## INFLATION IN NEW ZEALAND: DRIVERS AND DYNAMICS (Content unit 1nzlea2024002)

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### Introduction and key summary findings
- Scope: Investigates why New Zealand’s inflation is higher and further from target than comparator economies, assessing two main hypotheses: (1) persistence of pandemic era shocks; and (2) strong migration inflows fueling demand.
- Key findings:
  - Headline inflation reached 4.7 percent yoy in December 2023, down from a peak of 7.3 percent in 2022Q2, but still above the inflation target band of 1 to 3 percent.
  - Both global factors (supply disruptions, commodity prices, transport costs, exchange rates) and domestic policy (expansionary fiscal and monetary policy) contributed to higher inflation.
  - New Zealand’s delayed reopening (zero COVID policy and a late full reopening) likely caused a postponed demand shock relative to similar economies.
  - Pandemic-era shocks decay rapidly—lasting approximately one year—implying New Zealand should be experiencing the tail end impact of those shocks.
  - Large migration waves are associated with short-run increases in inflation, but these effects are relatively modest and no longer significant after four years; long-run dynamics show migration can lead to significant long-term gains to productivity, output, and capital growth.
  - Countries with tight labor markets follow similar patterns, except inflationary effects of migration dissipate faster.

### Identifying drivers and persistence of pandemic-era inflation
- Data and empirical methods:
  - Novel dataset of producer price inflation from 55 countries constituting 1195 country-sector pairs between 2020-2022.
  - Harmonized PPI data merged with input-output linkages from OECD’s World Input Output Table.
  - Lockdown intensity variable at country-sector-month frequency created by interacting sectoral lockdown stringency with ease-of-working-from-home measures.
  - Local Projection regressions à la Jordà (2005) estimate contemporaneous and dynamic effects of lockdowns and policy stimuli on producer prices.
  - Controls: lagged producer prices, maritime transport costs, exchange rates, oil price shocks, and COVID cases.
- Main explanatory channels used in the model:
  - Lockdown supply shocks: intensity of lockdowns in upstream sectors × degree of supply-exposure.
  - Lockdown demand shocks: intensity of lockdowns in downstream sectors × degree of demand-exposure.
  - Fiscal stimulus shocks: amount of fiscal stimulus in downstream sectors weighted by demand-exposure.
  - Monetary stimulus shocks: change in central bank assets in downstream sectors weighted by demand-exposure.

### Trends in four inflation drivers (Monetary, Fiscal, Commodity Prices, Lockdowns and Re-openings)
- Monetary policy:
  - Initially accommodative (policy rate cuts and large quantitative easing), later turned restrictive with rapid hikes in the policy rate in 2022.
- Fiscal policy:
  - Expansionary at the start of the pandemic and again in response to Cyclone Gabrielle and South Island flooding events in 2023.
- Global commodity prices and transport costs:
  - Commodity prices fluctuated substantially; maritime transport costs became disrupted in 2021/22 with later resurgences tied to regional conflicts and gas price increases.
- Lockdowns and reopenings:
  - Re-openings following strict lockdowns generated demand booms, especially in sectors shut down by intensive lockdowns.
  - New Zealand’s trajectory differed due to a zero COVID policy, reopening in 2020 and 2021 but experiencing a later full reopening after a second lockdown in late 2021.

### Empirical decomposition: drivers of New Zealand inflation (2020–2022)
- Year-by-year decomposition highlights:
  - 2020: main positive driver was lockdown supply-shocks, followed by expansionary monetary policy and fiscal policy; net effect was offset by lower demand due to downstream lockdowns.
  - 2021–2022: lockdown reopenings (demand shocks), continued accommodative monetary policy effects, higher energy prices, exchange rate movements, and transport costs collectively increased inflation.
  - Foreign contribution: foreign lockdown demand shocks contributed over 20 percent of New Zealand’s demand-driven inflation on average over the sample period.
- Policy implication:
  - Disinflation in global production (especially in China) should feed through into lower inflation in New Zealand due to meaningful foreign exposure.

