Economic future so bright, you gotta wear shades
The economic outlook appears very strong. If Treasury is to be believed, then Finance Minister Grant Robertson is doing alright.
He’s getting good grades. In fact, the future is so bright, he better wear shades.
Yes, that is an unnecessarily reductive pop reference, for anyone who was listening to commercial radio back 1986.
Budget commentary last week came loaded with references to the tough economic days of 1991.
But Treasury wasn’t singing the grungy, angst ridden tunes of that era. It was forecasting like it was Ferris Bueller planning a day off school.
Let’s run through some of its rosy expectations, with a view to exploring where they could come unstuck.
GDP growth is forecast to be 2.9 per cent in the June year 2021, 3.2 per cent to June 2022 and 4.4 per cent to June 2023.
These suggest our per-capita GDP performance will outshine the socalled “rock-star economy” years between 2013 and 2017 — when strong growth was flattered by record population growth.
Unemployment is forecast to rise a bit this year — to 5.2 per cent — before resuming its decline to 4.2 per cent by 2024.
Meanwhile, the fiscal position is forecast to start improving sooner than expected, with core Crown debt peaking at 48 per cent of GDP in 2023.
Annual deficits start declining on a much faster path, heading for a surplus by 2027.
We should always take forecasts with a grain of salt — especially in these strange pandemic days.
The economists who make them are the first to acknowledge that.
And it’s reassuring to remember that Treasury — since Covid at least — has been one of the most conservative and pessimistic economic forecasters in the country.
While these new forecasts are the most upbeat they’ve produced in some time, there is no reason to assume they’ve suddenly swung too far in the other direction.
A number of bank economists have noted that Treasury’s growth forecasts are starting to fall into line with the consensus of opinion.
But as Westpac’s Michael Gordon highlighted on Thursday, there is still some conservatism baked into Treasury’s outlook.
Westpac and Treasury are now running with similar GDP growth expectations.
But Treasury doesn’t see that
growth translating to anything like the level of Crown revenue that Westpac does.
Gordon finds this a bit baffling given assumptions about increased tax take are relatively straightforward.
“Treasury assumes that revenue relative to GDP will continue to fall in the coming years,” he says.
“With the economy moving into a post-Covid upswing, we think it’s more plausible that this ratio will rise, reflecting both company tax and bracket creep (as incomes rise and people move into higher income tax brackets)”.
Of course, Treasury has more riding on its forecasts, they are used to setting the government’s fiscal targets.
Treasury calls have a bearing on currency and interest-rate markets so it makes sense to stay on the conservative side of the ledger.
It leaves room for some downside without knocking the government’s economic programme off-track.
And nobody seems to mind a surprise on the upside.
But even with that conservative approach to the revenue outlook, Treasury still makes three big calls which look bold.
First is its assumption around the pandemic.
Treasury forecasts assume “significant” progress in border reopening by the start of 2022. Let’s hope so.
Delays on that front could seriously dampen New Zealand’s economic outlook.
But until those vaccinations are in our arms the risk of further Covid19 outbreaks, lockdowns and border setbacks remains real.
Another fairly heroic assumption is that annual house-price growth will plunge from nearly 20 per cent last year to a sweet spot just above zero next year.
From there they’ll track with inflation at around 2 per cent.
That’s putting a lot of faith in the Government’s new regulations and tax changes.
Or it’s getting very lucky. Either way there’s economic risk either side of that sweet spot.
If price growth doesn’t fall much then the Government will have to spend more to build and increase supply.
It would also have to spend more to address ever-widening wealth inequality.
But if the market really stalls, history suggests it is more likely to fall into negative territory.
Then we’d see the reverse of the “wealth effect” as the homeowning middle classes panic and consumer spending falls.
Perhaps Treasury’s biggest call, though, is on the inflation outlook.
That’s the big one dividing financial markets and economists around the world right now.
Inflation is building in the global economy. That much everyone seems to agree on.
Will it be a short-term Covid phenomenon or a will it spiral and force central banks to lift interest rates faster than expected?
Treasury has backed the thinking of the US Federal Reserve and economists like Paul Krugman.
It forecasts a spike in inflation to 2.4 per cent next year before a return to entirely manageable levels.
Others — particularly those on the right — fear that the recovery boom, combined with a return to “big government” social policies will spark a return to the stubborn, economically damaging inflation of the 1970s.
If interest rates rise faster than forecast, it would likely crash financial markets and put a serious spanner in the Covid-recovery works.
Suddenly it would be out with those 1986 pop culture references and in with tunes from 1987.
That’s the path that led New Zealand to the austerity of that infamous Budget in 1991.
And no one wants that.