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Pre-election Economic & Fiscal Update 2011

Annex: Assumptions for Medium-term Projections

The assumptions for the medium-term economic and fiscal projections are outlined in this section. The full assumptions can be found in the 2011 Fiscal Strategy Report, at

Table 2.10 - Summary of economic and demographic assumptions*
June Year[8] 2012 2013 2014 2015 2016 2017 2018 2019 2020 ….. 2026
Forecasts Projections
Labour force 1.0 0.7 1.2 1.2 1.2 1.0 0.8 0.8 0.5 0.4
Unemployment rate** 6.0 5.3 4.9 4.7 4.7 4.6 4.5 4.5 4.5 4.5
Employment 1.6 1.4 1.5 1.4 1.2 1.1 0.9 0.8 0.5 0.4
Labour productivity growth*** 1.4 2.1 1.7 1.4 1.1 1.2 1.4 1.5 1.5 1.5
Real GDP 2.8 3.4 3.2 2.8 2.3 2.4 2.3 2.3 2.0 2.0
Average hours worked per week**** 33.2 33.2 33.2 33.2 33.2 33.2 33.2 33.2 33.2 33.2
Consumers Price Index
(annual % change)
2.2 2.5 2.3 2.6 2.8 2.6 2.4 2.2 2.0 2.0
Government 5-year bonds (average % rate) 3.6 3.9 4.7 5.0 5.3 5.4 5.5 5.5 5.5 5.5
Nominal average hourly wage 3.6 3.5 4.1 4.2 4.1 3.8 3.8 3.7 3.5 3.5

* Annual average % change unless otherwise stated.

** Level of unemployment (average for year ending June).

*** Hours worked measure.

**** Total hours worked ÷ total number employed.

Sources: The Treasury, Statistics New Zealand

Two economic variables have had their medium-term, stable assumptions changed since the 2011 Fiscal Strategy Report. These are the Government 5-year bond rate and the average hours worked per week.

The medium-term, stable assumption for the Government 5-year bond rate has been lowered from the 6% annual value used at the Fiscal Strategy Report to 5.5%. Forward interest rates, five and ten years ahead, are now more than 50 basis points lower than they were prior to the Global Financial Crisis. The Pre-election Update forecasts reflect this, with lower 5-year bond rates than the Budget Update forecasts in every year. The change in the bond rate comes through a lower nominal risk-free rate, owing to lower real growth and inflation rate expectations in safe-haven economies. Since the crisis,and more recently with continued global financial turmoil, forecasters have been revising down long-run forecasts for growth and inflation in advanced economies.

In the long-term projections the Government 5-year bond rate is gradually returned to 6%, reaching this rate by the year ending June 2031 and then remaining at this rate in later years. This reflects the assumption that many of the conditions impacting on the Government bond yield curves may not persist beyond the next decade.

The average hours worked per week has had its medium-term, stable assumption lowered from the 33.6 hours per week used at the 2011 Fiscal Strategy Report to 33.2 hours per week. The value in the final year of the Pre-election Update forecasts, the year ending June 2016, is 33.2 hours per week, meaning that the new assumption is in place from the first projected year. The change reflects a declining average in recent years, as well as the assumption that an aging population is likely to lead to a lower future value. The next decade, and beyond, will see a greater percentage of the workforce reach the age of eligibility (currently 65) for NZS. Many of these workers will not retire completely, but are likely to switch from full-time to part-time employment or at least reduce their hours of work.

Transition of economic variables from the end of forecast

The stable values assumed for a number of key economic variables, in medium-term projections, reflect their expected levels or growth in a New Zealand economy that is growing on trend and is free from cycles. While such conditions rarely occur, and are temporary when they do, they are appropriate to apply in projections. This is because they occur far enough into the future that it would be difficult, and subject to significant error margins, to predict the onset and duration of any economic perturbations.

Up until mid-2008 the five-year forecast period was generally sufficient for the effects of current cycles and shocks to have worked their way through the economy. This meant that key economic variables could be assumed to be at trend growth rates or levels by the final year of the forecasts. The impact of the Global Financial Crisis meant that it was no longer valid to assume the economy would fully recover within the five-year horizon of the forecasts. Consequently, for a number of variables, transitions back to trend values over the early years of projections became necessary, and this is still the case at the Pre-election Update.

