Budget Review October 2022–23 Index
Dinty Mather
The purpose of the macroeconomic outlook in October Budget
strategy and outlook: budget paper no. 1 2022–23 Statement 2 is to present
the economic forecasts completed by the Australian Government Treasury
(Treasury). These forecasts underlie the Australian Government Budget and are
used to assist in calculating budget year outcomes and projections of
government revenue and expenses over the forward estimates (the fiscal
outcome).
Domestic macroeconomic parameters
Macroeconomic conditions have worsened since the 2021–22
Budget, the Mid-year
economic and fiscal outlook 2021–22 (2021–22 MYEFO), or the 2022–23
March Budget. Accordingly, Treasury forecasts for key domestic
macroeconomic parameters have been revised downwards in the October 2022–23
Budget.
The revisions are largely driven by world events. The International
Monetary Fund’s (IMF) October 2022 Outlook states
that:
Global economic activity is
experiencing a broad-based and sharper-than-expected slowdown, with inflation
higher than seen in several decades. The cost-of-living crisis, tightening
financial conditions in most regions, Russia’s invasion of Ukraine, and the
lingering COVID-19 pandemic all weigh heavily on the outlook.
The continued downward revisions over the past year
illustrate the difficulty of forecasting the development of short term economic
shocks. The revisions to 6 key economic parameters are illustrated in Figure 1
below.
Figure 1 Forecast and projected key economic
parameters for the October 2022–23 Budget, March 2022–23 Budget, 2021–22 MYEFO,
and 2021–22 Budget
Sources: Australian Government, Budget
Strategy and Outlook: Budget Paper no. 1: 2021–22, p. 9; Australian
Government, Mid-Year
Economic and Fiscal Outlook 2021–22, p. 17; Australian
Government, Budget
Strategy and Outlook: Budget Paper no. 1: 2022–23, p. 6; Australian
Government, Budget
Strategy and Outlook: Budget Paper no. 1: October 2022–23, p. 6.
Major trends reflected in the macroeconomic parameters are
due to the following expectations:
- Persistent
inflation and subsequent rising interest rates are expected to put downward
pressure on household spending, leading to a dampened demand for goods and
services in the economy.
- The
current tight labour market is expected to ease as economic activity slows,
resulting in slower employment growth.
- Wages
are forecast to grow in the next 2 years and as inflation dampens, by 2024 real
wages are expected to increase for the first time since early 2021.
- The
upwardly revised growth in nominal GDP is a result of inflation persisting into
2022–23.
- The
highest commodity prices on record during 2021–22, largely reflecting the
disruptions of natural gas flows from Russia to Europe, are expected to remain
high during 2022–23. Prices are then expected fall back to the long term trend,
resulting in a fall in the terms of trade in 2023–24 and creating negative
nominal GDP in that period.
Productivity growth assumptions in Budget
paper no. 1 (p. 6) have been realistically downgraded to reflect a
global trend. Although this assumption increases gross debt and debt servicing,
it is offset by an assumed increase in productivity and participation through
various workforce reforms.
The Parliamentary Budget Office in its online publication 2022–23
October Budget snapshot provides an historical time series of the 6 major
economic parameters including the performance of past forecasts.
Forecasting assumptions, risks, and
sensitivities
Forecasts are outputs from models that aim to emulate the
functioning of the domestic economy within a global context. Macroeconomic
forecasts are notoriously difficult to model from year to year and provide best
attempts to estimate the extent and severity of economic shocks as deviations
from the long term trend.
Because models cannot capture the full complexity of the
domestic economic system, assumptions must be made which will influence the
value of the parameters. This introduces uncertainty into the forecasts
resulting in ‘parameter variations’ in fiscal outcomes. Budget
paper no. 1 (p. 47) states that the detailed parameter forecasts, which
drive the fiscal outlook, are grouped into 3 key categories: prices, technical inputs,
and judgement.
Budget
paper no. 1 (p. 47) sets out price assumptions for key commodities and
their impact on revenues received by the Government. In general, key commodity
prices are expected to decline from current levels by the end of the March
quarter 2023, namely:
- The
iron ore spot price is assumed to decline from US$91/tonne
to US$55/tonne free on board (FOB).
- The
metallurgical coal spot price is assumed to decline from US$271/tonne to
US$130/tonne FOB.
- The
thermal coal spot price is assumed to decline from US$438/tonne to US$60/tonne
FOB.
- Crude
oil prices (TAPIS) are assumed to decline from US$108/barrel to around
US$100/barrel.
Technical assumptions, which influence the behaviours of
participants in the economy, generally impact on budget results too, namely:
- The
exchange rate is assumed to remain around its recent average level – a trade
weighted index of around 61.
- The
US dollar exchange rate is assumed to remain at around 65 US cents.
- Interest
rates in the Treasury forecast are informed by the Bloomberg survey of market
economists.
Expert technical judgements are applied to modelling outputs
to ensure realism. The judgements are about how one part of the economy might
affect other parts of the economy and how the domestic economic system is
affected by events in the international economy.
Forecast errors will always emerge and give rise to a
variance between real outcomes and expected ones. Confidence interval analysis
uses historical errors to assess the degree of uncertainty around current
forecasts. With continued high uncertainty in the world, forecast errors could
potentially be larger than in the past.
