The Reserve Bank's Process for Forecasting Business Investment

By Aldridge, Tim | The Reserve Bank of New Zealand Bulletin, June 2009 | Go to article overview

The Reserve Bank's Process for Forecasting Business Investment


Aldridge, Tim, The Reserve Bank of New Zealand Bulletin


1 Introduction

Investment in new capital goods is central to the long-run health of the New Zealand economy. Without investment, the capital stock would become run down, and be insufficient to support the production of goods and services which we demand to maintain our standard of living. Changes in business investment can also have significant effects on inflationary pressure. In the short term, high levels of investment may heighten inflationary pressure due to the increased demand for resources necessary to produce investment goods, whereas, in the long run, investment also increases the potential output of the economy.

When a firm purchases a new capital asset or structure which is used to produce output, this is classified as business investment, a component of expenditure on Gross Domestic Product. All businesses, however small, carry out investment. For a small firm, a significant investment may be the purchase of a desktop computer, whereas, for a large company, it may be an entire factory.

Because business investment is a volatile component of expenditure on GDP, it is important for the Reserve Bank to forecast it as accurately as possible. While there are a number of indicators that provide useful information, economic judgement, which is based on both economic theory and more qualitative information sources such as the views of individual firms, is also important in arriving at the final projection for business investment.

This article begins by discussing the components of business investment in section 2, and the Reserve Bank's approach to forecasting business investment is discussed in section 3.

2 Business investment and its components

The Reserve Bank forecasts business investment, residential investment and non-market (i.e. central government) investment separately. This is because each of these categories of investment is carried out by different sectors of the economy, and consequently, each category is driven by distinct factors.

In the national accounts, investment is described as gross capital formation, and is comprised of residential investment (i.e. new house construction and residential additions and alterations), changes in inventories, and investment in other fixed assets. At the Reserve Bank, we separate investment in other fixed assets into business investment and non-market investment. While the majority of business investment is carried out by the business sector, the category also includes investment carried out by state-owned enterprises and local government authorities. (1) Total nominal business investment in the year ended December 2008 was $21 .9 billion, or 12 percent of expenditure on GDP.

At the Reserve Bank, we also consider the components of business investment separately. Figure 1, overleaf, illustrates the relative size of each of the six major components of business investment.

These components are now discussed in turn. Figures 2 to 7, overleaf, plot the components of business investment as a share of GDP.

* Plant, machinery and equipment investment (excluding computers)

Statistics New Zealand publishes an estimate of plant, machinery and equipment (PME) investment, which captures investment in equipment used in the production process in industries including manufacturing, construction, agriculture and mining. Examples of PME investment include farm vehicles and machinery, construction machinery and electric-power generating machinery. Another recent, significant example of PME investment was an oil rig. At the Reserve Bank, we separate out computer investment from this component, because it has shown a different trend over history (see below). PME investment (ex-computers) is the largest component of business investment, accounting for around 28 percent of total business investment. This component fluctuates with the business cycle, around a relatively stable share of GDP, in both nominal and real terms. …

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