Abstract
Selected Issues
Trade, Net Migration and Agriculture: Interactions Between External Risks and the New Zealand Economy1
A. The Interaction of External Risks and Linkages in New Zealand
1. As a small open economy, New Zealand is vulnerable to external risks, a concern at a time when downside risks to the global economy have increased. The risks of greatest concern are those that would involve New Zealand’s key external linkages – trade in tourism and education services, trade in agricultural goods, and external wholesale funding of its banks – or key trading partners and markets – Australia, China, and global markets for agricultural goods. In this paper, the external risks related to trade are examined, using the Australia-New Zealand Integrated Monetary and Fiscal Model (ANZIMF), a version of GIMF, the IMF’s Global Integrated Monetary and Fiscal model (Box 1).
2. This paper considers three channels for New Zealand’s external linkages.
1) New Zealand is a large-scale agricultural exporter of agricultural goods, especially dairy products (Figure 1). Agricultural exports account for over 13 percent of New Zealand’s GDP.
2) New Zealand is a large exporter of tourism and education services, referred to hereafter as services. While it has a diverse clientele for both, its largest relationships are with Australia and China (Figure 2). Export links with Australia tend be strongest for services, while those for China tend to involve more agricultural goods.
3) Net immigration is a third source of external linkages, which has become increasingly important in the past five years. A novel feature of this paper is to consider the additional impacts from potential changes in net migration arising from the risks under consideration. Net migration into New Zealand, while slowing, is still near record-high levels. It is in part driven by external factors. Students coming to school in New Zealand (many from Australia and China) are staying as permanent residents afterwards. Australia also accounts for other migration flows – not just of Australian citizens but also returning New Zealand citizens who left when the domestic economy was relatively weaker.
New Zealand’s Agricultural Exports
(Percent of New Zealand GDP)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Sources: StatsNZ, UN COMTRADE, and IMF staff calculations.New Zealand’s Services Exports
(Percent of GDP)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Sources: OECD.stat EBOPS 2010 database, StatsNZ, and IMF staff calculations.ANZIMF – The Australia-New Zealand Integrated Monetary and Fiscal Model
ANZIMF is an annual, multi-region, micro-founded general equilibrium model of the global economy. It is based on the IMF’s Global Integrated Monetary and Fiscal model (GIMF), with supporting documentation that is broadly applicable to ANZIMF (Kumhof and others, 2010, and Anderson and others, 2013). Structurally, each country/regional block is close to identical, but with potentially different key steady-state ratios and behavioral parameters (Table 1). This exercise focuses on New Zealand.
Consumption dynamics are driven by higher-income, saving households and non-saving, lower-income households. Saving households face a consumption-leisure choice, based on the overlapping generations (OLG) model of Blanchard (1985), Weil (1989) and Yaari (1962). Households treat government bonds as wealth since there is a chance that the associated tax liabilities will fall due beyond their expected lifetimes making the model non-Ricardian. The long-term real global interest rate, therefore, is endogenous and equilibrates global savings and investment. The real exchange rate serves to adjust each country’s saving position (its current account and associated stock of net foreign assets) relative to the global pool. Non-saving, lower income households must consume all their income each year, amplifying the model’s non-Ricardian properties in the short term.
ANZIMF Expenditure Accounts Calibration
ANZIMF Expenditure Accounts Calibration
| New Zealand | Australia | China | Rest of Asia | United States | ||
|---|---|---|---|---|---|---|
| Share of Global GDP (Percent) | 0.23 | 1.7 | 15.1 | 14.6 | 24.4 | |
| Domestic Demand (Percent of GDP) | ||||||
| Household Consumption | 60.4 | 55.1 | 54.5 | 58.7 | 62.0 | |
| Private Investment | 16.3 | 21.3 | 25.0 | 21.0 | 18.2 | |
| Government Absorption | 23.3 | 23.6 | 20.5 | 23.0 | 19.8 | |
| Consumption | 19.5 | 19.8 | 13.5 | 20.0 | 16.3 | |
| Investment | 3.8 | 3.8 | 7.0 | 3.0 | 3.5 | |
| Trade (Percent of GDP) | ||||||
| Non-Commodity Exports | 14.1 | 19.1 | 17.4 | 26.3 | 13.7 | |
| Goods | 11.7 | 17.6 | 17.0 | 24.2 | 12.8 | |
| Services | 2.4 | 1.5 | 0.4 | 2.1 | 0.9 | |
| Non-Commodity Imports | -21.0 | -25.1 | -17.3 | -25.5 | -13.7 | |
| Goods | -19.4 | -23.1 | -16.5 | -23.6 | -13.2 | |
| Services | -1.6 | -2.0 | -0.8 | -1.9 | -0.5 | |
| Net Agriculture | 11.0 | 1.9 | 0.1 | -1.2 | 0.3 | |
| Key Parameters | ||||||
| Percent share of LIQ households | 25 | 25 | 25 | 40 | 25 | |
ANZIMF Expenditure Accounts Calibration
| New Zealand | Australia | China | Rest of Asia | United States | ||
|---|---|---|---|---|---|---|
| Share of Global GDP (Percent) | 0.23 | 1.7 | 15.1 | 14.6 | 24.4 | |
