Background Paper for the 2021 Statement on the Long-term Fiscal Position: Demographic, Economic and Fiscal Assumptions and Logic in the 2021 Long-term Fiscal Model

Executive Summary#

The Public Finance Act 1989 requires the New Zealand Treasury to prepare a Long-term Fiscal Statement (LTFS) on the long-term fiscal position of New Zealand at least every four years, covering a 40-year period at a minimum. The Treasury uses its Long-term Fiscal Model (LTFM) to produce some of the projections described and/or illustrated in the LTFS, as well as to provide a base scenario that is used as an input to other models whose outputs appear in the LTFS. The fundamental purpose of the LTFM is to project New Zealand's long-term fiscal position, under a given set of assumptions, so that potential future fiscal pressures can be identified and better understood.

This paper provides a description of the 2021 version of the LTFM, which has as its base the forecasts produced for the 2021 Budget Economic and Fiscal Update. There is a focus on the model structure, assumptions and logic used to produce the main projection of the model, in which net core Crown debt, as a percentage of gross domestic product (GDP), rises at an accelerating rate. This is designed to illustrate the main areas of fiscal pressure caused by the ageing population structure of New Zealand over the coming decades. In particular, the modelling assumes that once these pressures cause expenditure to overtake revenue, the deficits produced are funded through increased borrowing. As debt grows, so do the interest expenses that it generates, which further increase the ongoing operating deficits. This cycle of increased borrowing pushing up interest costs, which leads to even more borrowing, produces the accelerating net debt profile of this scenario.

It is important to understand that this is a projection, not a forecast. It illustrates a potential outcome that could result under a given set of assumptions. The key assumption is that no policy changes will be introduced to address fiscal pressures, but rather that successive governments will keep increasing borrowing to meet them. This is not realistic for a number of reasons. Among the most important of these are that:

• New Zealand's public finance settings require governments to set debt objectives
• for the last thirty years New Zealand's public debt to GDP has been largely decreasing, other than for a few years following the global financial crisis (GFC) and recently in response to the Covid-19 pandemic, and
• it is highly unlikely that overseas lenders would continue to provide funds to any country that showed no signs of addressing its fiscal problems.

This scenario is not a forecast of an outcome that the Treasury expects to occur, but rather a warning signal.  Fiscal pressures, caused by an ageing population structure and other factors like increasing demand for publicly funded health services, are real. Policy changes will be required to address them, although these may not necessarily be applied, completely or even partially, to the areas causing pressure. There are many options available to avoid these undesirable outcomes.

This paper explains the key demographic, economic and fiscal assumptions in the LTFM, and its modelling logic, in order to increase understanding of what causes the fiscal pressures that the model projects.