Additional fiscal stimulus could risk harder landing: OECD

By NZPA

Wednesday 25th May 2005

Additional fiscal stimulus beyond that already planned could put the economy's projected "soft landing" at risk, the OECD said in its latest report on New Zealand.

Such a scenario would need to be offset by higher interest rates in order to bring the economy back onto a sustainable growth path, the Paris-based agency of rich nations said in its regular report on the economy.

Finance Minister Michael Cullen said the report brought a "refreshing dose of reality" into the tax debate.

"The OECD could not be clearer."

Cullen said the warning reinforced the message that tax cuts would mean higher mortgage and interest rate costs.

The OECD said economic growth had been running ahead of potential, with labour shortages and inflationary pressures mounting.

"Higher interest rates will damp domestic demand through the coming year, although this will be offset by the income effects of the "working for families" package.

"Increased business investment will help ease capacity constraints and pave the way for higher productivity growth and increasing real wages."

It said demand was continuing to be fuelled by a vigorous expansion in government consumption.

The OECD said the seven interest rate hikes since the start of last year should be sufficient to bring the economy back onto a more sustainable path and give the Reserve Bank room to start easing rates slowly during the course of 2006.

"However, its task has been complicated by the fiscal stimulus that has come from additional government spending in 2004 and 2005, and any further relaxation of fiscal policy would need to be offset by higher interest rates."

The Government last week unveiled its sixth budget, which economists said was slightly more stimulatory than had been indicated it the December Economic & Fiscal Update.

Cullen said yesterday that in framing this year's budget, the Government was conscious that it didn't want to put more stimulus into an economy that was already suffering from capacity constraints and the resulting inflationary pressures.

"We did quite consciously look very carefully at the capital spending programme that was building up in the budget round and push some of it out beyond next year on the basis that that could be particularly stimulatory, especially placing pressure on the construction sector," Cullen said.

The OECD said that with the economy close to a turning point in the cycle, monetary judgments are especially difficult: if policy turns out to be too tight, the pace of activity could slow more rapidly and painfully, but if, instead, there remains inflationary pressure in the pipeline, the authorities might need to squeeze markets harder, raising the likelihood of an unwelcome downturn.

"A further risk would be a more pronounced household reaction to the turnaround in house prices."

The OECD is forecasting gross domestic product growth to slow to 2.9% in 2005 and 2.4% in 2006, from 4.8% in 2004.

That compares with Treasury forecasts in the budget of growth slowing from 4.2% in the March 2005 year to 2.3% in 2006 and 2.5% in 2007.

The OECD is forecasting annual inflation to hit 3.2% in 2006 - above the Reserve Bank's 1-3% target band.

"The labour market remains under pressure, with the unemployment rate currently just below 4% and shortages of both skilled and unskilled labour becoming more widespread, despite the significant expansion of the labour force."

The annual current account deficit is forecast at 6.1% of GDP in 2005 and 6.3% of GDP in 2006 - slightly lower forecasts than Treasury's.

"Strong import growth and a significant jump in investment income outflows, reflecting profits of foreign-owned firms, have pushed the current account deficit to high levels," the OECD said.

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