Six economic variables are adjusted from their end-of-forecast values. All except the Government 5-year bond rate contribute to the projection of nominal GDP, which is both a driver of a number of important fiscal variables, such as tax revenue, and the underlying deflator of key fiscal indicators.[9] The other five variables are:

  • aggregate labour force growth
  • CPI inflation
  • unemployment rate
  • average hours worked, and
  • labour force productivity growth.

For all but aggregate labour force growth, the transition involves selecting a medium-term stable assumption and a rate at which it is approached from the end-of-forecast value. The stable assumption is based on historical data, making allowance for any factors that could alter future values, such as the Policy Targets Agreement with CPI inflation. The rate of adjustment is determined by estimating a plausible path of recovery.

The aggregate labour force growth is not brought to a constant, stable rate. The transition used in this case is to make adjustments in the early projected years to reflect a period of economic rebuilding. When these adjustments dissipate, all growth in later years is aligned to Statistics New Zealand's labour force projections. Historical values of the aggregate labour force participation rate are used to gauge the appropriate adjustments.

Table 2.11 - Summary of fiscal assumptions
Tax revenue Linked to growth in nominal GDP. Source deductions (mainly PAYE tax on salary and wages) is projected using employment growth and nominal average hourly wage growth. The latter is multiplied by a fiscal drag elasticity of 1.35 for the first five years of projections. The two other major tax categories, corporate tax and other taxes (dominated by GST), are gradually returned from their end-of-forecast values to long-term constant ratios to GDP. Source deductions is also returned to a long-term GDP ratio after fiscal drag modelling ceases. The use of long-term stable tax-to-GDP ratios is to ensure that tax revenue projections are neither higher nor lower than would be expected when the economy is performing at its potential. All tax categories change at a rate of 0.2% of GDP per year, with final ratios-to-GDP of 11.2% for source deductions, 4.5% for corporate tax and 13.0% for other taxes. The long-term ratios are based on historical data, taking into account tax rate and policy changes that could affect them. Once the long-term ratios are reached the tax types remain at them in later projected years.
New Zealand Superannuation (NZS) Demographically adjusted and linked to net wage growth, via the “66% wage floor”. The latter refers to the net (after-tax) weekly NZS rate for a couple being constrained to lie between 66% and 72.5% of net average weekly earnings. As tax on average weekly earnings, being a part of overall PAYE, increases due to fiscal drag, the net average weekly earnings do not grow as quickly as the gross earnings.
Other benefits Demographically adjusted and linked to inflation.
Health, education, justice and other core Crown expense classes All growth assumed to come from a share of projected allowances for new operating spending.
Debt-financing costs A function of debt levels and interest rates.
Operating allowance $1.239 billion in the first projected year, the year ending June 2017. This is based on a $1.19 billion allowance for new operating spending, set for the year ending June 2015, grown at 2% per year from that year.
Capital allowance $0.918 billion in the first projected year, the year ending June 2017. Budgets 2012 through to 2016 inclusive assume a $900 million allowance for new capital spending. From Budget 2017 onwards, which coincides with the first projected year, the allowance is assumed to grow at 2% per year.
Surplus DMO financial assets $0 billion.
NZS Fund Contributions to the Fund are suspended until they restart in the year ending June 2018. When contributions begin again they are calculated by a methodology consistent with the NZS and Retirement Income Act 2001.[10]
Emissions Trading Scheme (ETS) The fiscal impact of the ETS depends on several highly uncertain factors, most notably future carbon prices and New Zealand's emissions targets from future international climate change agreements. The ETS has no impact on debt in the projected years, including and beyond the year ending June 2017. This is because a policy of full recycling of revenue is assumed. Net revenue (the value of credits received after free allocation of credits to participating industries and after meeting future emissions liabilities) is assumed to be recycled back to the public through fiscally equivalent, unspecified tax reductions or spending increases.
Future emissions liabilities The Kyoto liability included in fiscal forecasts reflects the government's obligation for Commitment Period One, which is for the period 2008-2012. Projections do not incorporate a quantitative estimate of any net emissions liability that may eventuate from New Zealand's obligations under future international climate change agreements.

Source: The Treasury


  • [8]Note that the economic forecasts in the Pre-election Update are based on a March year.
  • [9]Most graphs of fiscal indicators, such as core Crown net debt, show the variable as a percentage of nominal GDP. This makes points at various times easier to compare.
  • [10]The 2011 Fiscal Strategy Report provides details on contributions over the forecast and projection periodsand more information is available at
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