Video transcript: New Zealand Economic Outlook (2019)
Title: New Zealand Economic Outlook
Peter Gardiner
By way of introduction, I just thought I’d give you a bit of a context for the forecasts that we provide. So twice a year the Treasury updates its economic outlook. We produce one for what we call the Half-Year Economic and Fiscal Update, which we released in December, and we also do one in association with the Budget. We’re currently finalising our economic forecasts for the Budget. We can’t quite do that yet because we’re waiting on the Government to finalise its budget package. We’re encouraging them to do that this week so we can get on and do the economic forecasts and then the tax forecasts.
So what I’m going to talk to you a wee bit about today is how we saw things back in December when we released our Half-Year Economic and Fiscal Update. I also want to give you a bit of an update on what’s happened since then, because the world has moved on. And I just wanted to get you to understand some of the risks as they present themselves in the way that we see them. A lot of the work that we do helps support policy analysis, whether that be tax or skills policy or labour market policy, and that affects many dimensions of the Wellbeing Framework that Diana talked about today.
The Living Standards Framework that we’re trying to use, and, in particular, the Dashboard, is a challenge for us as macroeconomists who think about things in a fairly orthodox manner. And so one of the things that we’re trying to do is think a little bit deeper about some of the distributional impacts, how different elements or different parts of the economy might be affected over the next three to five years. So that’s a real challenge for us as orthodox macroeconomists, getting into some of the different dimensions of the outlook. As I said, I’m going to give you a fairly candid overview of how we’re seeing the economy. I’m going to start with some fairly broad messages. I want to reflect on how we were seeing things and give you a bit of an update, and then hopefully there’ll be a bit of time for questions at the end.
So, to start with, back in December we were expecting the economy to continue expanding, and this was very much underpinned by population-led growth, Government spending and pretty accommodative monetary policy conditions. We were forecasting, at that stage, the Government’s books to be in pretty good condition, so rising OBERGAL surpluses over the forecast period. But we also mentioned a number of risks that we saw. And I think if anyone is reading the papers today, you’ll understand some of those risks are very much presenting – in particular, the global outlook. But there are some things that are happening a bit more domestically, too, that will be worthwhile talking a wee bit more about.
So, in December when we published the economic forecast, we believed that the economy would expand at around two and a half to 3% per annum over the next four years. What we were thinking is that the economy is in a fairly mature state in its business cycle. So, if you think over the last decade since the Global Financial Crisis, New Zealand has actually had pretty good growth in the economy, up to around three, three and a half, 4%. And, as a consequence of that, we’ve got closer and closer to what we would describe as capacity. And, therefore, the ability of the economy to continue to grow at three, three and a half, 4%, is pretty limited. So, as a consequence of a number of those sorts of things, we see growth expanding, but certainly not at the same rate as we had done before.
Also, we thought that the nominal economy would continue to expand, in part due to a fairly elevated terms of trade. And the nominal economy is obviously pretty important for what happens to tax and tax revenue. We are expecting a pick-up in wage growth. So, over the last three to four years, you might have had wage growth averaging two and a half to 3%, and we thought that wage growth would pick up to about three and a half percent over the forecast period. And there are a couple of things that are underpinning that: in particular, changes to Government policy. We’ve seen recently the increase in minimum wage, as an example.
So what’s happened since December? Well, we’ve had a number of data route turns. In particularly, GDP came in at around 6%, just slightly below what we had anticipated. If you look at growth over the last half of last year, it totalled about 1%. Now, over the previous four years, what we’d seen is, in any half-year period, growth had probably averaged closer to one and a half, 2%. So that’s just indicative of an economy that’s just perhaps slowing down in its growth. By comparison, Australian GDP in the last half of last year increased by about half a percent. So we’re certainly expanding at a stronger rate than the likes of Australia.
When we take a little bit of a closer look at growth, we saw that growth was pretty broad-based across most industries, with the exception of the primary sector, and that was largely a mining industry phenomena. And then, when we look at consumption, on a consumption-based measure, we saw that private consumption in particular was supporting expenditure, but that, actually, growth and expenditure GDP was also fairly broad-based. On a nominal basis, though, the terms of trade wasn’t quite as strong as we’d anticipated, and the nominal economy didn’t quite grow as strongly as we had anticipated.
If we look a little bit closer at some of the other data that’s printed, so the unemployment rate lifted. But what I’d mention here is that we got a surprisingly positive outturn for the labour market in September, so the unemployment rate actually fell below 4% to 3.9%. And we didn’t think that was sustainable, so we’ve seen the unemployment rate just pick up again. Firms are still continuing to report that it’s really difficult to find their skilled and unskilled workers, and that’s just reiterated by our business talks that we recently did. So, prior to a forecasting round, we’ll go out and talk to a range of businesses. And one of the key messages that we’ve heard over the last three to four years – and it’s something that we’re continuing to hear – that it is really difficult to find the right people for roles – right through the country, in fact.
