The Treasury today published two working papers, one focusing on imbalances across the economy and the other on how the Crown's financial position interacts with events in the real economy. Treasury working papers express the views of the authors.
The first, by Macro Policy Senior Analyst Jean-Pierre Andre, is the final in a series of four examining the macro- and micro-economic factors that inhibit productivity growth and contribute to the nation’s economic imbalances. The paper Economic Imbalances: New Zealand’s Structural Challenge, focuses on the implications of persistent imbalances for the economy's resilience.
The paper suggests that, while prospects for the New Zealand economy remain strong, structural economic imbalances from the long-term build up of household and farm debts secured against overvalued property pose a threat to the economy. They do this by potentially magnifying the impacts of a significant future shock. In the event of such a shock, New Zealand's robust institutional arrangements may not always be sufficient to adequately mitigate the impacts as they have to date, especially if property-related debts were to rapidly rise from current levels. Accordingly, the working paper argues that New Zealand’s government should be vigilant in pursuing fiscal and regulatory policies that continue to build resilience through encouraging individuals to strengthen their financial position.
The second working paper is by Craig Fookes, an analyst recently seconded from the Treasury to the International Monetary Fund. It illustrates how new modelling techniques could be used to examine how the Crown's financial position might evolve in the event of large, hypothetical economic shocks.
The paper, Modelling Shocks to New Zealand's Fiscal Position uses scenario analysis and international comparisons to investigate the mechanisms through which a significant decline in the Crown's financial strength could theoretically raise the risk of a liquidity crisis.
One scenario models the impact on the fiscal position of a 7.8 Richter scale earthquake in Wellington (roughly 11 times larger than the September 2010 Canterbury earthquake) with an estimated cost to the Crown of $15 billion over three years. A second scenario examines what could happen to the Crown accounts in the event of a sudden decline in economic growth – calibrated on the experiences of countries like Spain and Ireland heading into, and in the wake of, the 2008-09 global financial crisis. Both scenarios, which are based around the Treasury’s December 2010 half-year economic projections, are hypothetical and have not been modified to take into account lessons from the September 2010 or February 2011 Canterbury earthquakes. It is important to note that research on this paper commenced prior to September 2010 and was completed prior to February 2011.
The modeling work, which helps illustrate how the fiscal picture could evolve in an economic crisis, forms part of a broad work programme underway at the Treasury aimed at improving the Crown's understanding of the wider Crown balance sheet and risk management practice.
Events abroad represent a risk for an indebted country like New Zealand. The author concludes that the types of liquidity pressures that have occurred abroad in recent times do pose potential economic risks to New Zealand.
The indicative results of the early modeling work suggest that, while low Crown debt levels provide a buffer against short-lived shocks, the impact of a more persistent economic shock, such as one that materially impacts on growth, could be expected to fall heavily on the wider population, perhaps through the need for a significant reduction in Crown spending, or the need for increases in Crown revenue, or both.
The latest research is published ahead of a conference to be held in Wellington on 23-24 June on macroeconomic policy issues which is being hosted by the Treasury, in conjunction with the Reserve Bank and Victoria University.
The conference organisers have commissioned three eminent international policy researchers to review aspects of New Zealand's economic performance and policy frameworks and their papers will form the centre-piece of the forum.