1 Introduction
Forecasts play a key role in formulating fiscal and monetary policy in New Zealand. Under the Fiscal Responsibility Act 1994, which sets out the principles of responsible fiscal management, The Treasury is required to prepare forecasts of the New Zealand economy that incorporate the impact of the short-term fiscal intentions and long-term fiscal objectives of the government of the day. The Reserve Bank of New Zealand Act 1989 provides the legislative framework for conducting monetary policy and requires the Reserve Bank of New Zealand to publish assessments of the New Zealand economy, which provide the basis for setting policy to maintain inflation within the target band.
The main tool used by The Treasury to produce medium-term projections is a large structural macroeconomic model, the New Zealand Treasury Model (NZTM), and for the Reserve Bank of New Zealand the Forecasting and Policy System (FPS).[1] However, large-scale structural models are generally not well suited to making short-term assessments as they focus on the medium-term dynamics of the economy. To help evaluate short-term fluctuations and cyclical turning points, statistical techniques and econometric forecasting tools, such as indicator models, are used instead.
The purpose of this paper is to develop a composite index of leading indicators of New Zealand employment that can be used to forecast quarterly employment growth. One advantage of composite indexes is that they allow incorporating information from many variables that could not be included in time series forecasts with short sample periods. Moreover, composite indexes may be less subject to instability due to policy changes. For example, the composite index of leading indicators of New Zealand employment includes firms’ employment intentions. It is hard to imagine any government policy that could substantially or permanently alter the relationship between employment intentions and actual job growth.
The remainder of the paper is organised as follows. Section 2 outlines the construction of a composite index of leading indicators. Section 3 develops such an index for New Zealand employment. The choice of component variables and their weights in the composite index are determined by their concordance with employment. The composite index of leading indicators is then included, as an explanatory variable, in a single-equation model to forecast quarterly employment growth. The indicator model is described in section 4 and its out-of-sample forecasting performance is evaluated relative to two benchmark models in section 5. Conclusions are presented in section 6.
Notes
- [1]NZTM is described in (Szeto 2002). A discussion of FPS can be found in (Hunt, Rose and Scott 2000).