Some of the other data that’s printed since then: capital goods, imports is still increasing, and that’s indicative of an economy that’s still wanting to invest. So business investment, whilst it’s slowed down, there’s still evidence here that we’re going to see continued growth in business investment. And dairy exports have expanded on the back of what’s been a really good production season. Although, just after December, we’ve seen dairy prices come back a wee bit. In the last couple of auctions, we’ve seen dairy prices pick up again, so that’s a good sign. The higher oil prices that we were confronted with in the latter part of last year have largely unwound, and the international oil price is around about $60 a barrel now. Last year they got up to around 75, $80 a barrel. Oil price is inherently difficult to forecast, so we pretty much take whatever it is today and just straight-line that and that’s our forecast for oil.
Probably the biggest news is what happened with the Reserve Bank. So, prior to the last Monetary Policy Statement, the Reserve Bank had taken a very neutral stance on monetary policy, and they’d said, “Depending on how things evolve, the next move in the OCR could be up or it could be down.” A couple of weeks ago, though, they took a stronger view than that. They said it’s most likely to be down. And they were talking about what’s happening in the global economy as a clear signal of how demand is shaping up, and how they think not just the economy will unfold but the level of activity that will translate into inflation. So, at the moment, financial markets are pricing in two cuts in the OCR, so about 50 basis points. So currently the OCR is at 1.75%. And markets are anticipating that it will come down to just above 1%. When that will happen, and even if it does happen, largely depends on how things evolve from here, particularly, I think, in the international economy.
Now, I just want to come back to some of those things that we think were important for growth in the economy over the next three to five years. So one of those things is population growth. I think what you want to take out of this is that our last migration cycle has been, when you look back historically, a pretty strong migration cycle. So two things have happened here: we’ve had fewer people leave to Australia – and part of that reflects the fact that, at least in the mining sectors in Australia, it hasn’t been as good and, therefore, fewer New Zealanders have left to go to the mining sectors. But we’ve also had pretty good inbound migration from non-New Zealanders coming into the workforce in particular. But we don’t anticipate that to continue; in fact, we’ve got the migration cycle easing somewhat. So that’s just not going to be as supportive to growth over the next three to five years as it has been over the past three to five years.
Confounding these things, though, we’ve had some changes in data. So Stats New Zealand have released some new measures of migration, and what that’s signalling is that migration perhaps didn’t reach as high a peak as we thought and may have eased earlier than we had thought. Most recent data, though, is signalling a bit of a change, though, so maybe the decline in migration isn’t quite as pronounced as we had anticipated. On the flip side, if you think about this, what it also means is that per capita consumption and some of those things is probably higher than we had otherwise anticipated. So maybe it’s not all bad to think about what these new migration statistics mean.
Rising income support consumption. So we see a fairly strong outlook for consumption growth, in part underpinned by a reasonably buoyant labour market. So we’ve seen the unemployment rate decline from peaks of around 6.5% after the Global Financial Crisis to around 4% now, and we anticipate that, over the next four years, that the unemployment rate will hover just above 4%. With wage growth, that’s been supported by some changes in Government policy, and we can think of wage settlements and minimum wage as good examples of those. We think that is quite strong growth in income that can support consumption growth. We also see fairly accommodative monetary policy conditions, too, which will keep things like mortgage payments fairly low.
Government spending supporting demand. So we expect to see a fairly strong fiscal impulse. At HYEFU we were forecasting, and the Government had announced, operating balances of $2.4 billion over the forecast period. The Government’s still yet to pin down what its budget package is, but hopefully we’ll expect to see that soon. Investment growth. So, as I mentioned earlier, capacity constraints were one of the factors that we point to around why growth isn’t going to be quite as strong as we had seen over the recent years. And I think the construction industry is an obvious example of that: there just isn’t the capacity in the construction industry to expand at a rate that we’ve seen over the last few years.
When we think about this, consents are still at record levels. We saw 34 and a half thousand consents in the last 12 months. At the height of the construction boom, say three or four years ago, I think we just peaked slightly higher than that. So that’s evident of the fact that we are wanting to expand, but there’s just limited capacity to do so at the moment. Part of that’s an Auckland story, but we’ve seen similar sorts of things right across New Zealand as well.
Non-residential investments. So we’ve got an elevated level of terms of trade and we think that that’s reasonably supportive for business investment. Terms of trade you might think of as a proxy for profits, and so, when profitability is high, then we expect business investment to be strong. One of the things that might weigh on that, and probably has done a wee bit, is the effects of business confidence. So there was quite a lot of noise about the effects of weak business confidence on the economy last year, but we didn’t see strong evidence of that. And it’s true today that we don’t see a great amount of evidence that suggests that weaker business confidence is genuinely translating into lower levels of activity. But it is something that we think probably is weighing on things at the margins.
But when you look at some other factors that are going on, we’ve got really low real interest rates, which is positive for business. And, with perhaps wage growth picking up, it means that businesses might choose to substitute capital for labour. The Government has also announced a 13 billion capital works envelope. So that’s a four-year programme. So that’s, I think, helping with planning decisions. So, rather than having to look at a one-year investment window, what you’ve got now is it’s the likes of NZTA or whatever who are able to plan over three to four years now with a bit more certainty than what they had done.
