Budget 2022: What does Treasury think is happening to the economy whose evolution underpins the budget policies?
Much policy discussion reminds one of the story of the New Zealand navy ship arriving in a US port who are invited to a game of football by the locals. The day before, the sailors are told it is American football, so they get a briefing on how to play the unfamiliar game. After the explanation of the various phases and the blocking and tackling and so on, the instructor says ‘We better have a trial practice; where’s the ball?’ One of the New Zealanders replies, ‘Bugger the ball, let’s get on with the game’. No doubt he became a politician or a commentator: ‘Bugger the analysis, let’s get on with the policy’.
Thus it was with the budget. Everyone gets overwhelmed with the details of the policy changes. But the analysis of what is happening to the economy whose evolution underpins the policy development, is usually ignored. It is much too boring, even if it is fundamental.
So what does Treasury, whose forecasts underpin the recent budget, think? Importantly, the Treasury forecasts are made by one of our biggest economic forecasting teams. They are made independently of its Minister of Finance, who may disagree with a forecast – in the past some have done so publicly. Their forecasts include government policies which Treasury may have advised against, as you would expect from every unbiased forecaster.
The forecasts in the May 2022 Budget Economic and Fiscal Update (BEFU) involve major changes compared to those in the December 2021 Half Year Economic and Fiscal Update (HEFU). There were two unanticipated shocks. Omicron Covid proved much more overwhelming than expected and no one anticipated Putin’s invasion of Ukraine with its international impacts, especially (for us) on the prices of hydrocarbons and grains. There are no quarterly figures but the current year ending in June 2022 was a year of two halves.
What swung the game around was the consumer price shock driven by the external events. That it mainly happened in the second half (this year) warns those cheering in the stands that the price rises cannot simply be because of government spending and the Reserve Bank’s monetary stance. Those policies were in place earlier.
As a result of the price shock, Treasury expects per capita private consumption to have fallen in June Year Ending 2022 (2021/2) compared to JYE2021 (2022/3). (Details in the appendix below.) Any average disguises wide variations so the forecasts are consistent with the conclusion that many people are struggling.
Treasury by mid-March must have observed this was going to happen. They were not alone. At the time I was involved in serious – if a little speculative – discussions around the likelihood of recession (fall in economic activity) towards the end of this 2022 year. Apparently, the government decided in March to inject around $2b into private incomes, although the precise package – the $350 for adults with incomes below $70,000 last year and not in receipt of the winter energy supplement – was probably decided later.
So Treasury thinks that private consumption will grow in the 2022/3 year, although it will not grow as rapidly as it did before the Covid pandemic.
The pattern for spending growth of public consumption spending (which does not include transfers or investment) is the opposite to private consumption. In the years before 2019/20 government spending grew slower that GDP (private consumption grew faster). But in the last three years it has grown much faster, partly to deal with the Covid shock, but also because one of the key political differences between Labour and National is their different philosophies about the balance between public and private consumption. However, the unwinding of the Covid spending – cross fingers there is no new Covid shock – means that under current (Labour) policies, public consumption spending is projected to stagnate after this year.
The Treasury thinks that inflation has been mainly driven by domestic demand – probably at tolerable levels but with the dangers of an inflation burst if it gets out of control. Additionally, there has been a boost from global factors, so we are experiencing an extra price shock, not the beginning of stagflation – ongoing price rises and high unemployment. It thinks price increases will remain high in 2022/3 but settle down in the 2-3% p.a. range thereafter.
However, their expectation is that economic growth will be sluggish after 2022/3. (This is an issue for another column – when I have worked out what is going on.) Unemployment increases from about 3 percent to 4½ percent. There is a bit of stimulation from export growth (I was surprised that they are expecting import prices to rise faster than export prices in the medium term). Investment is gangbusters next year but stagnates at that higher level after.
Treasury forecasts include upside and downside scenarios reflecting the uncertainty around their judgements about future events. In the upside scenario, disruptions from Covid and the Russian invasion of Ukraine are assumed to recede more quickly, resulting in less persistent inflation, so that monetary policy is tightened less aggressively in response, so that the impact on the real economy is smaller. Unemployment increases only a little and economic growth is slightly faster.
In the downside scenario, more persistent price pressures necessitate a sharper rise in interest rates, weakening GDP growth and pushing up the unemployment rate. The 90-day bill rate almost doubles for a short time and unemployment is up 1½ percentage points – say 40,000 plus workers. The scenario even expects a mild recession in 2022/3 and 2023/4. (The 2023 General Election would be slap in the middle of it.)
In the difficult circumstances we face, the central forecast does not look too bad. I have one reservation. The basic rule is that during a downward shock some have to suffer. Currently it is those hit by the price spike. However, the forecast suggests that should be over soon but the recovery is achieved by charging the future.
Net overseas borrowing rises dramatically. For this year and next it is about 6½ percent of GDP, over double the 3 percent level of the previous decade. In the medium term the borrowing drops back to 4 percent of GDP, still higher than the past level. The Net International Investment Position (roughly net overseas debt) increases from 45 percent of GDP in 2021 to 55 percent in 2026. We have eased the burden of living today by adding to the burden of those living in the future.
I reported that Treasury has carefully considered strategies for the government’s debt. Surely we need to be as thoughtful about the nation’s (public and private) debt.
Appendix. Annual Growth Rates (Per Capita)
Private Public GDP
June Years Consumption Consumption
2011/2-2018/9 2.6% 0.7% 1.9%
2019/0-2021/2 0.5% 7.9% 0.7%
2022/3-2025/6 1.2% -0.3% 1.1%
Source: BEFU 2022, pg 158 (adjusted to per capita)