KEY POINTS:
Personal and corporate income tax cuts are a good use of the budget surplus to counter economic slowdown, says the latest OECD report on the New Zealand economy.
However, the Paris-based club of rich nations called for a reduction in tax distortions favouring housing over productive investment as well as those that discourage labour supply.
It said New Zealand's economy was vulnerable due to heavy foreign debt.
Economic growth is seen slowing from 3.4 per cent last year to 1.3 per cent in 2008 before picking up to 2.1 per cent in 2009.
"Thus far in 2008, soft retail and slow house sales together with a sharp decline in consumer confidence suggest substantial further demand weakening.
"Consumers face headwinds from higher interest rates and inflation, and smaller house price rises are hitting balance sheets."
Inflation pressure will ease by year-end, allowing monetary policy to be eased and growth to pick up in 2009.
It noted a sharp fall in employment in the first quarter, a pick-up in migration, the effects of drought and a plunge in business confidence.
Inflation has been driven up by previous strong growth, booming commodity prices, tight labour markets and capacity constraints.
The authors said that the Official Cash Rate at 8.25 per cent was well above the OECD's estimate of neutral and it would be eased at year-end.
After peaking around mid-2008, inflation should abate as persistently tight monetary policy does its work. It is assumed that the Reserve Bank could start easing by the end of this year or early 2009.
The Government's recent decision to delay the introduction date for parts of a greenhouse gas emissions trading scheme removes an additional contributor to near-term inflation pressures.
"Together with the return to normal weather patterns, this should enable growth to rebound, reaching a 2-1/2 per cent annual rate by end-2009 while inflation moderates to 2-1/2 per cent.
The current account deficit should stabilise at around 8 per cent.
"Further global financial turbulence could harm growth prospects, given substantial external indebtedness boosted by annual current account deficits of 7 to 10 per cent of GDP since 2004, with most such borrowing having been channelled into consumption and housing rather than business investment."
The OECD sees several quarters of weaker growth ahead for most OECD economies. Headline inflation is seen remaining high for some time.
"This scenario is the combined outcome of financial markets turmoil, cooling housing markets and sharply higher commodity prices."
The OECD said the odds are improving that financial market turmoil has passed its peak.
"Still its fallout will continued to act as a brake on growth for considerable time to come.
It noted write-downs and credit losses linked directly or indirectly to the troubled subprime mortgage market amounted to US$380 billion ($492.5 billion).
It pointed to other headwinds that were likely to continue, including cooling housing markets and high commodity prices.
- NZPA
