Appendix: Assumptions and model details
Until 2005, all fiscal gap scenarios are largely based on the four-year fiscal forecasts in the Budget Economic and Fiscal Update 2001.
Economic assumptions
Table A.1 summarises the economic assumptions in the short-term forecasts and long-term scenarios.
| 2002 | 2003 | 2004 | 2005 |
2006- 2051 |
|
|---|---|---|---|---|---|
| Real GDP growth (% change) | 2.7 | 3.4 | 2.9 | 2.8 | 1.6 |
| Nominal GDP growth (% change) | 4.1 | 5.3 | 4.5 | 4.2 | 3.1 |
| Labour force growth (% change) | 1.2 | 1.5 | 1.5 | 1.2 | 0.1 |
| Unemployment rate (Household Labour Force Survey, %) | 5.4 | 5.1 | 5.1 | 5.1 | 6.0 |
| Inflation (Consumer Price Index, % change) | 2.3 | 2.3 | 2.2 | 1.8 | 1.5 |
| Nominal interest rate (10-year Government bonds, %) | 7.6 | 7.5 | 7.4 | 6.7 | 6.5 |
| Compensation of Employees (% of nominal GDP) | 42.5 | 42.5 |
Source: The Treasury, Statistics New Zealand
Real GDP grows in line with labour productivity (annual growth rate of 1.5%) and projected changes in labour input (which move in line with the labour force as rates of employment/unemployment and average hours worked are held constant).
Labour and capital shares of output are held constant at their 2005 ratios (i.e., the economy is assumed to be on trend from that point and so business cycle effects are ignored).
Demographic assumptions
Demographic information comes Statistics New Zealand (SNZ) population projections. The labour force projections used to derive labour force growth (in Table A.1 above) are also from SNZ. They are consistent with the population projections and are on 15 years and over basis. The population and labour force projections use a 1999 Base year. The Baseline fiscal gap scenario uses the SNZ “Medium” series population and labour force projections. The key assumptions are given in Table A.2.
| SNZ Medium population and labour force scenarios | 1999 Base | 2051 |
|---|---|---|
| Fertility rate, births per female | 1.98 | 1.90* |
| Mortality, male life expectancy at birth | 75.2 | 82.0* |
| Mortality, female life expectancy at birth | 80.4 | 86.5* |
| Net migration | Long term levels of 5,000 per year | |
| Labour force participation rates | Rates change until 2011. The rates for males are assumed to continue to decrease slightly for most ages 20 to 54 years. For ages 55+, the rates increase to reflect changes in the age of eligibility for NZS. For females, rates are assumed to continue increasing for most age groups. However, the pace of change slows and after 2011 the rates are assumed to remain stable at the 2011 level. | |
* Birth rates vary until the year 2011, and then remain unchanged. Mortality rates remain unchanged between 2051 and 2101.
Source: Statistics New Zealand
For simplicity, the LTFM holds average hours worked, the unemployment rate and labour productivity growth constant where in practice these may be influenced by changes in the age/gender composition of the labour force.
Tax revenues and expenses
The path of tax revenue is driven by nominal GDP growth. Because capital and labour shares of output are held constant, tax bases as shares of GDP also remain constant. In “bottom-up” mode the LTFM assumes the tax system is neutral with respect to nominal wage increases and to price inflation (i.e., there is no “fiscal drag”).
Table A.3 summarises the expense assumptions used beyond 2005.
| 2006 – | |
|---|---|
| NZS | Demographically influenced and grows in line with wages after reaching 65% of the average wage |
| Health | Demographically influenced. Increases at 1.5% a year in real per capita terms in Baseline scenario. Increases at 2% and 1% a year in real per capita terms in Higher Spending and Lower Spending scenarios respectively |
| Education | Demographically influenced. Increases at 1.5% a year in real per capita terms in Baseline scenario. Increases at 2% and 1% a year in real per capita terms in Higher Spending and Lower Spending scenarios respectively |
| Social welfare transfers | Demographically influenced and indexed to wages |
| Other | Increase at 1.5% a year in real terms |
| Finance costs | A function of debt levels and interest rates |
Source: The Treasury
The tax and expense assumptions underpin the projections of the operating balance in the projected “Statement of Financial Performance”.
Assets and liabilities
The LTFM also projects a “Statement of Financial Position”. Satellite models are used to project some of its specific components (e.g., outstanding student loans and the outstanding pension liability of government employees).
As discussed in Section 5.4, the LTFM assumes that replacement assets are purchased to maintain depreciating assets (so that depreciation is neutral in terms of the gross debt calculation).
Three items; Physical Assets, State Highways and the net worth of State-owned Enterprises and Crown Entities largely represent Crown assets. Excluding Military Equipment, assets at the Crown/Departmental level are largely land and buildings. Almost all decisions on physical asset purchases take place outside the budget process, by State-owned Enterprises and Crown Entities (funded from retained surpluses and debt) or by Departments.
In the LTFM, Physical Assets increase in line with the growth of Total Other Expenses and Defence. State Highways increase in line with the growth of Total Other Expenses. As a result, the ratio of these expenses to the relevant asset is constant.
Finally, some items on the balance sheet remain constant in nominal dollar terms and so fall relative to GDP (e.g., Receivables and inventories, Payables and provisions, Currency issued, and Other financial assets).
The borrowing requirement (change in gross debt) is determined by the difference between the operating balance and changes in assets (e.g., net worth of State-owned Enterprises and Crown Entities, advances for student loans, changes in Physical Assets and State Highways) and changes in liabilities (other than gross debt). This captures the fact that the operating surplus does not reflect cash available for debt reduction (e.g., the retained surplus of State-owned Enterprises and Crown Entities). When the operating balance exceeds the (net) change in assets and liabilities, the borrowing requirement is negative and can be applied to debt reduction or financial asset accumulation.
Net debt is defined as gross debt less selected “Financial assets”, where in Table 4 these comprise Marketable Securities and Deposits (predominantly in foreign-currency), advances to State-owned Enterprises and Crown Entities, outstanding student loans, other advances and cash. The selection of financial assets is arbitrary.
Outstanding student loans increase with continued borrowing and accumulating interest. The scheme matures (i.e., outstanding loans level off) as repayments increase. Outstanding loans are projected to increase from around 4.5% of GDP currently to 8% by 2020. They then tail off slightly to 7% by 2050. Other financial assets remain constant in nominal terms and fall as a share of GDP. The combination of these changes means that “Financial assets” increase from 11.5% of GDP to a peak of around 12.3% before returning to around 10%. As a result, net debt tends to reflect movements in gross debt.
