Macroeconomic stimulus has been so powerful and the elimination strategy so effective that major labour market indicators are now stronger than before the pandemic. The unemployment rate fell to 3.4% in the third quarter of 2021, the lowest rate since 2007, and the employment rate increased to the highest rate on record. Wage growth has returned to the pre-pandemic level. With employers reporting record hiring intentions, the labour market is likely to tighten further, putting upward pressure on wages.

Inflation soared to 5.9% in the year to the fourth quarter of 2021, well above the Reserve Bank’s 1-3% target band, and core inflation measures increased to above the upper bound of the band. Five-year ahead inflation expectations have increased for households but less so for businesses.

The containment measures reintroduced in August 2021 were maintained in Auckland until early December, when the government shifted to a minimisation and protection strategy. The new COVID-19 Protection Framework has three settings (red, amber and green) that take into account health system preparedness and population public health dynamics. Individuals who are vaccinated against COVID-19 face fewer restrictions on their movement and activities, as in many other OECD countries. The government also announced its intention to open the border progressively to vaccinated travellers by April 2022 subject to a negative COVID-19 test result on arrival and after seven days of self-isolation but delayed implementation owing to the arrival of the Omicron variant. The government also announced an expansion in intensive-care-unit capacity with ventilators.

The Reserve Bank of New Zealand (RBNZ) is tightening monetary and macroprudential policies with a view to achieving its price and financial stability objectives. Government budget deficits have begun to fall from the high levels reached during the first wave of the COVID-19 shock and will decline gradually from 2022. Macroeconomic policy tightening will contribute to slowing growth from almost 5% in 2021 to 2.5% in 2023.

The RBNZ hiked the policy rate by 25 basis points in October and again in November 2021 to 0.75%, and projected further increases to 2.6% by end-2023. It halted its Large Scale Asset Purchases programme in July 2021 and is working on a strategy to manage its large government bond holdings (16% of GDP).

Highly expansionary monetary policy and the suspension of loan-to-value ratio (LVR) restrictions in 2020 spurred mortgage lending, pushing up household debt to 169% of disposable income and house prices to levels that the RBNZ judges to be unsustainable (Figure 2). To limit financial stability risks, the RBNZ has increased LVR restrictions and has begun a public consultation on introducing debt-servicing-to-income or debt-to-income restrictions. Tightening monetary and macro-prudential policies, lower migration inflows and the March 2021 tax measures to discourage investment in rental properties have reduced housing demand. This, together with policy measures underway or planned to increase housing supply should eliminate shortages and increase affordability.

Following a 9.7% of GDP fall in the government’s preferred fiscal balance measure to a deficit of 7.3% of GDP in 2019-20 (fiscal years end 30 June), the deficit remains high but is projected to be almost eliminated in 2022-23 as large COVID-related spending is phased out. Steadily rising surpluses are projected through 2025-26 as such spending continues to be phased out.

Economic growth is projected to slow in response to macroeconomic policy tightening and the stabilisation of commodity export prices, albeit at high levels (Table 1). Consumption growth will fall to a more sustainable pace as housing wealth gains diminish and employment growth slows. The unemployment rate will remain at very low levels and inflation will fall back to within the Reserve Bank’s target band by 2023.

The main downside risks to the outlook include a delay in border re-opening caused for instance by the emergence of more virulent COVID variants against which vaccines are less effective and a large and sudden house price correction. The main upside risks include stronger demand for New Zealand’s agricultural exports and public health conditions that permit a more rapid phasing out of restrictions on economic activities than assumed.

The fiscal measures taken to support the economy during the COVID-19 crisis have substantially increased the government debt-to-GDP ratio. On unchanged policies, the debt-to-GDP ratio will rise considerably over coming decades owing to po-pulation ageing (Figure 3). Additional measures are needed to put public finances on a sustainable medium-term path, including linking the pension eligibility age to life expectancy.

New Zealand has considerable scope to boost productivity by fostering growth of its digital sector and stimulating digital innovation. This requires strengthening the domestic pipeline of digital skills, making sure that regulations evolve with technological change and enhancing exports by firms exploiting digital technologies.

New Zealand is relatively advanced in some aspects of digitalisation, such as the high share of small firms selling online or use of the Internet of Things. However, the digital sector is smaller than in other OECD countries and has relied heavily on skilled migrants to fill jobs requiring advanced digital skills. It is now facing a severe skills shortage caused by border restrictions in the short term and competition from other countries in the longer term. The domestic pipeline of graduates with advanced ICT skills is narrowing, as weak mathematics and science achievement by students in primary- and lower secondary schools closes the door to tertiary studies in ICT-relevant fields.

The diffusion of digital technologies is also held back by a copyright regime that does not accommodate the use of some digital technologies, the cost of adopting digital tools for small businesses and the difficulty of reaping high returns on investment in digital technologies by exporting.

The government has been developing several policy initiatives on digitalisation, including the Industry Transformation Plans to foster the development of digital technology and agritech sectors. It recently embarked on the production of a national digitalisation strategy, which aims to promote trust, inclusiveness and growth in the digital economy and society. This strategy would help stakeholders in a wide range of policy areas to work together in a coherent way.

The introduction of unemployment insurance would help to make the diffusion of digital technologies more equitable by reducing the burden on workers displaced by digitalisation - most displaced workers do not qualify for the means-tested unemployment benefit.

New Zealand is not on track to meet either its 2030 abatement commitment or its 2050 net zero carbon emissions target. It has a solid institutional framework but needs to implement abatement measures. The carbon price is too low and efficient complementary measures, which address market failures not corrected by carbon pricing alone, still need to be taken.

The zero carbon amendments to the Climate Change Response Act 2002 require a fall in net carbon emissions to zero and a 24-47% decline in biogenic emissions from agriculture (currently almost half of total emissions) by 2050. The amendments create the Climate Change Commission (CCC) to advise on measures to achieve these objectives and to monitor progress. NZ Emissions Trading Scheme (ETS) reforms in 2020 placed a hard cap on permits in the scheme and created a cost containment reserve that can be used to limit price increases and a price floor below which permits will not be sold into the scheme. Taking into account actual and recommended complementary abatement measures, the CCC estimates that inflation-adjusted carbon prices will need to rise from NZD 68 per tonne of CO₂-e in early December 2021 to NZD 140 by 2030 and NZD 250 by 2050 for New Zealand to meet its abatement objectives from domestic sources.

The government has already taken various complementary abatement measures, notably in the areas of urban development, building codes and the provision of public/active transport infrastructure and the CCC has recommended others. New measures will need to complement carbon pricing and avoid the risk of high-cost abatement in situations where lower-cost abatement would be forthcoming through the ETS.

The government is preparing an Emissions Reduction Plan for publication in 2022 outlining policies and actions to help bridge the gap between the current emissions trajectory and the one required to meet the 2050 targets.