| Domestic Demand (Percent of GDP) | ||||||
| Household Consumption | 60.4 | 55.1 | 54.5 | 58.7 | 62.0 | |
| Private Investment | 16.3 | 21.3 | 25.0 | 21.0 | 18.2 | |
| Government Absorption | 23.3 | 23.6 | 20.5 | 23.0 | 19.8 | |
| Consumption | 19.5 | 19.8 | 13.5 | 20.0 | 16.3 | |
| Investment | 3.8 | 3.8 | 7.0 | 3.0 | 3.5 | |
| Trade (Percent of GDP) | ||||||
| Non-Commodity Exports | 14.1 | 19.1 | 17.4 | 26.3 | 13.7 | |
| Goods | 11.7 | 17.6 | 17.0 | 24.2 | 12.8 | |
| Services | 2.4 | 1.5 | 0.4 | 2.1 | 0.9 | |
| Non-Commodity Imports | -21.0 | -25.1 | -17.3 | -25.5 | -13.7 | |
| Goods | -19.4 | -23.1 | -16.5 | -23.6 | -13.2 | |
| Services | -1.6 | -2.0 | -0.8 | -1.9 | -0.5 | |
| Net Agriculture | 11.0 | 1.9 | 0.1 | -1.2 | 0.3 | |
| Key Parameters | ||||||
| Percent share of LIQ households | 25 | 25 | 25 | 40 | 25 | |
Private investment relies on the Bernanke-Gertler-Gilchrist (1999) financial accelerator. Investment cumulates to the private capital stock for tradable and nontradable firms, which is chosen by firms to maximize their profits. The capital-to-GDP ratio is inversely related to the cost of capital, which is a function of depreciation, the real corporate interest rate, the corporate income tax rate, and relative prices, and an endogenously determined corporate risk premia.
Government absorption consists of exogenously determined spending on consumption goods and infrastructure investment. Both affect the level of aggregate demand. Spending on infrastructure cumulates into an infrastructure capital stock (subject to a constant but low rate of depreciation). A permanent increase in the infrastructure capital stock permanently raises economy-wide productivity.
Trade is tracked bilaterally between all regions. There are flows for goods, services, and agricultural goods, and they react to demand, supply and pricing (i.e., the terms of trade and bilateral real exchange rates) conditions. Agricultural goods trade, and its related demand and supply equations, are based on a broad array of products, as New Zealand has strong exports for dairy products, meat, and fruit.
The nominal side of the economy depends on implicit Phillips’ curves and monetary policy. The core price is the consumer price index (CPI), while relative prices mimic the structure of the national expenditure accounts. There is also wage inflation, which is implicitly a key driver for CPI inflation. In the short term, the nominal side of the economy is linked to the real side through monetary policy, which is conducted under a CPI inflation targeting regime, where with an interest rate function returns expected inflation to target over several years.
Fiscal policy is driven by a sufficiently detailed government sector that can reproduce simplified fiscal accounts for each country. Fiscal policy aims to maintain a debt target (expressed in flow space as a deficit target), using at least one of seven policy instruments available in the model. On the spending side, they are government consumption, infrastructure spending, general lumpsum transfers to all households (such as pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ households (such as welfare, certain pensions). On the revenue side, the instruments are taxes on consumption (the goods and services tax, GST), personal income (PIT) and corporate income (CIT).
Relative to standard versions of GIMF, this model contains sectors for agriculture and for services. The data definition for the agriculture sector in this application covers all agricultural goods, but the focus for New Zealand is on dairy with significant contributions from meat (lamb and beef) and fruit (kiwi fruit). Similarly, the definition of services is restricted to tourism (mostly travel, accommodation, and food services) and education (mostly travel and correspondence courses).
The agriculture sector. The U.S. dollar global agriculture price is determined when producing countries sell in a global market, from which all countries then compete for their demands based on price. Countries produce agricultural goods from their endowment. Supply moves in tandem in the short term with the gap between the current and medium-term average global price and reacts (optionally) to demand-driven long-term changes in the global price. Both the short- and long-term price elasticities of supply are 0.40. Net export flows are explicitly tracked, although it is possible from the structure of the model to deduce the bilateral flows. Agricultural goods are part of consumption and inputs to both tradable and non-tradable intermediate goods production (much more for tradables).
The services sector. Services are produced from tradable and nontradable goods. They are priced as an input for consumption in New Zealand or exported to be consumed by foreigners. Services are exclusively part of consumption, and their demand vis-à-vis consumption goods is relatively inelastic. Consumption of services is a combination of services provided domestically or abroad. This allows for a final price of services that will enter the CPI, much as consumption services combines with the consumption of goods to define final household consumption.