Now I want to talk a wee bit about the international economy, because I think it’s fair to say this is on watch. And it’s no surprise, if you watch the news, that there a number of things going on globally that are potentially a bit of a drag on the New Zealand economy. So we’ve heard quite a lot about China/US trade tensions. And this is a concern, but it’s not as big a concern as you might think. What we’re talking about here is the total amount of bilateral trade between the US and China that’s affected by the tariff – in the tariff wars, you might describe them as – is only about 10% of that bilateral trade. It’s even less when you think about it in world terms. It is a risk, though, and we’re just keeping a mindful eye on what might happen there.
Brexit: so who knows exactly what’s going to happen? It’ll be interesting to know soon; we’ve heard that there are more delays. There might be an exit package that’s ratified, but also there might be no exit package. So the UK might leave the European Union without a package in place. I don’t know whether we quite fully understand what the implications of that might be. At the margins, though, it will mean a change in some of the historical preferential access arrangements that we’ve had to the likes of the UK market. So, when I think about that, I think about access to the UK market for mutton and lamb. So we have quite high quotas into the UK, and we don’t actually fill that now because the number of sheep in New Zealand has declined quite substantially over the last 20 years. And it’s about four times as high as somewhere like Australia. So, as things get renegotiated, some of our preferential access might be just shortened up a wee bit.
The other thing that we also keep an eye on is what’s happening with China, and, in particular, debt. So the extent to which companies in the Chinese economy have to borrow is actually quite high at the moment. And, if there is a drag on the Chinese economy, well, then that could crunch down on firms in China and that could have more of an impact on demand, in particular, directly for New Zealand goods. But also we’re thinking about the contagion impacts, particularly through Asia and maybe into Australia as well. Speaking of Australia, Australia’s growth hasn’t performed that well recently. And there’s perhaps two phenomena that are a result of that. One is the Royal Commission on banks and how they’ve shortened up access to funding. And that’s caused a bit of a collapse in the housing market. Housing prices have declined in real terms by about 15% to date, and a number of commentators are expecting house prices to decline up to 20%.
That’s quite a different sort of scenario than what we see in New Zealand. In New Zealand we don’t typically see real declines in house prices. What we see is people just taking their house off the market as prices suffer. The other thing that’s happening in Australia is that the consumer isn’t spending quite as much. But some of the other things are actually going pretty well in Australia, so business investment is still chugging along. And the export sector is doing really well on the back of some pretty strong commodity prices. So it’s not all bad when you think of Australia.
So what we’d say at the moment is that things aren’t translating into a crisis yet. So we’re seeing what’s happening in the global economy as a bit of a soft landing, certainly not a crash landing. If there were a whole bunch of things to come together, though, it might look a bit more like a… I wouldn’t say a crash landing, but maybe a hard landing, anyway. The other thing that I’ll just mention here is inverted yield curves. I don’t know if anyone’s taking note of this. A lot of commentators, particularly in the US, say that when you get long rates that are higher than short rates, it’s an indication that the economy is heading towards recession. And if you look back over US economic history, you do see this. But there are, I think, some key points of differences with what’s happening in the US now and what’s happened over history.
Firstly, the spreads are only about 50 basis points, and it’s only been for a very short period of time. Over history, what you’ve seen is that the spreads, and the inverted yield curve, blow out to about 250 basis points, and it can be for a prolonged period of time. So we’re not, certainly, I think, in a scenario where we’re talking about a US recession. I’ll skip over that slide because I think I’ve covered the points. I did want to talk a wee bit about the impact of a softening world outlook on New Zealand. And so we’ve got the main demand channel, but it also affects prices as well. And, in particular, one of the things that we think a bit harder about is what’s happening with the terms of trade.
So, as you can see in this chart here, the terms of trade over the last 20 years has been on an upward trend, and there are two things that are going on here. The price for our exports has generally increased at a faster rate than the price of imports, and that’s largely a proteins story on the export side of things. But we also import a whole range of goods, and they generally aren’t increasing at the same rate as some of our commodity exports. And we expect this to remain so. So, when you look at in-market supply and demand conditions for the likes of wood, meat and dairy, things are still pretty good. There’s still strong demand, particularly for wood and dairy into China, and supply conditions for the likes of dairy in the northern hemisphere are still pretty favourable for New Zealand dairy farmers.
Before I finalise my discussion and come back to what it means for the Government’s finances, I just thought I’d talk a wee bit about tax developments. So we’ve been continually surprised at the amount of tax that the economy has generated over the last three to four years. We continually under-forecast tax. Part of that’s been a business tax story; and, when we look at year-to-date tax numbers, what are we seeing? So GST is slightly higher or slightly ahead of forecast. Corporate taxes, though, are slightly behind forecast. We think that the corporate tax story is largely a provisional tax thing that will wind its way out as we conclude the fiscal year.
So, overall, we think that the Government’s books will continue to improve over the forecast period. So we’re now in surplus, and we expect that to be maintained. But that requires tax receipts to remain reasonably robust, and also it requires a measure of fiscal discipline from the Government.
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