Predicting budget risks: house prices and nuclear war

By David Donaldson

Wednesday May 3, 2017

Victoria’s economy is booming at the moment, making Treasurer Tim Pallas’ job relatively easy: apart from the public sector “efficiency” measures to shave off $1.2 billion over the forward estimates, cuts are few and far between in this year’s state Budget.

After years of losing residents to other states, Victoria now has the strongest labour market in the country and revenue is pouring in, thanks in part to strong house price growth.

But of course local practitioners of the dismal science aren’t letting the success go to their heads, with much of this morning’s IPAA Victoria budget breakfast focusing on how exactly it could all go wrong.

Both guest speakers, Age economics correspondent Peter Martin and Grattan Institute fellow Danielle Wood, argued that Treasuries tend to be optimistic about the future, often failing to foresee downturns until we’re in the middle of one. A fall in house prices could wipe out the predicted $1.2 billion surplus without too much effort, so both said they would prefer a bigger number as a buffer against uncertainty.

Treasury Secretary David Martine argues it’s very difficult to predict what conditions will be in the future.

“Maybe I’m just an optimist at heart, but I actually think in the next few years in Victoria our economy will continue to grow pretty strongly and the budget will remain in a pretty good, strong position,” he told The Mandarin.

“Because to me the fundamentals are there, and it’s hard to see what the trigger is going to be that changes that. So population growth has been very strong, and I think it’s going to remain strong. People are just coming back to Victoria.”

Population growth is one of the reasons that the surplus isn’t bigger: more people means a growing need for vital infrastructure, not to mention more teachers. It’s also helping to offset one of the other significant long-term risks, the ageing population, as those moving south of the Murray tend to be younger than their new neighbours.

Yet Martine is not blind to the risks, focusing in his presentation on the two key scenarios that could negatively impact the state economy: a house price fall and global instability.

Although land transfer duty makes a lot more money for the Victorian government than a few years ago, it still comprises less than 10% of the state’s total revenue, he noted. The Budget forecasts that land transfer duty will continue to grow, but below trend in the near future, before returning to trend longer term. If anything, it will probably grow more strongly than the model predicts, thinks the secretary.

So Treasury is wary of relying too heavily on the volatile housing market to deliver funds.

Even more difficult is predicting what will happen internationally, which Martine names as the “biggest concern”. The world may continue muddling along. He notes that when Trump and Brexit happened many people’s reactions were “the world’s come to an end, and then a week later, things are back to normal.”

Or the international situation might not turn out fine — not that the Victorian government has much control over that.

“I mean who knows, we could be firing nuclear missiles at each other next week,” says Martine. “It’s very unpredictable.”

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