New Zealand: Trade Patterns in ANZIMF
(Percent of New Zealand nominal GDP)
New Zealand: Trade Patterns in ANZIMF
(Percent of New Zealand nominal GDP)
| Category for New Zealand | Australia | China | Global | |
|---|---|---|---|---|
| Aggregate Exports | 4.5 | 5.0 | 27.5 | |
| Agriculture | 1.2 | 2.6 | 13.4 | |
| Tourism and Education Services | 0.3 | 0.4 | 2.4 | |
| Goods and Other Services | 3.0 | 1.9 | 11.7 | |
| Aggregate Imports | 3.4 | 5.4 | 27.5 | |
| Agriculture | 0.5 | 0.1 | 2.4 | |
| Tourism and Education Services | 0.2 | 0.4 | 2.0 | |
| Goods and Other Services | 2.7 | 4.9 | 23.1 | |
New Zealand: Trade Patterns in ANZIMF
(Percent of New Zealand nominal GDP)
| Category for New Zealand | Australia | China | Global | |
|---|---|---|---|---|
| Aggregate Exports | 4.5 | 5.0 | 27.5 | |
| Agriculture | 1.2 | 2.6 | 13.4 | |
| Tourism and Education Services | 0.3 | 0.4 | 2.4 | |
| Goods and Other Services | 3.0 | 1.9 | 11.7 | |
| Aggregate Imports | 3.4 | 5.4 | 27.5 | |
| Agriculture | 0.5 | 0.1 | 2.4 | |
| Tourism and Education Services | 0.2 | 0.4 | 2.0 | |
| Goods and Other Services | 2.7 | 4.9 | 23.1 | |
3. This paper considers how external risks affect New Zealand through the three spillover channels.2 The components and magnitudes of the risk scenarios are illustrative only. Their results are presented relative to a baseline forecast consistent with the IMF’s World Economic Outlook. The risk scenarios address three configurations of spillovers to New Zealand:
Section B: Spillovers through all three channels, by considering a growth slowdown in China. It includes exacerbating impacts from net migration and also considers potential roles and interactions for New Zealand’s monetary and fiscal policies.
Section C: Spillovers through the net migration channel, by considering an illustrative growth slowdown in Australia.
Section D: Spillovers from lower global agricultural prices caused by demand or supply factors, contrasted with impacts from domestic supply factor.
Section E concludes.
B. Spillovers from a Growth Slowdown in China
4. Global trade tensions could result in a broad-based growth slowdown in China. This risk scenario considers the possibility that global trade tensions could disrupt the ongoing structural reform process. In that case, China’s real GDP would be significantly lower than expected under current baseline forecasts, along with most components of GDP. However, exchange rate and terms of trade adjustments would mitigate the impact on New Zealand’s GDP, although domestic demand would contract.
A Growth Slowdown in China3
5. China would experience substantially weaker real GDP growth under this scenario (Figure 3).4 Real GDP growth would be about 1 percentage point lower than in the baseline in the short term, and about 0.6 percent lower for nine years. In the long term, the level of real GDP would be 11.9 percent lower relative to the baseline. Two-thirds of the decline would be from lower productivity, which leads to higher production costs and lower production capacity compared to the baseline. China’s goods would be more expensive and would experience reduced foreign demand. Inflation in tradable goods prices would be even weaker than before, being 1.0 percent lower by the third year, and would only return to baseline after ten years. Lower inflation in China would result in a negative inflation impulse to countries that import substantial quantities of Chinese goods, such as New Zealand.
Growth Slowdown in China – Outcomes in China
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value. Source: IMF staff calculations.6. Household consumption would be considerably lower in this scenario. The decline in house prices would decrease household wealth, while the lower productivity would reduce firms’ labor demand and, consequently, labor income, wealth, and consumption. Consumption growth would be around 0.2 to 0.5 percentage points weaker than that of real GDP growth. Imports would also be lower, including imports of agricultural goods. The latter would result in lower global prices for agricultural goods of almost 1 percent on impact and of 2.1 percent in the long term.
Spillovers to New Zealand
7. New Zealand would experience strong spillovers through trade channels (Figure 4). The China-led fall in global agricultural prices would reduce the value of New Zealand’s production, although lower prices would also shore up foreign demand outside China and New Zealand. A real depreciation of the New Zealand dollar would mitigate the impact on exports over time. New Zealand’s tourism and education exports would be 1.6 percent lower in the short term, for example, but would decline by only 1.0 percent in the long term. The impact on agriculture and services would be a wealth shock, and lead to a depreciated REER. Therefore, while goods exports would be 1.1 percent longer in the short term, goods exports would be 0.5 percent higher in the long term.
Growth Slowdown in China – Spillovers to New Zealand
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value. Source: IMF staff calculations.8. Economic activity would contract in the short term but would return to baseline in the long term because of expenditure switching. The lower agricultural goods prices lower New Zealand’s wealth and consumption, with the latter being 0.9 percent lower relative to baseline in the long term. But given the behavior of exports, real GDP would contract by only 0.2 percent on impact and be broadly unchanged relative to baseline in the long term.
How Lower Net Migration Could Exacerbate the Negative Impact on New Zealand
9. A growth slowdown in China could have the additional impact of reducing Chinese student migration into New Zealand (Figure 5). A part of New Zealand’s services exports is consumed in the country by temporary residents, namely exports of education services. In recent years, this type of export has also contributed to increases in net migration into New Zealand because students obtain work permits after graduation. Here, the net migration of Chinese students is assumed to decline in line with the economic slowdown. The combination of lower consumption in China and a shift in preferences toward domestically produced goods and services might well result in fewer Chinese students attending school in New Zealand. This would not only reduce services exports but could also mean fewer students remaining in New Zealand after graduation. Currently, 17 percent of net migration comes from China in New Zealand. In the scenario below, it is assumed New Zealand’s population is 0.1 percentage points lower per year for 10 years – approximately 40 percent of the share of New Zealand’s net migration inflow coming from China.
