Our Outcome Contribution (Continued)

Why macroeconomic performance is important

A stable and sustainable macroeconomic environment allows individuals, businesses and the Government to plan more effectively for the longer term, contributing to higher economic growth and higher living standards for New Zealanders.

By creating an appropriate environment for sustainable growth, macroeconomic performance is fundamental to all of the Government’s themes – economic transformation, national identity and families – young and old. Through the Budget process, the Treasury plays a key role in helping Ministers prioritise initiatives within these themes, ensuring that additional government spending is oriented towards achieving priorities through fiscally sustainable, value-for-money initiatives.

Over the last decade and a half, New Zealand has seen a marked reduction in the variability of many major macroeconomic variables such as economic growth, inflation, unemployment, interest rates and key fiscal aggregates. The exchange rate is one exception to this general trend. Overall, these developments have allowed individuals, firms and governments to make better decisions and contributed to an increase in trend growth. Looking forward, some variability in most, if not all, of these aggregates is expected as the economy responds to domestic and international developments.

New Zealand is recording a sustained period of economic growth increasingly driven by domestic demand. Notwithstanding slower growth over the last two years, this has seen the build-up of macroeconomic imbalances, including a high current account deficit and inflation pressures. Policy response to these imbalances, together with a relatively unusual set of international financial conditions, has led to a sustained high exchange rate. As a result, export- and import-competing sectors of the economy have been under pressure.

The current mix of economic conditions has meant some of the macroeconomic “rules of the game”, as well as the manner in which macroeconomic policy is operated, are being questioned. This discussion, together with the evolving economic and macroeconomic factors discussed above, forms the backdrop for the Treasury’s macroeconomic role.

While the macroeconomic imbalances are expected to unwind in a relatively benign manner as the period of moderate growth continues, a sharper adjustment cannot be ruled out. Inflationary pressures stemming from a buoyant housing market and domestic demand growth remain. As the graph below shows, inflation is expected to remain relatively high in some areas of the economy such as in non-tradable goods (those sectors of the economy not exposed to significant international competition, including service industries).

CPI Inflation

These macroeconomic factors impact on fiscal policy. Higher than expected growth has resulted in increased tax revenue, yet there is a trade-off between spending this revenue and the potential for aggravating inflation further.

The Government also faces longer-term challenges. In June 2006, the Treasury produced the first Statement of Long-term Fiscal Position, identifying fiscal pressures likely to eventuate over the next 40 years as a result of factors such as population ageing. The Government’s fiscal strategy is contributing to dealing with these pressures, for example by building up financial assets in the New Zealand Superannuation Fund. In addition, the Government is looking at ways to ensure more sustainable funding paths in areas such as health.

The Treasury contributes to a stable and sustainable macroeconomic environment primarily by: advising on the underlying fiscal and macroeconomic policies and frameworks; providing tax, expenditure and macroeconomic forecasts; reporting on the fiscal position; contributing to debt and financial asset management; and managing the Budget process. In doing this, the Treasury works closely with agencies such as the Reserve Bank. It also engages with all government agencies to ensure spending and tax policy support a stable and sustainable macroeconomic environment and a sustainable fiscal position. International relationships include the OECD and the International Monetary Fund.

Our focus

The Treasury is focusing on areas where our work is likely to have the most impact on the performance of the macroeconomy and supporting Ministers in their priority outcome areas.

Macroeconomic stability

A key focus over the next three to five years will be on the existing macroeconomic imbalances, ensuring that the frameworks and tools available are the best possible for managing the required adjustment of these imbalances.

In 2007/08, the Treasury will:

• provide Ministers with advice that supports them in dealing with the current imbalances in the context of domestic and international forces impacting on macroeconomic developments
• further deepen our understanding of the relationship between current imbalances and macroeconomic frameworks, and investigate any further viable options as appropriate.

Fiscal strategy and long-term fiscal policy

Over the next three to five years, the Treasury will provide advice that helps the Government to make further progress towards its long-term fiscal objectives, as well as ensuring that fiscal policy appropriately contributes to macro stability. This includes advising Ministers on managing cyclical fluctuations and structural changes in the fiscal position. A particular focus for 2007/08 is on the sustainability of health spending and related policies.

In 2007/08, the Treasury will:

• advise Ministers on short- and medium-term fiscal policy settings
• promote understanding of long-term fiscal issues among the public, Vote teams within the Treasury and policy teams within the broader public sector
• support the development of options for managing long-term fiscal challenges, including in healthcare.

Fiscal reporting

Over the next three to five years, the Treasury’s goal is that key stakeholders, including the Minister of Finance, consider that the Treasury’s reporting fully illuminates fiscal performance and impacts on the economy.

In 2007/08, the Treasury will:

• maintain the quality of the government’s financial statements as New Zealand moves to implementing the International Financial Reporting Standards, while clearly communicating Crown financial performance.

Debt and (DMO) financial asset management

Management of Crown debt and financial assets will contribute to the macroeconomic performance outcome over the next three to five years by maximising the long-term net return on the Crown’s financial asset and debt portfolios, within an appropriate risk management framework. Asset management also contributes to the State sector performance outcome; in areas where these assets directly contribute to the Government’s overall objectives, the Treasury assists agencies in optimising their performance.

The focus for the macroeconomic performance outcome is contributing to managing the Crown’s balance sheet through the Debt Management Office. This provides a resource to help meet future expenditure commitments and claims on the Crown, including those driven by demographic change.

As part of the Stepping Up changes, the Debt Management Office has become part of the Treasury’s Macroeconomic Group, to allow advice on macroeconomic and fiscal issues to link with Crown balance sheet management and to better link debt issuing/repayment more closely with Budget and fiscal strategies.

In 2007/08, the Treasury, through the Debt Management Office, will:

• continue managing the shift from predominantly debt management to a mix of debt and asset management, as well as to the increasing importance of foreign-currency hedging.

Budget

Over the next three to five years, the Treasury’s high-level result is that Budget decisions deliver better State sector performance, are consistent with meeting the Government’s fiscal strategy and take account of short-term macroeconomic stability. Budget management therefore contributes to economic and macroeconomic performance, as well as to the performance of the State sector.

In 2007/08, the Treasury will focus on:

• ensuring funding decisions are more explicitly linked to a clear set of Government theme objectives
• better understanding baseline expenditure and performance information, ensuring baseline funding is focused on key performance priorities for Ministers.

Forecasting

The Treasury’s goal over the next three to five years is that key stakeholders, including the Minister of Finance, accept Treasury’s tax, expenditure and macroeconomic forecasts as the best possible for the decisions they need to make. In some areas of forecasting, particularly tax forecasting, the current pattern of forecast errors makes effective planning and Budget decision-making more difficult for the Government. We need to improve the quality of our forecasts, and our communication of those forecasts.

In 2007/08, the Treasury seeks to:

• improve the accuracy of our forecasts relative to previous performance
• provide a coherent and integrated “story” derived from the forecasts that is easily accessible and readily applicable to the needs of stakeholders such as the Minister of Finance.