Sensitivity analyses are also used to examine uncertainty by
considering a range of values given to the key assumptions. For example,
modelling forecasts stated in Budget
paper no. 1 (pp. 245–46) provide a sensitivity analysis of the iron ore
price on the nominal GDP forecast and tax receipts. Treasury estimates that a
US$10/tonne FOB increase in the iron ore price will result in an increase in
nominal GDP of around $4.4 billion in 2022–23 and an increase in tax receipts
of $0.5 billion in the same year.
Statement 8 of Budget
paper no. 1 provides further information on confidence interval
analyses and sensitivity analyses around the economic parameter forecasts and
how they play out in the fiscal outlook. With the range of global uncertainties
and the general assumption of returns to lower pricing, there will continue to
be significant revisions in the parameter forecasts in the near future and thus
alterations to the overall fiscal outlook and fiscal position.
Modelling climate change
The significant fiscal impact and risk associated with
climate change is well understood and stated in Budget
paper no. 1 (pp. 103–104). However, from an economic forecasting
perspective, which informs the fiscal outcome, it seems as if the economic
effects of weather events, for example the recent October 2022 floods, are
modelled retrospectively as short term shocks to the long term trend (baseline
economy). Although this makes sense, the advent of climate change and the
resulting more frequent and extreme weather events point to a possible change
in the baseline economy. This is complicated to model and as the Australian
Government 2021 intergenerational report states (p. x):
The effects will depend on domestic and global actions, as
well as the pace, extent and impacts of climate change.
Budget
measures: budget paper no. 2: October
2022–23 (p. 190) however provides:
$29.8 million over 4 years from 2022–23 (and $6.9 million per
year ongoing) for the Treasury to restore capability to model climate risks and
opportunities.
Whether the endeavours of the Treasury to extend its capacity
to model climate risks into the base economy will improve accuracy will not be
known until future budget forecast reporting.
Benchmarking
All organisations and individuals base their macroeconomic
models on their own sets of assumptions and expert opinions. However, most
modellers examine the assumptions of others in an attempt to ‘beat the market’
by creating more predictive models. The following figures show competing model
outputs from 5 organisations for 2 key macroeconomic parameters: economic
growth as measured by real GDP and inflation as measured by the CPI.
Caution should be applied when comparing and benchmarking
the October 2022–23 Budget to other forecasts. The current world and domestic
economic situations are volatile, requiring updates and revisions to model
outputs at very short intervals.
The 5 organisations that the October 2002–23 Budget economic
growth and inflation forecasts are benchmarked against are: the March 2022–23
Budget, the Reserve Bank of Australia August forecasts, the IMF October interim
forecast for both the world and the Australian (domestic) economy, Deloitte’s
October Budget Monitor and the Oxford Economics October update.
In general, the current Treasury modelling is within the
bounds of alternative forecasting results.
Figure 2 demonstrates that although forecast macroeconomic
growth to 2024–25 in the October 2022–23 Budget has
been downgraded by 1% from the March 2022–23 Budget, it is within trend with
other forecasting results.
Figure 2 Real GDP forecast benchmarks
Sources: Australian Government, Budget
Strategy and Outlook: Budget Paper no. 1: 2022–23, p. 6; Australian
Government, Budget
Strategy and Outlook: Budget Paper no. 1: October 2022–23, p. 6;
Reserve Bank of Australia, Statement
on Monetary Policy, 5. Economic Outlook, August 2022; Deloitte Access
Economics, Budget Monitor, 11 October 2022, p. 6.; Oxford Economics, World
Economic Prospects Monthly, 12 October 2022; International Monetary Fund (IMF),
World
Economic Outlook: Countering the
Cost-of-Living Crisis, (Washington, DC: IMF, 2022), p. 125.
The results from all the forecasters indicate that
Australian economic growth is expected to be higher than world economic growth
for 2022–23 but lower for the 2023–24 and 2024–25 periods. The IMF explains
that lower than world growth for Australia from 2023–24 is expected because emerging market and developing economies will grow more
strongly than advanced economies.
Subject to further unexpected macroeconomic shocks and
geopolitical risks emerging, there is some consensus that both world economic
growth and Australian economic growth are expected to recover after 2023–24. In
other words, the world and Australian economic slowdowns are expected to last
for at least another year and a half before they recover.
Figure 3 below illustrates that Treasury modelling of
consumer price inflation for the October 2022–23 Budget appears to be broadly
in line with that of other forecasters for 2023–24 and within close bounds for
2024–25.
Figure 3 Consumer price inflation forecast
benchmarks
Sources: Australian Government, Budget
Strategy and Outlook: Budget Paper no. 1: 2022–23, p. 6; Australian Government,
Budget
Strategy and Outlook: Budget Paper no. 1: October 2022-23, p. 6;
Reserve Bank of Australia, Statement
on Monetary Policy, 5. Economic Outlook, August 2022; Deloitte Access
Economics, Budget Monitor, 11 October 2022, p. 6.; Oxford Economics, World
Economic Prospects Monthly, 12 October 2022; International Monetary Fund (IMF),
World
Economic Outlook: Countering the
Cost-of-Living Crisis, (Washington, DC: IMF, 2022), p. 125.
There is a consensus among all forecasters that the
Australian CPI will be lower in all periods than world CPI. Again, this is due
to higher inflation forecasts for emerging market and developing economies compared
to advanced economies.
All online articles accessed October 2022
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