Budget 2021 capped a particularly busy forecasting and fiscal reporting year for the Treasury – one punctuated by September’s Pre-Election Economic and Fiscal Update (PREFU), which is ordinarily in election years sandwiched between May’s Budget Economic and Fiscal Update (BEFU) and the Half Year Economic and Fiscal Update (HYEFU) which is usually released in December.
The EFU ‘cycle’
Each of the Economic and Fiscal Updates (EFUs) gives the opportunity to ‘open the books’ to the public, and it’s no coincidence that the BEFU is annually released on the day of the Government Budget. This is because the simultaneous release of both is required by public finance law – to meet principles of transparency and responsible fiscal management that, legislatively at least, date back to the Fiscal Responsibility Act 1994 (FRA).
Also related to the principles of transparency and responsible fiscal management is the monthly release of the Financial Statements of Government (FSG), against which analysts, commentators, and other interested parties can assess the Government’s financial position at a point in time and the financial results of operations and cash flows for the period ending to which they relate. Additionally, the progress of earlier-set-out fiscal strategy – as articulated in the Fiscal Strategy Report – is communicated, essentially getting the picture on forecast versus actual.
The Minister of Finance has responsibility for aspects of the EFUs, in particular for the disclosure of Government decisions and other circumstances with material economic or fiscal implications. The EFUs include forecast financial statements.
While the Treasury’s official Updates are released twice yearly in non-election years, forecasting goes all year round. Typically, there is the BEFU, and then the HYEFU – later in the calendar year at the time of the financial half-year. Originally, in deference to the month of its usual release, this Update was known as the DEFU (the December Economic and Fiscal Update).
Budget Policy Statement
Every third calendar year, in advance of the general election, there is also the PREFU which – depending on when the election date falls – may or may not that year be followed by a HYEFU. The Government’s Budget Policy Statement (BPS), released every year – for the following calendar year’s Budget – is usually released at the same time as the HYEFU. This isn’t always the case though: where following a general election late in the previous calendar year, the BPS may be released early in the actual year of the Budget to which it relates. For example, following the October 2020 general election, the BPS for 2021 was released on 9 February.
The Government of the day was required by the FRA, and is still required by the inclusion of its core tenets – by amendment in 2004 – in the Public Finance Act 1989 (PFA), to release the BPS no later than 3 months before the start of each financial year, which begins on 1 July.
The BPS sets out the long-term objectives for the Government’s Budget objectives – including as they relate to debt levels. It was, at its inception, initially criticised by some, on the basis that it could allow a Government to essentially write its own rules with no sanctions for those that set themselves loose fiscal policies or fail to meet its own targets. This, though, was countered by others suggesting that essentially debt and surplus targets are required to be committed to by the Government of the day – a harder target to miss or abandon than, say, one that has been set for an incoming Government by the one previous.
By law, the PREFU must be published between 20 and 30 working days before the general election. Because of COVID-19, last year’s was prepared against an unprecedented set of circumstances and challenges: with the original general election date being deferred by 4 weeks from 19 September to 17 October, the PREFU release date was re-scheduled to 16 September from the originally intended 20 August. While this didn’t necessitate a case of ‘back to the start’ for the Treasury forecasting, revising assumptions and base data for the release of 16 September was still necessary.
Despite the hiatus between one EFU release and the next, there are continuous phases to the forecasting cycle. These can ordinarily be segmented by calendar quarters (with some overlapping), with a different focus to each.
A full forecast round usually takes 3 to 4 months to complete – for the BEFU, this is February to May; for the HYEFU – September to December. With the PREFU, the forecasting ordinarily begins around 3 months before the date of the general election.
Last year, perhaps not surprisingly, and because of the ongoing impact of COVID-19, saw an even more heightened interest in, and call for, forecasting and fiscal reporting. So, while the official Updates were prepared and released as per the process in ordinary times, they were complemented by other analysis.
In April 2020, for example, the Treasury began publishing a weekly COVID-19 Economic Dashboard alongside its Weekly Economic Updates (WEU), which together have substituted for the Monthly Economic Indicators, the release of which has ceased for the time being.
The 26 June 2020 issue of the WEU included, as a special topic, an update on the developments that had taken place since the BEFU (released on 14 May) and how these had at the time influenced the economic outlook. This issue included scenario-based updates on variances against the BEFU underlying assumptions – as of late June.
As of June 2021, the WEU continues to be published.
Why forecast in the first place?
Why, it could be asked, does the Treasury forecast in the first place? There are a number of answers to this. The first is: because we have to. The PFA requires the Minister of Finance to present an EFU to the House of Representatives each financial year, on the day the Budget is delivered. Another is because the Treasury’s economic and tax and fiscal forecasts play a key role in informing the decisions of the Government of the day.
