Uncertainty

As noted above, there is much uncertainty about the indicator estimates. There are two broad sources of uncertainty which can lead to revisions in the indicator estimates:

• estimation uncertainty of the key model parameters (ie, the output gap and the average sensitivity of tax revenues to changes in the output gap), and
• forecast uncertainty relating to future fiscal and economic developments.

In addition, summary indicators such as fiscal impulse do not allow for the composition of fiscal policy changes or how a change in fiscal policy will be transmitted through the economy. Treasury research using time series statistical analysis indicates that spending and taxes have different effects on New Zealand GDP.[3] Therefore the fiscal impulse indicator is only a very imprecise guide to the impact of fiscal policy on the economy.

Sensitivity analysis is performed by calculating the indicators using alternative output gaps (from the RBNZ, IMF and OECD) and values for the elasticity of tax revenues with respect to the output gap which are half and twice the magnitude of the baseline estimate. The range of alternative estimates is plotted in Figures 4 to 6 (with data reported in Tables 16 and 17). Differences in the output gap estimates are the result of differences in estimation technique, other adjustments based on expert judgment, differences about the underlying forecast outlook and the availability of data at the time of forecast finalisation.

An alternative means of showing uncertainty is to compute confidence intervals based on historical forecast errors of observable economic and fiscal variables and historical revisions to the Treasury's output gap estimates. This is shown for the cyclically-adjusted balance indicator in Figure 3. The confidence interval calculated is conditional on current policy and reflects only observed revisions to the Treasury's official output gap estimate, rather than the full uncertainty implied by different estimation techniques. Details of the methodology and parameter values for the confidence intervals are reported in Treasury Working Paper 10/08.[4] This analysis would suggest that there is a structural fiscal deficit with a high degree of confidence.

Figure 3 - Fan chart for cyclically-adjusted balance

Source: The Treasury.

Note: the coloured bands represents sequential deciles such that the difference between the 10th and 90th percentiles represents an 80% confidence interval.

Figure 4 - Output gap range

Source: The Treasury

Figure 5 - Cyclically-adjusted balance range

Source: The Treasury

Figure 6 - Core Crown fiscal impulse range

Source: The Treasury