Macroeconomic Outlook

Budget Review 2022–23 Index

Dinty Mather

The purpose of the macroeconomic outlook in 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).

Major economic parameters for domestic economy

Because macroeconomic conditions have improved since the 2021–22 Budget and the Mid-Year Economic and Fiscal Outlook 2021–22 (MYEFO 2021–22), the Australian Government forecasts for key domestic macroeconomic parameters have been revised upwards, as illustrated in Figure 1 below. The revisions are broadly driven by a stronger than expected momentum in labour markets and consumer spending which are expected to offset the COVID-19 pandemic disruptions and other shocks like the recent floods in Queensland and New South Wales, and the Russian invasion of Ukraine.

Figure 1 Forecast and projected key economic parameters for the 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.

The major trends in the macroeconomic parameters are due to the following expectations:

GDP growth recovered after initial COVID-19 lockdown measures and is expected to continue growing, however considerable risks remain where continued growth will rely on the effective management of any future COVID-19 outbreaks.
Forecast GDP growth is expected to drive employment growth and further declines in unemployment.
Moderate wage growth is forecast in response to the impacts of the pandemic, continued spare capacity in the labour market, and low wage increases in new federal enterprise bargaining agreements and state public sector wage caps.
Key commodity prices, particularly iron ore, improved Australia’s terms of trade and supported mining industry profitability which will flow through into nominal GDP and sustained tax receipts for 2022.
Australian growth is not expected to be hampered by the international economy as most of its major trading partners have also experienced a rebound in economic activity after the initial COVID-19 disruptions, but again considerable risks remain with the possibility of further outbreaks.

Modelling results in Budget paper no.1 2021–22, MYEFO 2021–22 and Budget paper no.1 2022–23 all show a nominal GDP growth for 2022–23 (relative to 2021–22) as lower that the real GDP growth for the same relative period. This does not mean that nominal GDP falls; rather it grows at a slower rate for that year relative to the year before because of expected decline in the terms of trade as elevated prices for Australian commodity exports fall.

It is unclear how the Treasury places expected economic impacts of climate change into its models. It seems as if the economic effects of weather events are modelled retrospectively as short term shocks to the baseline economy, and as stated in the Australian Government 2021 intergenerational report:

The effects will depend on domestic and global actions, as well as the pace, extent and impacts of climate change.

With the advent of more frequent climate induced shocks and the ability to measure clear trends of the economic impact of climate change, it is probable that the baseline modelling will be altered to incorporate these trends.

The Parliamentary Budget Office in its online publication 2022–23 Budget snapshot provides an historical time series of the 6 major economic parameters including the performance of past forecasts, as well as other Budget 2022–23 forecasts.

Inflation risk and supply chains

In recent media speculation, much has been made about the potential for inflationary pressures to increase significantly in the short to medium term. The budget forecasts show a temporary increase, which returns to longer run expectations that inflation will remain in the RBA target range. One of the issues with inflation, especially during periods of global and domestic price shock, is the degree to which it is expected to be persistent versus temporary.

A recent publication by the International Monetary Fund (25 March 2022) points out that the COVID-19 pandemic led to pent up demand from huge stimulus packages which overwhelmed the capacity of global supply chains. This caused shipping costs to surge; the costs of shipping a container increased seven-fold in the 18 months following March 2020. The IMF shows that these shipping costs are an important driver of inflation around the world, and that the effects peak after a year and last up to 18 months.

The effects are influenced by the share of imports in domestic consumption and a strong and credible monetary policy. The study concludes that:

the inflationary impact of shipping costs will continue to build through the end of 2022. This will create complicated trade-offs for many central bankers facing increasing inflation and still ample slack in economic activity. Moreover, the war in Ukraine is likely to cause further disruptions to supply chains, which could keep global shipping costs—and their inflationary effects—higher for longer.

According to the Australian Government Productivity Commission (22 July 2021), Australia is not particularly vulnerable to import disruptions and, apart from iron ore, only 1.5% of the value of all goods imported are vulnerable to disruption. Australia also has a strong and credible monetary policy.

However, inflationary pressure around the world due to COVID-19 disruptions, particularly with cost increases in freight, and the war in Ukraine could drive up price levels in Australia leading to inflationary pressure. The duration and persistence of world inflationary pressures is uncertain.

Forecasting and projections

Forecasts are outputs from models that aim to emulate the functioning of the domestic economy within a global context. The modelling outlines expected economic activity for the budget year (2022–23) and the subsequent financial year (2023–24). Beyond the 2023–24 forecasts, projections are based on expectations of the path back to the potential output of the economy. The forecasts determine what is usually called ‘parameter variations’ in fiscal outcomes.

Because models cannot capture the full complexity of the domestic economic system, assumptions must be made about some factors which will influence the parameters. This introduces uncertainty into the forecasts. Budget paper no. 1 2022–23 (pp. 37 and 224) states that the detailed parameter forecasts which drive the fiscal outlook are grouped into 3 key categories—prices, technical inputs and judgement.

Price assumptions for key commodities impact on revenues received by the Government. In general, many prices are expected to decline from current levels by the end of the September quarter 2022, namely:

The iron ore spot price is assumed to decline from US$134/tonne to US$55/tonne free on board (FOB).
The metallurgical coal spot price is assumed to decline from US$512/tonne to US$130/tonne FOB.
The thermal coal spot price is assumed to decline from US$320/tonne to US$60/tonne FOB.
Crude oil prices (TAPIS) are assumed to decline from US$114/barrel to around US$100/barrel.

Technical assumptions, which influence the behaviours of participants in the economy generally, may impact on budget results too, namely:

The exchange rate is assumed to remain around its recent average level—a trade weighted index of around 60.
The $US exchange rate is assumed to remain at around 72 US cents.
Interest rates are assumed to move broadly in line with ‘market expectations’.
Population growth is forecast to be 0.7% in 2021–22, 1.2% in 2022–23 and 1.3% in 2023–24.

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 2022–23 (p. 214) 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 increase in tax receipts of $0.2 billion in the same year. Budget paper no. 1 2022–23: Statement 7 provides further information on confidence interval analyses and sensitivity analyses around the economic parameter forecasts.

With the range of global uncertainties, and the general assumption of returns to lower pricing, there will continue to be significant swings in the parameters which drive the overall fiscal outlook.

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