Growth Slowdown in China – Net Migration Effects in New Zealand
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value. Source: IMF staff calculations.10. The shock to net migration would operate through its impact on labor supply. It would decrease the productive capacity of New Zealand and increase wage pressures. Given the lower long-term labor supply, demand for capital would be less, so investment would be 0.2 (short term) to 0.7 percent (long term) weaker relative to the scenario without the net migration effects. Wealth would be lower, leading to household consumption being 1.8 percent lower instead of 0.9 percent. Pressures from consumption and investment would reduce imports, decreasing the short-term current account deficit before the long-term re-equilibration from the change in the REER.
11. The fall in net migration would exacerbate the negative spillovers to New Zealand from China. Real GDP would now be 0.7 percent lower than baseline in the long term. Short-term losses in the economy would be confined largely to the domestic sector. In the long term, the external sector would not be as strong, as the REER would depreciate less (only 0.9 percent) because of stronger real wages relative to the case without changes net migration. Services exports would be 1.6 percent lower relative to baseline, compared to 0.7 percent under the case without changes in net migration.
The Interaction of Monetary and Fiscal Policy
12. A need for a fiscal policy response to an economic downturn in New Zealand is becoming more likely than it has been in the past. The global risk profile is increasingly tilted to the downside, at a time when the Reserve Bank of New Zealand’s (RBNZ) policy rate is already at a low of 1 percent. If a major risk realized, the effective lower bound (ELB) on nominal interest rates might be more likely to become a constraint on monetary policy. This section considers the effects of a fiscal policy response to a slowdown in China with the policy rate at the ELB. The effects on New Zealand would be relatively small if the RBNZ could cut the policy rate but much larger if it could not (Figure V.1, blue versus red lines).
13. The effectiveness of a fiscal policy response would depend on the instruments used. Depending on the instruments, the multipliers of the discretionary fiscal policy response would be different. Two options at the opposite end of the spectrum of the multipliers are considered below:5
Lower Multipliers, Quicker to Deploy: Increased government consumption spending and a GST rate cut.
Higher Multipliers, Slower to Deploy: Increased government infrastructure investment and GST rebates targeted to lower-income households.
Each pair of fiscal instruments would be changed by 0.5 percent of GDP relative to their original paths for five years (Figure 6, green solid and dashed lines). As aggregate demand increased and led to inflationary pressures, it is assumed that the monetary authority would not increase the overnight cash rate even if inflation were to enter its target range in later years.
Growth Slowdown in China with Various New Zealand Policy Options
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Source: IMF staff calculations.14. Both forms of fiscal stimulus would have the same qualitative effects. The additional stimulus would push up inflation between 0.5 to 0.8 percentage points by the fifth year, thereby reducing the real interest rate and stimulating the economy. It would also increase the government-debt-to-GDP ratio, but by a manageable amount – only between 2.0 to 2.5 percent of GDP after 5 years. This is lower than what the cumulation of the deficits over the same period would seem to imply at first consideration, because the stronger nominal growth provided by the stimulus would increase the denominator of debt-to-GDP ratio relative to baseline.
15. In the case of the lower-multiplier fiscal stimulus, there would be a multiplier for real GDP of 0.7 on impact. Real GDP would peak at 1.0 percent higher in the fifth year, relative to the growth slowdown in China constrained by the ELB and no additional fiscal policy response. Government spending would automatically increase aggregate demand. The temporary cut in the GST rate would only increase consumption for lower-income, non-saving households. Higher-income saving households consume smoothly from their stock of wealth, so the GST rate cut would add little to household wealth and have no discernible effect on households’ level of consumption.
16. In the case of the higher-multiplier fiscal stimulus, there would be a multiplier for real GDP of 1.1 on impact. Real GDP would peak at 1.6 percent higher in the fifth year, relative to the growth slowdown in China constrained by the ELB and no additional fiscal policy response. Public infrastructure investment, besides increasing aggregate demand, would increase productivity over the medium-to-long term. This would encourage more short-term private investment and increase the economy’s productive capacity for an extended period. A larger share of a targeted GST rebate would likely be spent compared to a general GST rate cut, as it would affect only households that would benefit strongly from such a rebate. There would be the risk that infrastructure investment could not be increased as rapidly as depicted here.
17. New Zealand’s openness would mean that either fiscal stimulus package would effectively induce a “fiscal devaluation.” The REER would depreciate between 0.4 and 0.6 percent more than the case without fiscal stimulus. A fiscal devaluation would stimulate the economy through the export channel.
18. In both cases, there would be a fair degree of leakage to abroad from the fiscal stimulus. In New Zealand’s open economy, a significant portion of the fiscal stimulus would be spent on imports. There would be a higher current account deficit (higher imports for consumption and investment, or conversely, higher investment and government dissaving) of between 0.2 and 0.3 percentage points of GDP. Other more-closed economies might have higher multipliers from the same package, and smaller increases in their current account deficits.
