In this week's midyear budget review, Joe Hockey's claim to have
found a black hole left by Labor was dishonest, but the revised
forecasts for the economy and the budget deficit are credible and not
the product of political spin.
In other words, there was nothing wrong with the document -
it was prepared with Treasury's and the Finance Department's usual
diligence and professionalism - just with what Hockey said about it.
Paradoxically, Hockey deserves credit for making the budget
document a lot more transparent and informative than it was under Labor.
Some of this is the result of the deal he did with the Greens to remove
the silly Tea Party-style ceiling on government borrowing introduced by
Labor and replace it with a lot more detail about the composition of
the debt. But Hockey has included much more new information than that.
One innovation is that Treasury is now providing ''confidence
intervals'' for its key forecasts. For instance, its forecast is for
real gross domestic product to grow by just 2.5 per cent this financial
year. This means that if Treasury's forecast errors are similar to those
in the past 15 years, there is a 70 per cent probability the actual growth rate will prove to be somewhere between 1.5 per cent and 3.25 per cent.
With that sobering consumer warning, Treasury finds there has
been a ''substantial deterioration'' in the outlook for the domestic
economy just since the pre-election budget review in August. The
economy's transition from resources to non-resource drivers of growth is
now likely to be slower than previously forecast.
''Resources investment is expected to fall more sharply,
while activity in the non-resources sectors has been subdued, with
positive signs in those sectors thus far limited to the established
housing market, above average measures of consumer sentiment and
improving business sentiment,'' it says.
The forecast growth in real GDP of 2.5 per cent in the
present financial year is unchanged since the election, but the
composition of that growth has changed a lot. Forecasts for consumer
spending, home building and business investment are all revised down to
the point where growth in domestic demand (gross national expenditure) has been cut by 0.75 percentage points to 1.25 per cent.
But this is offset by an upward revision in the contribution to overall GDP growth made by external demand (''net exports'' - volume of exports minus volume of imports) of 0.75 percentage points to 1.25 percentage points.
The strong contribution from the external sector comes from
strong growth in mineral exports as the resources boom moves to its
production and export phase. But the upward revision arises because
weaker domestic demand means weaker demand for imports.
Treasury has revised its forecast for growth in real GDP next
financial year, 2014-15, down from 3 per cent (our medium-term trend
rate of growth) to 2.5 per cent. That is, another year of clearly
below-par growth, leading the unemployment rate to keep drifting up to
6.25 per cent.
This expected weaker performance is explained by downward
revisions to forecasts for consumer spending and business investment.
This time, however, it's not offset by an upward revision in the
expected contribution from net exports.
Moving from the economy to the budget, it's obvious that
slower than expected growth in real GDP and slowly rising unemployment
mean slower growth in tax collections and faster growth in government
spending on the dole.
But, as Wayne Swan used to say, we live and pay tax in the nominal
economy, so it's what happens to nominal GDP that has more influence on
the budget, not real GDP. And though the forecast for real GDP growth
in this financial year hasn't changed, the forecast for nominal GDP
growth has been cut by 0.25 percentage points to just 3.5 per cent.
And get this: the forecast for nominal GDP growth in 2014-15 has been cut by a huge 1 percentage point to 3.5 per cent.
Why? Remember, nominal GDP equals real GDP plus inflation. We
already knew that the national accounts, production-oriented measure of
inflation (known as the GDP ''deflator'') would be lower than other,
consumption-oriented measures of inflation because the prices we get for
mining exports are falling.
What's new is the greater weakness in the domestic
economy, which should mean the prices of goods and services produced for
domestic use rise more weakly than expected. In particular, wages growth is expected to be very low. This domestic weakness explains the big downward revision in GDP inflation.
Although most of the deterioration in the expected budget
deficit for this financial year is explained by government policy
decisions (the ones Hockey tried to blame on Labor), for the following
three years the expected deterioration is almost wholly explained by
Treasury's changed economic forecasts and projections.
At present, Treasury forecasts only the next two years. For
the following two it uses mechanical projections based on the assumption
the economy has returned to trend rates of growth. But this can look quite unreal when (as is expected in
2014-15) the economy is a long way from trend in the last forecast year.
This is why Treasury has changed its projection methodology a little,
raising its projections for the unemployment rate in the last two years
from 5 per cent to 6.25 per cent. It's likely to move to forecasting all
four years.
Treasury has also moved to a much more detailed and careful
method of guessing what will happen to mining export prices in future.
Some conspiracy theorists have claimed these changes were
designed to make the outlook for the budget deficit worse than it really
is, to soften us up for big cuts in May.
But the fine print shows the change to unemployment
projections accounts for just $3.7 billion of the four-year total $68
billion worsening in the budget bottom line, while the export prices
change contributes just $2 billion. No conspiracy.