### Dynamics and impulse responses (persistence)
- Core impulse response findings:
  - Lockdown supply and demand shocks are strong and persistent global inflation drivers but should abate within approximately 1 year.
  - Illustrative magnitudes reported:
    - A full lockdown of a major supplier that accounts for 50 percent input costs would lead to a 5 percent PPI inflation in the affected sector (contemporaneous effect).
    - A sector that sells 50 percent of its output to a locked-down country would experience a 9 percent deflationary impact (contemporaneous effect).
  - With reopenings ended at the end of 2022, New Zealand is currently experiencing the tail end impacts of pandemic-era inflation drivers.

### Migration and the macroeconomy — scope and methodology
- Scope:
  - Panel of macroeconomic variables across 34 countries over 23 years; instrumental variables approach to address endogeneity and isolate push-driven migration shocks.
- Identification and econometrics:
  - Focus on large immigration waves using an IV based on the stock-share of past migrants and total outflows from origin countries (Beine, Docquier, and Ozden (2011) approach).
  - Sample: OECD panel database of 34 countries, with data from 1995 to 2018 (yearly data for 1996–2018 in estimations).
  - Local projections (Jordà, 2005) with 2SLS IV; baseline regresses changes in macro outcomes on immigrant flows ∆III_Ft relative to previous period employment S_F,t−1, with country and time fixed effects and lagged controls X_F,t−1.
  - Instrument constructed as D̂t = Σj (I_jF,t−5 / I_jt,t−5) * ∆I_jt; migration stock data are at five-year intervals and IV data are winsorized at the top one percent.

### Migration: supply-side effects (average responses up to five years)
- Labor productivity increases by almost 1 percent five years after a large migration shock.
- Total factor productivity (TFP) increases following the migration shock.
- Capital stock responds and capital-labor ratio increases in the short term.
- Unemployment rate rises as migration inflows add to labor supply (WEO: Unemployment rate reported in figures in percent units).
- Native employment rises modestly five years after the shock, but the increase is not statistically significant.

### Migration: demand-side effects, housing, and consumption
- Housing and consumption responses:
  - BIS nominal house price index increases by 2 percent within four years (effect statistically significant at the margin).
  - House price-to-income ratio increases by about 2 percent within four years (effect not statistically significant by year 5).
  - House price-to-rent ratio increases but response is not statistically significant.
  - Real consumption increases consistent with population growth adding to domestic demand.
- Interpretation:
  - Housing affordability deteriorates in the near term as housing supply cannot react immediately.

### Net impact on output and inflation from migration shocks
- Output:
  - Economic output increases by 1.2 percent by the fifth year following a migration shock.
- Inflation:
  - Peak impact on inflation occurs 1 year after the shock, where inflation increases by 0.2 percentage points.
  - The inflation effect declines over time and is no longer statistically significant after four years.
- Overall dynamic:
  - Large migrant waves are associated with short-term demand-led inflation but raise productive capacity over the longer term, yielding favorable dynamics for output and productivity over a five-year horizon.

### Role of labor market tightness
- Sub-sample results for tight labor markets:
  - Initial inflationary impact of migration waves is smaller and turns deflationary from year 2 to year 5.
  - By year 2 the point estimate for inflation is negative; by year 5 it is negative and statistically significant.
  - Impact on output follows a similar trajectory to the full sample but with a somewhat lower point estimate.
- Relevance to New Zealand:
  - Important given the recent migration wave occurred amid extremely tight labor markets in New Zealand.

### Robustness checks
- Exercises performed:
  - Remove all lagged controls from the baseline specification (Annex Figure A1): most results remain consistent.
  - Include only the lagged dependent variable as a control (Annex Figure A2): results remain largely consistent.
  - Results robust to changing the lag structure in regressions (results available upon request).

