Facing not one economic risk, but two
Inflation is today’s danger — and then there’s recession
This is a Budget in which Grant Robertson’s foot has moved from the accelerator to the brake pedal. Government spending will grow more slowly than the economy which has to support it.
In crafting the Budget in a “challenging and uncertain environment” there were two big macro-economic risks for the
Finance Minister to be mindful of.
The obvious one is the need not to fling additional fuel onto the inflationary fire. He has not.
The other risk is one he does not like to talk about — the risk of recession. Slamming on the brakes would cost the economy momentum just as the road ahead looks increasingly uphill.
The case for Robertson’s defence on the charge of spendthrift inflationfuelling starts with the fact that the Budget’s bottom-line measure, Obegal, will shrink from a deficit of
$19 billion in the fiscal year now ending to $6.6b in the coming year and return to surplus in 2024/25, albeit a year later than was forecast before Omicron and the war in Ukraine.
Core Crown expenses are forecast to fall marginally ($1.4b) in dollar terms in the year ahead and more to the point, measured against the size of the economy, from 35.4 per cent of nominal gross domestic product in 2021/22 to 31.6 per cent in the coming fiscal year.
Over the next four years that ratio is forecast to average 30.8 per cent — the same level it averaged during Bill English’s term as Finance Minister.
By the way, that does not mean the Government is responsible for 31 per cent of all the spending in the economy. Much of the Budget is payments to superannuitants and beneficiaries, where the tax and transfer system just redistributes spending power between one set of households and another.
Central government consumption — the claim it makes on the economy’s real resources of labour and electricity and the like — is more like 20 per cent of GDP, measured on an expenditure basis.
The Treasury’s measure of how stimulatory or contractionary the net effect of the Government’s tax and spending plans are on overall demand in the economy — the total fiscal impulse — flips from a strongly supportive 4 per cent of potential GDP in 2021/22 to a contractionary 2 per cent of GDP in the coming year and the year after.
“It recognises we have had a couple of years of very large expenditure,” Robertson said.
A much smaller deficit, a much reduced spend-to-gdp ratio and a flip out of a strongly expansionary fiscal impulse.
Together they mark a return to more normal fiscal settings, of the kind Reserve Bank governor Adrian Orr called for when pressed on the “monetary policy needs mates” issue by MPS on the finance and expenditure select committee recently. But the risk of entrenching inflation isn’t the only macroeconomic risk Robertson needed to be mindful of.
There is also the risk, growing by the day, that the next external shock to wallop us will be global recession.
The epicentre could be, as it was last time, the United States.
Its GDP shrank in the March quarter and the Federal Reserve, staring at inflation north of 8 per cent, has embarked on an aggressive tightening.
The aim would be the fabled soft landing, but the risk of an undercarriage-buckling hard one in the world’s largest economy is significant.
Across the Atlantic, as well as the inflation challenge, is abject reliance on energy supplies from a country which has embarked on a war of territorial aggression on Europe’s eastern border. What could possibly
go wrong?
And in China a different war is raging, between a policy of Covid elimination and the infectiousness of the current variants. The latest economic numbers out of our largest trading partner make grim reading.
Meanwhile in New Zealand, the economic headwinds are getting stronger and colder: falling real incomes for most wage and salary earners, combined with falling house prices turning off the wealth effect which has helped support consumption.
The weekly tally of Covid deaths exceeds the total death toll from the virus in the first two years of the pandemic, with negative effects on both the supply and demand sides of the economy.
And an official drought has just been declared in Waikato and South Auckland, following one in the far south already declared in March. Drought is never a good sign in our grass-fed economy.
The Treasury’s central economic forecast is nonetheless quite cheerful, albeit in a fingers-crossed sort of way.
Words like “resilient”, “robust” and “rebound” feature prominently. It is a semantic stretch.
GDP growth on an annual average basis is forecast to pick up from 1.7 per cent this year to 4.2 per cent in 2022/23 before sliding back to 0.7 per cent the year after.
The unemployment rate, 3.2 per cent now, is forecast to climb back to 4.8 per cent in three years’ time.
Inflation is the “principal challenge” not only in this country, but for the US, United Kingdom, Australia and the euro area, with unpleasant implications for interest rates and equity prices.
The Treasury notes a risk global growth will be “derailed” because of extended conflict in Ukraine, Covid outbreaks in China or both.
So its downside scenario looks increasingly relevant, one in which New Zealand interest rates go higher and house prices fall more, flowing through to less consumer spending, while demand for exports of goods and services is reduced.
The net effect of all this is little by way of pain relief in the Budget for people faced with the cost-of-living crisis. Just over $1b of temporary measures spread over some 80 per cent of the working age population does not go far. It would represent little more than half of 1 per cent of household consumption, the cost of which is rising at nearly 7 per cent a year.
The Treasury acknowledges a risk that global growth
will be ‘derailed’ either because of extended conflict in
Ukraine, Covid outbreaks in China
or both.