19. The effects of New Zealand’s fiscal stimulus would be reinforced if there was to be simultaneous fiscal stimulus elsewhere in Asia and Australia (Figure 7). The fiscal stimulus in other economies would have some positive spillovers through trade channels, and further stimulate aggregate demand. This is in turn, in the presence of monetary accommodation, would allow for a lower real interest rate and greater REER depreciation, which would further stimulate aggregate demand.
Growth Slowdown in China with Fiscal Stimulus in Different Economies
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Source: IMF staff calculations.C. Spillovers from the Interplay of Net Migration and the Australian Economy
20. Because of New Zealand’s deep economic links with Australia, a growth slowdown in Australia might have large impacts on New Zealand. This includes the Trans-Tasman Travel Arrangement, which allows free movement of labor between the two countries. In any slowdown originating in Australia, net migration could potentially play a large role – a factor not often considered for many countries, given the unique relationship and patterns of population movements between Australia and New Zealand over time.
A Growth Slowdown in Australia
21. In this illustrative scenario, Australia’s real GDP growth would be substantially weaker (Figure 8).6 Real GDP growth would be lower by about 3 percentage points on impact, and continue to be negative, subtracting around 0.5 percentage points off growth for another 9 years, such that real GDP would be 9.3 percent lower in the long term. Over 20 percent would be attributable to lower population growth from lower net migration. Lower population and productivity would reduce the productive capacity of the economy, and lead to higher marginal costs and inflation. Exports would become more expensive to produce. This would induce the Reserve Bank of Australia (RBA) to cut interest rates, and there would be a short-term 2 percent REER depreciation before being reversed by the continuing negative productivity shock. Therefore, foreign demand would eventually fall after its initial positive reaction to the short-term depreciation and help drive the REER to appreciate by 4.3 percent in the long term.
Growth Slowdown in Australia – Outcomes in Australia
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.22. Imports would weaken with the economy. Lower housing prices would subtract from financial wealth, restricting consumption, reinforced by lower productivity and population. Demand for tourism and education services would be reduced by 5.9 percent on impact, falling to 9.8 percent lower, before settling at only 4.7 percent lower. Agricultural imports are much less important for Australia than China, particularly from New Zealand, so the impact would only be around 0.2 percent of GDP in the short term, approaching 0.3 percent in the long term.
Spillovers to New Zealand
23. To understand the spillovers to New Zealand, it is useful to compare its relationship with Australia versus China. The relative impacts should reflect the magnitudes of the growth slowdowns under consideration – that of Australia (9.3 percent of GDP in the long term) would be less than that of China (11.9 percent of GDP in the long term). Spillovers would also reflect that trade linkages are stronger with China than Australia. In the context of ANZIMF, the relationship is close to that in the data in 2016 (Table 2). Moreover, shocks emanating from China are more likely to move global prices than those from Australia as China is more than nine times the size of Australia in terms of nominal U.S. dollar GDP.
24. New Zealand’s exports would be lower (Figure 9). New Zealand’s services exports would be about 0.4 percent lower (0.6 percent in the long term), much less than in the China growth slowdown considered above, and in line with the composition of New Zealand exports. Similarly, goods exports would be roughly 1.3 percent lower (0.4 percent in the long term). Net agricultural exports would be broadly unchanged, because Australia has weaker demand for New Zealand agricultural goods than China, and no significant impact on global agricultural prices, unlike China.
Growth Slowdown in Australia – Spillovers to New Zealand
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.25. These factors would weaken the domestic economy and real GDP would be 0.1 percent lower in the short and long terms. The fall in exports would reduce productive capacity and labor demand. The depreciation would discourage imports of consumption and investment goods. Overall, consumption would fall by 0.6 percent. Because of weaker inflation from aggregate demand, monetary policy would provide some short-term stimulus with lower real interest rates. There would be a short-term 0.1 percent of GDP deterioration in current account. In the long term there would be little impact on the current account as there would be a rebalancing between the domestic and external sectors, facilitated by a REER that would be 0.2 percent lower on impact, and 0.4 percent lower in the long term.
How Net Migration Could Improve Outcomes for New Zealand
26. The results presented above do not account for the unique net migration patterns between Australia and New Zealand, which could potentially offset the negative impacts on New Zealand (Figure 10). This can be illustrated by attributing 20 percent of Australia’s lower population growth to higher net migration to New Zealand, Real GDP would expand steadily at about 0.2 percent per year, reaching 2.0 percent higher than baseline in the long term. The short-term benefits would be confined largely to the domestic sector. However, the external sector would also benefit in the long term as productive capacity would expand beyond domestic demand needs. Consequently, the REER would depreciate by 1.5 percent relative to baseline (instead of 0.4 percent). However, there would be little effect on the agriculture sector, as it would still be operating at capacity.
Growth Slowdown in Australia – Net Migration Effects in New Zealand
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.27. The impacts would come from the net migration shock increasing labor supply. It would directly increase the productive capacity of New Zealand and reduce wage pressures. Moreover, investment would peak at 2.0 percent higher in the short term to build up the capital stock needed to complement labor and would stabilize at 1.6 percent higher in the long term. There would be increased household wealth and 2.2 percent higher consumption. Higher consumption and investment would stimulate imports, increasing the current account deficit by 0.5 percent of GDP (instead of only 0.1 percent of GDP).
