NZ Budget 2011 Ignores Oil Shock Impacts

The Times [article behind a paywall] has just broken a story that the UK government has been undertaking research on the likely adverse effects on their economy of an oil price spike.
The Times reports that

"A sudden huge increase in oil prices would cut more than £102 billion from the economy over the next five years, wrecking Britain's economic recovery, increasing unemployment and provoking industrial action, according to government research."

The simulation undertaken for the UK government indicates a decline in the level of real GDP - of around 1.7% in each of the first two years (2011 & 2012) as a result of around 102% oil price increase in 2011. (The oil price has already risen 50% since October 2010). The advice suggests the impact of the shock is concentrated in the first two periods, then slowly diminishes through time, as the economy returns to its long run steady state equilibrium. View documents.

Of course this research assumes that the oil shock is temporary. It does not calculate the effect of a series of oil shocks with attendant recessions, interspersed by weak recoveries.. This is the scenario thought to be most likely by peak oilists - as global oil production inexorably declines. See NZ Parliamentary Report on Peak Oil.

A breakdown of the impact on UK GDP from the oil price shock shows that consumption, investment, and terms of trade are all adversely affected....
• Consumption is adversely affected due to direct affects – this is a reflection of the inability of consumers to switch their bundle of goods away from oil intensive commodities (low elasticity of substitution).

• Similarly investment is adversely affected due to adjustment and direct affects – again this is due to rising costs, and the inability of companies to completely switch away from oil intensive inputs (low elasticity of substitution).

• Net trade is also affected as the UK is a net oil importing country. The shock results in a transfer of income from oil importing to oil exporting countries – as the price of oil rises. (NZ would be similarly adversely affected as a net importer of oil (around 2/3rds net imports)

Higher inflation and higher unemployment also flow from oil price shocks, according to the UK report.

See also my earlier post with calculations provided by the NZ Parliamentary Research Unit of the costs to NZ of rising oil prices.

The report demonstrates that the effects of peak oil are known to the UK government, but there is still no urgency to take serious action.  

Meanwhile in New Zealand there is no recognition (at least publically) that oil price shocks are a threat to our economy, let alone any suggestion that it should get advice as to the likely impacts on GDP inflation and unemployment .

For confirmation look no further than Treasury’s most recent advice to the NZ government in its Budget Economic and Fiscal Update 2011 - Published 19 May 2011

While a range of global risks are identified the effects of an oil price spike is almost completely discounted ….

“Political instability in the Middle East and North Africa has the potential to further disrupt oil supplies, leading prices to spike. There is uncertainty about the impact of the Japanese earthquake. We have assumed a short-term negative impact, largely offset by the subsequent recovery.”

Here are Treasury’s forecasts ..

So there you have it --- the UK government is concerned enough about the oil shock to get advice, with estimates of a decline in GDP of nearly 2%, for each of the next 2 years, greater inflation and unemployment, (arising from a 100% oil price rise),

But in NZ, NZ Treasury and Finance Minister Bill English both discount or ignore the threat and present ridiculously rosy projections for GDP growth, inflation and unemployment.