### Conclusions and policy-relevant implications on inflation and migration
- Drivers of New Zealand’s inflation dynamics:
  - Expansionary fiscal and monetary policy, high global commodity prices, exchange rates, transport costs, and pandemic-era demand shocks.
  - International demand factors account for approximately 20 percent of the total demand shock.
  - Slower inflation dynamics in New Zealand were likely influenced by later reopening and delayed demand shock.
- Expected trajectory and risks:
  - Migration likely to have major macroeconomic impacts: higher output, higher productivity, increased capital usage, and short-term increases in inflation driven by higher real consumption and housing costs.
  - On the OECD sample, dynamics are expected to be largely favorable over the next five years because supply-side benefits take longer to materialize than demand-driven effects.
  - This favorable outlook is especially pronounced among countries with tight labor markets.
  - New Zealand needs to stay vigilant to upside inflation surprises or an unruly pick-up in house prices or housing costs.

### Mitigation options to meet New Zealand's climate goals
- Headline commitments:
  - NDC: 50 percent reduction of net emissions below gross 2005 level by 2030.
  - Commitment to domestic emissions budgets and net zero emissions of all GHG except biogenic methane by 2050.
  - Planned mix of domestic net emissions reductions and offshore mitigation; so far, no offshore mitigation has taken place.
- Modelling approach and baseline:
  - IMF staff projections use the Climate Policy Analysis Tool (CPAT) and assume no tightening of existing policies and no new policies; CPAT projections are more conservative than MfE’s official projections.
  - MfE estimates with implemented and adopted policies as of 1 July 2023 gross and net emissions will fall by 16 and 31 percent respectively by 2030 from 2021 levels.
  - CPAT holds current policy levels fixed and accounts for pre-existing policies implicit in observed fuel use and emissions.
- Implications if domestic emissions remain at baseline:
  - New Zealand would need to partake in substantial international mitigation to meet its NDC unless domestic mitigation ambition is increased.
  - Gradual adjustment to stronger domestic mitigation minimizes adjustment costs by allowing time for retraining, investment in green technology, and gradual decommissioning of high-emissions capital.
- Two illustrative policy scenarios using the ETS and methane pricing:
  - Scenario 1: Raise the ETS effective carbon price on gross emissions by US$50 in 2024 and then gradually increase by an additional US$50 over the next six years.
    - Mechanism: lower the number of available units (modeled as a de facto carbon tax calibrated to act like an increase in the effective emissions price of an ETS targeting gross emissions).
    - Result: emissions begin to gradually decline across several sectors, but agricultural emissions remain constant because agriculture is not included in the ETS; agriculture makes up approximately half of all emissions.
  - Scenario 2: Combine the increased effective carbon price on gross emissions with a methane price of US$50 rising to US$100 by 2030.
    - Mechanism: methane fee could be based on farmer self-reporting and could be a pilot for larger administrations.
    - Result: this doubles the reduction in emissions relative to baseline as all sectors contribute, including agriculture.
- Qualitative conclusions on policy effectiveness:
  - ETS can achieve effective abatement, but is most effective when combined with pricing agricultural emissions.
  - Exact quantitative results should be treated with caution given uncertainties: New Zealand’s high marginal abatement cost, non-linearities in availability of forestry credits, and complexity of the ETS.
- Additional policy options and considerations:
  - Feebates: fees on deforestation and rebates for afforestation or changes in forest management that sequester carbon.
  - Strengthen incentives for gross emissions reductions in the ETS to avoid environmental integrity risks and operational risks such as wildfires.
  - Incentivize R&D for technology to lower methane emissions from cattle and sheep (e.g., switching to higher-productivity livestock, enhancing livestock feed with additives such as seaweed).
  - Consider lowering the value of future forestry credits or decoupling forestry from the ETS; if decoupled, continue incentivizing afforestation.

