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Pre-election Economic and Fiscal Update 2017

Risks and Uncertainties Around the Economic and Fiscal Outlook

The main forecasts are based on a set of assumptions (such as the evolution of the exchange rate, the terms of trade and population growth) and judgements around how developments in one part of the economy impact the rest of the economy[9]. Should these assumptions and judgements prove incorrect, the economic and fiscal outlook would deviate from that presented in Chapters 1 and 2. As shown in Figures 3.1 and 3.2, fan charts based on past forecast errors provide one way to illustrate the degree of uncertainty surrounding the outlook. Alternative scenarios are also useful as they provide an assessment of how the economy and fiscal position may deviate from the main forecast when key assumptions and judgements are altered[10].

Risks to the economic outlook add uncertainty to government revenue forecasts…

The amount of tax revenue that the Government receives in a given year is closely linked to the performance of the economy. For example, a fall in dairy export prices reduces farm incomes, which impacts on investment and consumption spending. Government tax revenue is affected through a number of channels including taxes on wages and salaries, corporate profits, and sales of goods and services.

Figure 3.1 shows a fan chart of nominal expenditure on GDP[11]. The width of the fan increases further into the forecast period, meaning the further away from the present the more uncertainty there is around the main forecast. The area within the outermost edges of the fan shows where nominal GDP is expected to be 90% of the time. At the end of the forecast period, this is within +/-7% ($22.6 billion) of the main forecast. The boundaries of the darker fan show where nominal GDP is expected to be 70% of the time. At the end of the forecast period, this is within +/-4.4% ($14.2 billion) of the main forecast. In the two scenarios considered in this chapter, nominal GDP forecasts remain within the darker fan (70th percentile).

Figure 3.1 - Nominal GDP fan chart
Figure 3.1 - Nominal GDP fan chart.
Sources: Statistics New Zealand, the Treasury

Figure 3.2 shows the uncertainty surrounding the main tax revenue forecast[12]. At the end of the forecast period, the outermost shaded area captures a range of approximately +/-$10.4 billion, within which actual tax outturns are expected to fall 90% of the time[13].

Figure 3.2 - Tax revenue fan chart
Figure 3.2 - Tax revenue fan chart.
Source: The Treasury

…and uncertainty around fiscal expenditure pressures

Government expenses may also be impacted by economic developments. One channel is through changes in labour market conditions that affect the demand for working-age benefits. Another channel is through the indexation of a range of welfare benefits to wage and price movements. Government tax expenditures, including Working for Families, may also be affected by labour market conditions. Changes in net migration flows may also impact on the demand for central government services, particularly health, education and publicly funded infrastructure. Over the longer term, current policies imply population growth and population ageing will place increasing pressure on public expenditure, particularly in the areas of health and superannuation[14].

Changes in the valuation of long-term liabilities, such as the ACC claims liability and the GSF retirement plan, caused by changes in inflation and long-term interest rates, may also affect the Crown operating balance.

One-off and unexpected expenditures can also have a large impact on the Crown's fiscal position. In recent years, earthquakes have demonstrated the inherent exposure of the Crown’s fiscal position to unexpected events. More generally, uncertainty is inherent in forecasting the fiscal impacts of new policy initiatives.

Notes

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