D. Spillovers to New Zealand’s Agriculture Sector
28. New Zealand’s agriculture sector faces external risks that differ from those that could originate within the country. At the global level, a decrease in agricultural prices is considered, driven by either a permanent global (excluding New Zealand) supply increase or demand decrease of 10 percent for agricultural goods. These are contrasted against a supply decrease within New Zealand alone because of a sustained drought that lowers agricultural output by about 6 percent for 2 years before starting to recover.
Global Risks from Both Supply and Demand
29. In the long term, the global price would be 2.7 percent lower from either a global supply increase or demand decrease (Figure 11, red and green lines). Overall, the long-term effects would be similar between demand and supply shocks. In the short term, demand would move sluggishly in response to higher supply, because it would need the lower price to clear the market. Volume supplied would be assumed to be fixed in the long term. There would be short-term supply changes in response to price changes. Since the global price must fall to re-equilibrate global demand and supply, it would return demand to its baseline levels in the demand shock, whereas in the positive supply shock it would lift demand to absorb the additional supply.
Agriculture Sector Risk Scenarios
(Deviations from WEO-consistent forecasts)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A001
Note: The bar marked “SS” is the steady-state value.Source: IMF staff calculations.30. From the perspective of New Zealand, it only would experience a negative wealth shock from lower prices. In the short term, there may be some fall in production which could slow the fall in prices, but in the end, production would remain unchanged. Consumption would be weaker from the wealth effect – 0.5 percent in long term, but substantially more at 1.0 percent in the short term for the global supply shock. As households would need time to adjust their demand to lower wealth, they would also dissave in the short term. This would lead to a higher current account deficit by 0.5 percent of GDP and a REER depreciation of 1.2 percent under the global supply shock, but a nearly unchanged current account deficit and a REER depreciation of only 0.7 percent under the global demand shock.
31. There would be a long-term rebalancing of the domestic and external sectors. Long-term real GDP would be roughly unchanged, even after the initial short-term negative impact from the rapid current account deterioration in the global supply risk scenario. In the medium term, the REER depreciation would lead to higher non-agricultural exports of about 1.3 percent.
How Domestically-Driven Risks Have Different Outcomes
32. For a domestically-driven risk such as a sustained drought in New Zealand, the outcomes would be markedly different (Figure 11, blue lines). One hand, the real GDP loss would be less, at only 0.4 percent on impact. However, the external sector would be much weaker from lower exports, with a higher current account deficit of 0.8 percent of GDP. There would be little impact on the global agricultural price. First, the drought is assumed to be only temporary, but more importantly, New Zealand is only a small global player, despite the large importance of agriculture in the domestic economy. Consequently, there would be little short-term mitigation from the 0.4 percent REER, depreciation, and there would be no significant external-domestic sector rebalancing.
E. Conclusions
33. The current set of external risks have the potential to be extremely damaging to New Zealand, but two factors would likely mitigate the economic impact. First, the flexible exchange rate regime is a reliable shock absorber and automatic stabilizer from the perspective of real GDP, although it leads to a rebalancing between the domestic and external sectors in the economy. Second, net migration flows can reduce the negative impact of lower external demand under some circumstances, such as a growth slowdown in Australia. However, this is not a reliable stabilizer – the magnitude of net migration is subject to many factors, plus it can also reinforce negative impacts, such as the example of a growth slowdown in China.
34. Fiscal policy could also offset some of the short-term costs of adjustment. Fiscal policy can provide stimulus at relatively small and manageable cost to the already-low government debt to GDP ratio. Moreover, at the current juncture, fiscal policy might need to provide the bulk of policy support against negative shocks, as monetary policy might be ineffective if has become constrained by an effective lower bound on the monetary policy interest rate.
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Annex I. Key Assumptions Underlying the Simulations
Key Model Assumptions for ANZIMF
1. All agents in the model (including households, firms and the fiscal and monetary authorities) have perfect foresight.
2. The model has non-linearities in the financial accelerator, and potential for non-linearities in the conduct of monetary policy by either encountering the zero-interest-rate floor (the effective lower bound, ELB) or using monetary accommodation. Otherwise, the model is approximately linear for small enough shocks.
3. All countries in ANZIMF have the same economic structures, differing only through their parameterization and calibration.
4. The baseline calibration of ANZIMF is based on parameter values consistent with 2017 for the great ratios to GDP such the capital stock, government debt and deficit, net foreign assets and current account balance, and national accounts aggregates as well as trade flows, and 2016 and 2017 for services data.
5. The real exchange rate is a “jumper,” adjusting immediately in the first year to shocks, since it follows the standard forward-looking, risk-adjusted uncovered interest rate parity condition which equates the forward sum of Australia-international interest rate differentials with the one-year in the exchange rate. However, there is no financial friction in the equation required to bring the net foreign asset position to its steady state, as the net foreign asset position and its dynamics solve endogenously as part of the OLG framework.
6. The agriculture sector is a global market with one global price.
7. China has a flexible exchange rate, with no capital controls. Capital controls are hard to model in this context, and in the current environment, it is not clear that China would always impose them if there were to be sudden movements in elements of the balance of payments.
