Treasury has just released a report it prepared for the Govt in August, in advance of Cabinet’s meeting to prepare its economic strategy for the country. The report “Getting Started on Closing the Income Gaps,” focuses on the difficulties of NZ’s economy catching those of Aust and the rest of the OECD by 2025.

It makes some stark observations, most of which are now fairly common knowledge - it warns both Govt and private consumption has run well ahead of income, and business investment has been modest. It says debt levels are too high and so are house prices. There is also nothing in the current projections or set of policies that suggests material progress is likely in reversing the large per capita income gap that exists between New Zealand and the average of its OECD peers, or, most notably, Aust.

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What the report does tell Ministers is there is a need for a rapid slow down in Govt spending, and they “have the opportunity for once-in-a-generation reorientation of the tax system.” It warns the less ambitious the approach to other taxes like GST, land tax and capital gains tax, the harder would be the required choices about where to concentrate income tax reductions. Since 2002, NZ has had the fifth-highest rate of increase in Government spending in the OECD.

Treasury is saying if Govt spending is cut, markets would respond to the lower actual and expected OCR and as a result the exchange rate could be expected to fall. One possible scenario might see a period of 3-4 years in which the exchange rate settled well below its long-run average (somewhat akin to the period of undervaluation over the turn of the century).

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