Thursday, 16 May 2013

Today's Budget - what ifs

By now you'll have seen extensive coverage of the Government's Budget forecasts for GDP, employment, inflation, the exchange rate, and all the rest of it. What you probably won't have seen much of in the media is coverage of the 'what ifs' - what if the Government's forecasts don't pan out? What might happen instead? What would the fiscal books look like if the domestic or global economies did a lot better or a lot worse than the Government expected?

Again, this is one of the questions that is actually addressed in the bundle of bumph that comes with the Budget (specifically, in Chapter 3, 'Risks and Scenarios', in the Budget Economic and Fiscal Update, often known as the BEFU).

The good news is that the economic outlook has picked up since last December's Half Year Economic and Fiscal Update (you guessed it, the HYEFU). Back then, the risks to the outlook had been skewed to the downside - the probability was that if events unfolded in an unexpected way, it would be for the worse, and there were good reasons for that. The finances of the Eurozone's most indebted economies were still in disarray, the US was skidding towards the top of the 'fiscal cliff', and there were worries that China might have been heading for a significant slowdown in its rate of growth. Here at home, the impact of the Canterbury rebuild on economic activity always seemed to be just over the horizon and never actually here yet, and there had been an unexpectedly sharp jump in the unemployment rate. And there wasn't much that looked like springing an unexpected pleasant surprise.

This time round, Treasury reckons - and I think they've got it right - that the risks are more evenly balanced, and that things are as likely to be better than the Government expects as they are to be worse. This, of course, is the same conclusion that the world's equity markets have also come to this year: things aren't as bleak as they looked four or five months ago, and share prices have risen substantially pretty much everywhere as a result.

Why be more optimistic? The US, despite its dysfunctional policymaking, avoided the 'cliff', though it's still a long way from getting out of its partisan policy omnishambles; the Eurozone has made some progress with some of its more indebted problem children, though still has plenty of problems on its plate; China is still growing at a vigorous rate, even if not quite at the rates of before. And at home the Canterbury rebuild is finally showing some legs, and recent economic data (including the unemployment rate) have been notably better than before.

Obviously, there are still risks - the drought could be really bad, a wheel could come off in one of the bigger Eurozone countries, whatever - but there's now as much reason to be optimistic as pessimistic.
It's nice to see, too, that whichever of the Treasury's 'upside' or 'downside' scenarios might actually play out, the economy looks to be in reasonable shape either way. Even on the downside scenario, there's no recession (which, as I mentioned in my April 28 post, 'Recession - what recession?', is also the view of the rest of the forecasting community), and unemployment continues to fall (but more slowly). Treasury notes (correctly) that its 'upside' and 'downside' scenarios don't cover every eventuality - something much better, or much worse, could still happen - but on a sensible guess at the likely range of outcomes, things look reasonably comfortable either way.

If there's any big difference between the upside and downside scenarios, it's on the interest rate front. Treasury's central forecast is that the 90 day bank bill yield will stay around its current 2.7% for another year or so, and then gradually rise to 4.8% by March 2017. If the economy does really well, though, house prices will rise more sharply, inflation pressures will pick up, and we'll hear a more forceful message from the Reserve Bank, with the 90 day bank bill yield rising to 6% rather than 4.8%.

Obviously, a really good burst of economic growth would be terrific for everyone. Just don't expect to continue to get dirt-cheap mortgages if we have one.

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