower net migration inflows), the unemployment rate is forecast to be lower than in the Budget Update throughout the forecast period, especially in the March 2009 and 2010 years. It is forecast to remain below 4% until the March quarter 2010 and then to rise only slowly to 4.1% by the end of the forecast period as growth in employment falls below growth in the labour force.

… will support earnings growth

With lower unemployment and continuing difficulties for firms in recruiting staff, as well as higher inflation, nominal wage growth is expected to be higher than in the Budget Update. Average ordinary time hourly earnings are forecast to increase by more than 4% on an annual average basis until the last year of the forecast period. Moderate but easing wage growth, combined with steady employment growth, is expected to lead to labour income growth continuing to decline from its recent peak of 7.5% annual average growth in mid-2006 to 6.1% in the year to March 2008, but remain at or above 5% until the end of 2011.

Consumption growth maintained in the short term

Figure 1.12 – Real private consumption
Figure 1.12 – Real private consumption.
Sources:  Statistics New Zealand, The Treasury

Continuing, although easing, momentum in the labour market is expected to support private consumption growth. The boost to private consumption in late 2006 and early 2007 keeps annual average growth high in the second half of 2007 and first quarter of 2008(Figure 1.12). Other positive factors supporting consumption growth throughout this period are the higher dairy payout and associated higher exchange rate in the early part of the forecast period, making imports of goods and services cheaper. Growth in private consumption, which accounts for more than 60% of GDP, is expected to slow over calendar 2008 to a low of 2.1%, but the assumed reduction in personal taxes from April 2009 boosts annual average growth in the following year to 2.6%, before growth slows over the remainder of the forecast period.

Capacity constraints encourage businesses to continue to invest …

Figure 1.13 – Real market investment
Figure 1.13 – Real market investment.
Sources:  Statistics New Zealand, The Treasury

Capacity constraints and labour shortages will continue to support market investment in the short term as firms seek to expand output and supplement or complement labour input. The increase in the terms of trade and resultant higher profits (not only for the dairy industry), plus the associated higher exchange rate, are also expected to support market investment in the near term. However, as the economy slows and the exchange rate declines, growth in market investment is expected to ease from a peak of 5.6% in the March 2008 year (boosted by high quarterly growth in late 2006 and early 2007), to a trough of less than 1% in the year to June 2010 as a result of continuing high interest rates (Figure 1.13). It subsequently recovers somewhat in the final two years of the forecast.

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