4 The firm and the rest of the model (continued)

4.7  Imports of private consumption goods and services

Further to the addition of the desired debt term, another important change since Szeto (2002) is the disaggregation of imports into different components (consumption, capital goods etc). In both the steady-state and dynamic model, imports of both consumption goods (imc) and services (imcs; household overseas holiday expenditure) are expressed as a share of total consumption. It is therefore useful to think about the consumption import equations as determining the share of imported consumption goods and services of total consumption (ie, the penetration ratio) rather than the level of consumption imports (which will also vary with the overall level of consumption). In both the dynamic and the steady-state model, a decrease in the price (relative to the domestic price) of imported consumption goods (rpmc) and services (rpmcs) will increase this ratio as it is now relatively cheaper to source goods and services offshore than domestically. The relative price of each of imported consumption goods and services is calculated by taking the respective foreign prices (an exogenous input) and multiplying it by the nominal exchange rate and the inverse of the domestic price level. The trend term in both the dynamic and steady-state imported consumption goods equation (TF) reflects New Zealand's increased preference for imported goods since the removal of import controls, as well as their lower relative price because of higher productivity in the tradables sector (see Figure 11).[16]

Figure 11: Real consumption goods import share of total private consumption

Source: Statistics New Zealand

In the dynamic model, both imported consumption goods and services are also sensitive to changes in the nominal exchange rate (etwit). The sensitivity of imported consumption services partly reflects the sensitivity of New Zealand outbound travel (a large component of imported consumption services) to exchange rate movements (see Stephenson et al., 2007).

Steady-state equations

Dynamic equations

4.8  Residential investment

In steady state, residential investment (ihr) depends on growth in population and productivity (gr_1), as well as investment required to replace depreciated stock (drrb_eq). Population growth (popgr_eq) reflects both natural increases and migration (both exogenous assumptions) with the larger the population the more housing required. The productivity term (cbetats) is used as a proxy for real incomes; rising real incomes are likely to be associated with increased demand for housing, with more people likely to seek holiday homes, better quality homes or other second homes as they become wealthier.

In the dynamic part of the model, residential investment seeks to partially close the gap between the actual housing stock (kh) and the steady-state housing stock (ekh). The use of such a relationship to drive dynamics is consistent with work done on the housing market by the Department of Prime Minister and Cabinet (DPMC) who concluded: “Supply responses in the housing market tend to be slow as it takes time to turn undeveloped land into new houses or to subdivide land. While the response was slow, the construction industry has responded to population growth” (DPMC, 2008, p.1). In the dynamic equations, monetary policy is also assumed to impact on residential investment in the form of a yield curve (ycurve), with looser monetary policy leading to more residential investment relative to periods when monetary policy is tight.