2.6  Reconciling results: 2006 to 2009 (continued)

2.6.4  Updated demographic projections

Despite the importance of Statistics New Zealand's demographic projections to the modelling in the Statements, updating them made little difference to the projections. The line labelled Step 4: Demographic update in Figure 2.5 applies the demographic projections used in the 2009 Statement to the other changes introduced so far (IFRS data, simplified model, modelling changes including those to tax).

The 2006 Statement used Statistics New Zealand's official National Population Projections published in December 2004. These were an update based on Census 2001 data. For the majority of the modelling the Series 5 projections were used, which assume medium fertility, medium mortality and medium net migration (10,000 each year is the long-term annual value used).

The 2009 Statement used 2008-base demographic projections provided to the Treasury by Statistics New Zealand. These were based on 2006 Census data, updated to reflect changes observed in births, deaths and migration at 30 June 2008. These were not official projections, but an interim set produced by Statistics New Zealand before official projections were available on 27 October 2009 (too late to be used in the 2009 Statement modelling). For the majority of the 2009 Statement modelling, including the projections depicted in Figure 2.5, Series 5 assumptions were used.

The updated demographic projections did not make a great deal of difference to the net debt track because the changes to the demographic variables tended to be greatest in the early years. It is in these initial projected years that net migration figures are most volatile and, to a lesser extent, temporary lifts or falls in birth rates have an impact. While these are important, they are generally not long-lasting and consequently their impact on the net debt projection is not as great as if they were permanent shifts. Rather, as the demographic projections progress out into future years, more standard long-term assumptions around net migration, fertility and mortality dominate, and these generally do not change too much from update to update.

2.6.5  New economic base

All of the modelling changes introduced so far have led to a lower net debt projection than that of the 2006 Statement. Of these changes, the tax revenue projection has made the biggest impact on the path of net debt. In terms of the 2050 level reached, the sum total of the four steps examined have reduced net debt, as a ratio of nominal GDP, from 106% in the original 2006 Statement to 74%. While this shift of around 30% seems significant, it needs to be viewed in the context of how quickly debt rises once finance costs start to impact. To illustrate, only seven years earlier (2043) in the 2006 Statement the net debt to GDP ratio was 73%.

Figure 2.6 - Net debt, 2006 projections and the final sets of changes

Source: The Treasury

The next change, incorporating the 2009 Statement economic base, does have a significant effect on the net debt track. This impact is shown in Figure 2.6 as the line labelled Step 5: New economic base. It results from applying the 2009 economic base to the set of changes introduced up to the fourth step of applying updated demographic projections.

It is worth noting a caveat at this point, which is that it is not possible to separate completely the impacts of an updated economic base from those of an updated fiscal base. For example, if unemployment (an economic variable) had not risen owing to the recession, unemployment benefit expenditure (a fiscal variable) would not be so high. Even more significantly, if GDP growth were stronger (an economic variable), this would flow through to higher tax revenues (a fiscal variable).

In modelling an updated economic base, elasticities and assumptions are applied to flow the impacts of the economic changes through to fiscal variables. However, these are not going to match exactly the actual impacts that occurred. Furthermore, with a gap of three years between the Statements, updated fiscal data will incorporate changes that are due to more than just changed economic conditions. With a new policy, such as KiwiSaver, which was not in place at the time of the 2006 Statement, it is relatively simple to ascribe its impacts totally to updated fiscal data. However, with something like expenditure on the Domestic Purposes Benefit, some of the change will be due to policy decisions taken in the intervening years, some to average rates paid not turning out exactly as forecast in 2006, some due to demographic changes such as rises in fertility, some due to the impacts of the general economy (CPI indexation of rates, higher unemployment, etc), and likely some further causes not mentioned here.

The main point is that, if this analysis were to be done in a different order, the proportions of change attributed to the economic update and the fiscal update respectively would likely be different (but the total would not change). We have chosen to put the economic update impact first, mainly because we do have elasticities and assumptions that we can apply to flow these changes through to fiscal data. Moving in the opposite direction is even harder to assess in terms of causation.

The economic base used for the 2009 Statement was that from Budget 2009. This was a forecast done as the impacts of the recession unfolded on the New Zealand economy. At that time, owing to the projected persistent effects of the recession, several key economic variables were forecast not to have returned to their long-term or equilibrium levels or rates of growth by 2013. The following variables were adjusted in the first few years of the projections, to return to their long-term levels or rates of growth: age-and-gender group labour force participation rates; Consumers Price Index (CPI) inflation; unemployment rate; and average hours worked. All variables return to their trend rates or levels by 2016.

Despite this, the impact of a far weaker economy over the next few years than was forecast for the same period in the 2006 Statement has a marked effect on the net debt projection. For example, the 2006 Statement assumed nominal GDP would grow by 34% between 2007 and 2013 (from $160 billion to $214 billion). Despite starting from a higher 2007 base of $169 billion in the 2009 Statement, growth to the 2013 level of $203 billion is only 20%.

2.6.6  New fiscal base

The final step is to introduce the fiscal base from Budget 2009, which takes the projection to that of the 2009 Statement. This is depicted in Figure 2.6 as the line labelled Step 6: New fiscal base = 2009 Statement. As has been discussed, had the economic and fiscal base update steps been reversed, then the attribution of their individual impacts would likely be somewhat different. Despite this, it is clear that the impact of the recession on the fiscal base is quite marked.

The other big contributor to the fiscal impact has been new policies and programs introduced since the 2006 Statement. The most significant of these, in terms of the impact on net debt projections, are the personal tax cuts that have occurred. Another notable addition to expenditure is KiwiSaver subsidies.

The combined changes result, for net debt as a percentage of nominal GDP by the final projected year of 2050, in an increase from 106% in the 2006 Statement to 223% in the 2009 Statement. The transitional steps for this particular year are depicted below in Figure 2.7.

This illustrates that the big changes come from the updated economic and fiscal bases, rather than the modelling and demographic changes. Changing the way tax revenue is projected, for example, reduces net debt by 16 percentage points of GDP in 2050, while updating the economic base boosts net debt by 60 percentage points of GDP and the new fiscal base lifts net debt by a further 89 points.

Figure 2.7 - Stepwise changes to 2050 net debt, 2006 to 2009 projections

Source: The Treasury