8. There are no substantial financial market channels. ANZIMF only has a financial accelerator (albeit using the full general equilibrium form with non-linearities) and assumes complete domestic ownership of firms. All net foreign asset positions are denominated in U.S. dollars, in all countries. Some financial channels could be mimicked by correlated, exogenously-specified shocks.
9. The model is at an annual frequency, so degree of detail for some of the economy’s dynamics are lost, particularly in the first year for investment.
Risk Scenario Assumptions
The risk scenarios result from shocks originating in China. Australia and the rest of the world interact with spillovers that are either direct, via third countries, or via the global agricultural goods market.
Growth Slowdown in China
The scenario is composed of four separate shocks in China:
1. Lower productivity. Permanent 5 percent reduction in tradables and nontradables productivity. Phased in as a -2 percentage points on productivity growth in year 1, and -1 percentage point on growth in years 2 through 4.
2. Lower housing wealth. 10 percent decline on impact in year 1 in nontradable sector net worth, to proxy for the permanent fall in the value of the housing stock.
3. Increased corporate risk premia. Permanent 0.5 percentage point increase in the corporate risk premia for both tradable- and nontradable-producing firms. Phased in by year 4, declining from an initial 2 percentage point increase on impact in year 1.
4. Lower agricultural goods demand. Permanent 5 percent reduction in demand for agricultural goods. Phased in over 5 years.
Additional Net Migration Effect in New Zealand. There are permanently fewer migrants to New Zealand from China. There is a 0.1 percent reduction in labor force growth for 10 years in New Zealand, so that the New Zealand population is permanently 1.0 percent lower.
The Interaction of Fiscal and Monetary Policies in New Zealand. The overnight cash rate (the RBNZ’s monetary policy rate, and ANZIMF’s short-term interest rate) is assumed to be unchanged for 5 years and is expected each year to be unchanged until the end of the following year. There are two different configurations of fiscal stimulus presented.
1. Higher-multiplier fiscal stimulus. 5-year, 0.25 percent of baseline GDP higher spending on government infrastructure investment. 5-year 0.25 percent of baseline GDP rebate of GST revenues to non-saving, lower-income households.
2. Lower-multiplier fiscal stimulus. 5-year, 0.25 percent of baseline GDP higher spending on government consumption (wages, salaries and other operating expenses). 5-year cut in the general GST rate such that government revenues are 0.25 percent of baseline GDP lower each year.
Growth Slowdown in Australia
The scenario is composed of four separate shocks in Australia:
1. Lower net migration. Permanent 2.5 percent reduction in labor force. Phased in over 10 years at 0.25 percentage points per year.
2. Lower productivity. Permanent 2.5 percent reduction in tradables and nontradables productivity. Phased in over 10 years as a -0.25 percentage points per year.
3. Lower housing wealth. 20 percent decline on impact in year 1 in nontradable sector net worth, to proxy for the permanent fall in the value of the housing stock.
4. Increased corporate risk premia. Immediate and permanent 0.5 percentage point increase in the corporate risk premia for both tradable- and nontradable-producing firms.
Additional Net Migration Effect in New Zealand. There are permanently more migrants to New Zealand from Australia. There is a 0.26 percent increase in labor force growth for 10 years in New Zealand, so that the New Zealand population is permanently 2.6 percent higher.
Agriculture Sector
There are three different scenarios under consideration, each consisting of one shock:
1. Higher global agriculture supply. Immediate and permanent 10 percent increase in the global supply of agricultural goods, outside of New Zealand, by increasing the endowment (long-term supply curve).
2. Lower global agriculture demand. Immediate and permanent 10 percent reduction in the global demand for agricultural goods, outside of New Zealand, by reducing the consumer’s preference parameters for agricultural goods directly.
3. Drought in New Zealand. The supply of agricultural goods in New Zealand is reduced by 6.25 percent in years 1 and 2. It takes until year 6 for long-term supply to return to its previous levels. The short-term elasticity of agricultural goods supply is set to 0 in years 1 and 2, so that agricultural goods supply cannot respond to short-term price movements. The elasticity is increased gradually, returning to its original value by year 6.
Annex II. New Zealand’s Fiscal Multipliers in ANZIMF
ANZIMF has seven fiscal instruments. On the spending side, they are government consumption, government investment (infrastructure), lumpsum transfers to all households (such as pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ households (such as welfare, certain pensions). On the revenue side, the instruments are taxes on consumption (the goods and services tax, GST), personal income (PIT) and corporate income (CIT).
Fiscal multipliers can be computed from the change in real GDP in model simulations. ANZIMF can be simulated with a change of one percentage point of baseline real GDP for two years for each fiscal instrument, separately, to provide fiscal stimulus to the economy. Two assumptions for monetary policy can be considered – either the RBNZ sets the overnight cash rate (OCR) to keep inflation within the target range, or it accommodates the fiscal stimulus by leaving the OCR unchanged for two years, so that monetary policy does not crowd out any of the fiscal expansion.
The fiscal instruments act on the economy through direct channels that then feed through the rest of the economy. The only reduced-form effect is the productivity increase induced by an increase in government infrastructure investment. This is calibrated using an estimate of the elasticity of output with respect to infrastructure capital of 0.170 from Bom and Ligthart (2014).
