Statement 3: Fiscal Strategy and Outlook
Appendix B: Medium‑Term Analysis Methodology
Medium‑term economic projections
The fiscal aggregates in the 2009‑10 Budget are underpinned by projections of the economy formulated through updated methodology, under which GDP is forecast to grow below trend in the year following the budget year, and projected to grow above trend in the projection years of 2011‑12 and 2012‑13 (see Statement 2).
The medium‑term projections extend this methodology by projecting GDP to grow above trend for a further four years, having the effect of bringing the unemployment rate down by half a percentage point each year until it reaches the non‑accelerating inflation rate of unemployment (NAIRU) of 5 per cent in 2016‑17 (Figure 1). This is consistent with the pace of the mid‑1980s and mid‑1990s recoveries. Once the NAIRU is reached, GDP is assumed to grow in accordance with changes in population, participation and productivity, just as in the intergenerational reports.
Figure 1: Projections methodology in the forward estimates, medium‑term projections
and Intergenerational Report
Source: Treasury.
The medium‑term projections also factor‑in a gradual decline in the terms of trade over a ten year period from 2013‑14. This reflects a judgment that, despite the recent decline in commodity prices, the terms of trade remain at relatively high levels in historical terms. The phase‑down assumes the terms of trade decline by around 15 per cent by 2022‑23 — approximately the same level as their average in the Australia's Low Pollution Future report (Australian Government, 2008).
Receipt projections
The medium‑term receipts are projected by revenue head in a similar way to the forward estimates period, although some simplifying assumptions have been made. The medium‑term receipt projections are based on long‑term demographic and economic projections, which give key income and employment parameters. While the economy is recovering, this approach is more appropriate than adopting a constant tax‑to‑GDP ratio (the methodology used in intergenerational reports for long‑term tax projections) as it accounts for the operation of the automatic tax stabilisers and incorporates the ongoing impact of policy decisions. In accordance with the Government's medium‑term fiscal strategy, the medium‑term projections are formulated on the basis that taxation as a share of GDP will remain below the 2007‑08 level, on average. Taxation as a share of GDP averages 23.8 per cent over the medium‑term period to 2019‑20.
Expenditure projections
Spending is projected to grow at 2 per cent in real terms until the budget returns to surplus, in accordance with the Government's fiscal strategy. Once surplus is reached in 2015‑16, spending is projected in accordance with the methodology used in intergenerational reports. That is, health, education, payments to individuals, aged care and superannuation costs are modelled to reflect the impact of demographic and other change, while other payments are projected to remain constant as a proportion of GDP. The next intergenerational report, which the Government plans to publish before the 2010‑11 Budget, will provide a more detailed exposition of these issues.
Comparison of economic projections with IGR2
The global recession has had a significant impact on the size of the economy in comparison to the projections that underpinned the last intergenerational report (IGR2, released in March 2007). By 2010‑11, in real terms GDP is forecast to be more than 5 per cent smaller than where it was expected to be in IGR2. Reflecting the projection assumption of above‑trend growth until the economy returns to full capacity, this gap closes rapidly through the medium‑term projection period. Higher population growth trends that have established themselves since IGR2 also assist in returning GDP to its previously‑projected levels, and ultimately to exceed them.
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