The forecasts also inform other work being progressed within the Treasury, such as advice given to the Government, as well as contributing to other products or informing decisions, such as the monthly financial statements or the size of the Bond Programme.
Also, the Treasury’s forecasting work fits with its priorities of its core strategic intent: helping with ensuring that that the ‘business cycle’ is managed in a way that supports sustainable growth. Put simply, managing the business cycle can be helped by having an understanding of which part of the cycle the country’s economy is in, and where it may be heading. This view is informed by its economic forecasts, notwithstanding additional influences such as the current complexities and uncertainty resulting from the economic impact of external environmental factors, such as the impact of COVID-19.
What to forecast – and how far ahead?
The Treasury produces economic forecasts for a large range of economic indicators.
The PFA specifically requires 3 years’ worth of economic forecasts of Gross Domestic Product (GDP) and its major components, consumer prices, unemployment and employment, and the current account position of the balance of payments.
The forecast period for EFUs (including the PREFU) is 5 years. The PREFU 2020 also included a 10 year outlook, as was the case with the PREFU 2017.
The fiscal forecasts contained in each EFU must include forecast financial statements, so the Treasury also forecasts tax revenue and receipts, including tax collected by both Customs and Inland Revenue, such as GST, source deductions, and residents’ withholding tax (RWT).
These alongside the forecasts for all entities then form the forecast financial statements and related fiscal indicators, which is a key part of the EFU documents.
Economic and tax forecasting – from scene setting to sign-off
So, how are the economic forecasts developed? First, there is the ‘scene setting’: at the beginning of a forecast round, the Treasury discusses how its views about the economic and fiscal outlook have changed since the last round. These views are based on the continual monitoring of macroeconomic and fiscal developments that are undertaken year-round. This is followed by the economic forecasting team’s preliminary forecast round, drawing on a variety of methods to inform short-term forecasts of the range of economic indicators they produce, including those required under the PFA and those needed to produce the fiscal forecasts.
The initial indicator forecasts are fed into a macroeconomic forecasting model of the New Zealand economy. This model, called Matai, provides a unifying structure that allows all the indicators to interact and, based on past experience, predicts the outcomes of those interactions over the forecast period.
The model outputs are reviewed by the team, drawing on others across the Treasury, including the Treasury Secretary and others with knowledge of government policy initiatives and other relevant developments. This information is used to form judgements that influence the model output. Matai is in fact an organising and documentation framework for the forecasters. It encompasses all relevant information gathered from off model sources.
There is then external QA of forecasts, during which the preliminary macroeconomic forecasts are scrutinised by a panel of external specialists. Preliminary tax forecasts, for example, are scrutinised by the Inland Revenue tax forecast team (which also – using Treasury macroeconomic forecasts – forecasts tax revenue and receipts, but with different tax forecasting methods).
Before economic forecasts are finalised, the Treasury’s forecasting team interviews businesses around the country, to supplement the data-based analysis of the economy with a qualitative, ‘on-the-ground’ perspective. The preliminary macroeconomic and fiscal forecasts are then communicated to Ministers, who use these to help with informing Budget decisions. The Treasury’s final forecasts will include the economic and fiscal impacts of these decisions.
For the final forecasts: the process then begins again. The team analyses the data received after preliminary forecasts were finalised, including updated fiscal forecasts, any policy or spending decisions since by the Government, updates their indicators, re-runs Matai, and proceeds through another round of internal discussion (while at this stage of the process there isn’t another external panel for the macroeconomic forecasts, the tax forecasts are still cross-checked with Inland Revenue).
Economic forecasts are typically finalised 4 or 5 weeks prior to publication – but fiscal forecasts may not be finalised until shortly before publication. This is because Ministers will continue to discuss the details of the Budget. Sometimes Budget decisions will come too late to be included in the economic forecasts, but typically, major decisions around the scale of revenue and expenditure initiatives are agreed by Ministers early in the process.
Economic forecasting within the COVID context
In the past, the approach the Treasury has taken in preparing the forecasts has, to some extent, been determined by the length of time since the last forecast update – and within the context of the view of the existing economic environment and how it may have changed since the EFU previous. For example, for the last two pre-election updates prior to 2020’s (ie. in 2014 and 2017), a ‘targeted’ approach was taken for collecting updated forecasts from government agencies, ie. from a selected group of government agencies – because there was a relatively stable economic outlook at the time.
Last year, however, given the uncertainty around the economic outlook, and that the evolving impact of the COVID-19 pandemic was likely to progressively result in widespread impact on the Government’s finances, the Treasury collected updated fiscal forecasts from a much wider than usual group of agencies. This is similar to the process for preparing a HYEFU or BEFU.
The Treasury’s next official Economic and Fiscal Update will be the HYEFU, the release timeframe for which is yet to be confirmed.