ANZIMF Fiscal Multipliers for New Zealand
ANZIMF Fiscal Multipliers for New Zealand
| First Year | Second Year | |
|---|---|---|
| Normal Conduct of Monetary Policy | ||
| Government Consumption | 0.71 | 0.61 |
| Government Investment | 0.88 | 0.85 |
| Transfers to All Households | 0.10 | 0.08 |
| Transfers to LIQ Households Only | 0.38 | 0.35 |
| Goods and Services Tax | 0.27 | 0.26 |
| Personal Income Tax | 0.24 | 0.23 |
| Corporate Income Tax | 0.18 | 0.21 |
| Overnight Cash Rate Held Fixed for Two Years | ||
| Government Consumption | 0.83 | 0.67 |
| Government Investment | 1.03 | 0.93 |
| Transfers to All Households | 0.12 | 0.09 |
| Transfers to LIQ Households Only | 0.45 | 0.39 |
| Goods and Services Tax | 0.31 | 0.29 |
| Personal Income Tax | 0.29 | 0.26 |
| Corporate Income Tax | 0.39 | 0.37 |
ANZIMF Fiscal Multipliers for New Zealand
| First Year | Second Year | |
|---|---|---|
| Normal Conduct of Monetary Policy | ||
| Government Consumption | 0.71 | 0.61 |
| Government Investment | 0.88 | 0.85 |
| Transfers to All Households | 0.10 | 0.08 |
| Transfers to LIQ Households Only | 0.38 | 0.35 |
| Goods and Services Tax | 0.27 | 0.26 |
| Personal Income Tax | 0.24 | 0.23 |
| Corporate Income Tax | 0.18 | 0.21 |
| Overnight Cash Rate Held Fixed for Two Years | ||
| Government Consumption | 0.83 | 0.67 |
| Government Investment | 1.03 | 0.93 |
| Transfers to All Households | 0.12 | 0.09 |
| Transfers to LIQ Households Only | 0.45 | 0.39 |
| Goods and Services Tax | 0.31 | 0.29 |
| Personal Income Tax | 0.29 | 0.26 |
| Corporate Income Tax | 0.39 | 0.37 |
Spending generally, but not always, provides larger multipliers than tax cuts (Table 3, top half). Government absorption multipliers are most effective, as they enter the measurement of real GDP directly, as well as stimulating the rest of the economy. Infrastructure investment is more effective than regular government spending, as it also raises productivity. Lumpsum transfers targeted to liquidity-constrained (LIQ) households are third-most effective, as they are consumed in full immediately by the targeted recipients. The GST is next, as it affects consumption behavior of all households contemporaneously. PIT applies to all households, but saving households smooth out the extra income as part of their large stock of wealth; only the liquidity-constrained households spend it immediately. CIT has even smaller effects, as its only impact is on firms, who take a longer-term planning view. But coupled with an unchanging OCR, the CIT multiplier exceeds that of the GST and the PIT. Lumpsum transfers to all households have the smallest effect, as the lumpsum transfers to the saving households are smoothed out, in the same manner as a PIT cut. Moreover, lumpsum transfers are nondistortionary, unlike the distortionary PIT.
When the RBNZ accommodates the fiscal stimulus, the multipliers are larger (Table 3, bottom half). Apart from the CIT, the ordering remains unchanged. The multipliers are roughly 15 to 20 percent larger (over 100 percent for the CIT) than with the normal conduct of monetary policy.
The extent and ordering of the multipliers are generally consistent with other countries such as the United States, including other macroeconomic models (Anderson and others, 2013; Coenen and others, 2011). However, magnitudes are smaller, as New Zealand is a small, more open economy that will use a larger share of fiscal stimulus to buy foreign relative to domestic goods and services.
Prepared by Dirk Muir (APD). The chapter benefited from valuable comments by the Treasury of New Zealand and participants at a joint Treasury and Reserve Bank of New Zealand seminar.
This scenario is derived from previous scenarios focused on China (Dizioli and others 2016) and Australia (Karam and Muir 2017)
The growth slowdown in China is based on four shocks. The trade tensions are assumed to result in lower productivity growth of about 0.5 percent per year for 10 years, reducing economy-wide productivity levels by 5 percent in the long term. At the same time, firms would face higher risk premiums, an increase of 0.5 percentage points relative to baseline. House prices in the major urban centers would fall by 10 percent over two years. Demand for imported agricultural goods would decline by about 0.5 percent per year, summing up to levels that are 9 percent lower in the long term, as household preferences would be shifting to local products.
Annex II discusses the multipliers from the seven fiscal instruments available in ANZIMF and orders them from highest to lowest.
This growth slowdown in Australia is based on four shocks. There would be a slowdown in net migration, reducing labor supply about 0.25 percent per year for 10 years. At the same time, there would be a negative shift in expectations around the effects of new technology on the economy, resulting in permanently lower path for productivity, also about 0.25 percent per for year for 10 years. Both factors would contribute to a 20 percent decline in housing prices during the first two years, reducing household wealth and consequently consumption. All three factors would contribute to higher perceived country risk for Australia, which would permanently increase the country risk premium by 0.5 percentage points within a couple of years, further depressing investment.