*Source: IMF staff estimates and analysis in the provided chapter content.*

### References ____________________________________________________________________________ 24

### INFLATION IN NEW ZEALAND: DRIVERS AND DYNAMICS

### Introduction
- Scope: Investigates why New Zealand’s inflation is higher and further from target than comparator economies, assessing two main hypotheses: (1) persistence of pandemic era shocks; and (2) strong migration inflows fueling demand.
- Key summary findings:
  - New Zealand’s headline inflation reached 4.7 percent yoy in December 2023, down from a peak of 7.3 percent in 2022Q2, but still above the inflation target band of 1 to 3 percent.
  - Both global factors (supply disruptions, commodity prices, transport costs, exchange rates) and domestic policy (expansionary fiscal and monetary policy) contributed to higher inflation.
  - Unique to New Zealand, the delayed reopening of the economy (zero COVID policy and a late full reopening) likely caused a postponed demand shock relative to similar economies.
  - The impact of pandemic-era shocks decays rapidly—lasting approximately one year—implying New Zealand should be experiencing the tail end impact of those shocks.
  - Large migration waves are associated with short-run increases in inflation, but these effects are relatively modest and no longer significant after four years. Long-run dynamics show migration can lead to significant long-term gains to productivity, output, and capital growth.
  - Countries with tight labor markets follow similar patterns, except inflationary effects of migration dissipate faster.

### Identifying Drivers and Persistence of Pandemic-Era Inflation
- Data and methods:
  - Uses a novel dataset of producer price inflation from 55 countries constituting 1195 country-sector pairs between 2020-2022.
  - Merges harmonized PPI data with input-output linkages from OECD’s World Input Output Table.
  - Constructs a lockdown intensity variable at country-sector-month frequency by interacting sectoral lockdown stringency with ease-of-working-from-home measures.
  - Employs Local Projection regressions à la Jordà (2005) to estimate contemporaneous and dynamic effects of lockdowns and policy stimuli on producer prices.
  - Controls include lagged producer prices, maritime transport costs, exchange rates, oil price shocks, and COVID cases.
- Main explanatory channels (as defined in the model):
  - Lockdown supply shocks: combine intensity of lockdowns in upstream sectors with degree of supply-exposure.
  - Lockdown demand shocks: combine intensity of lockdowns in downstream sectors with degree of demand-exposure.
  - Fiscal stimulus shocks: amount of fiscal stimulus in downstream sectors weighted by demand-exposure.
  - Monetary stimulus shocks: change in central bank assets in downstream sectors weighted by demand-exposure.

### Trends in Four Inflation Drivers (Monetary, Fiscal, Commodity Prices, Lockdowns and Re-openings)
- Monetary policy:
  - Initially accommodative (policy rate cuts and large quantitative easing), later turned restrictive with rapid hikes in the policy rate in 2022.
- Fiscal policy:
  - Expansionary at the start of the pandemic and again in response to Cyclone Gabrielle and South Island flooding events in 2023.
- Global commodity prices and transport costs:
  - Commodity prices fluctuated substantially; maritime transport costs became disrupted in 2021/22 with later resurgences tied to regional conflicts and gas price increases.
- Lockdowns and reopenings:
  - Re-openings following strict lockdowns generated demand booms, especially in sectors shut down by intensive lockdowns.
  - New Zealand’s trajectory differed due to a zero COVID policy, reopening in 2020 and 2021 but experiencing a later full reopening after a second lockdown in late 2021.

### Drivers of Inflation (Empirical Decomposition)
- Decomposition results for New Zealand (2020–2022 period):
  - In 2020, the main positive driver of inflation was lockdown supply-shocks, followed by expansionary monetary policy and fiscal policy; however, these were more than offset by lower demand due to lockdowns in downstream sectors.
  - In 2021 and 2022, lockdown reopenings (demand shocks), continued accommodative monetary policy effects, higher energy prices, exchange rate movements, and transport costs collectively increased inflation.
  - Foreign contribution: foreign lockdown demand shocks contributed over 20 percent of New Zealand’s demand-driven inflation on average over the sample period.
  - Implication: disinflation in global production (especially in China) should feed through into lower inflation in New Zealand due to meaningful foreign exposure.

### Dynamics (Persistence and Impulse Responses)
- Impulse response findings:
  - Lockdown supply and demand shocks are strong and persistent drivers of global inflation but should abate within approximately 1 year.
  - Illustrative magnitudes from impulse responses (interpretation given in the paper):
    - A full lockdown of a major supplier that accounts for 50 percent input costs would lead to a 5 percent PPI inflation in the affected sector (contemporaneous effect).
    - A sector that sells 50 percent of its output to a locked-down country would experience a 9 percent deflationary impact (contemporaneous effect).
  - For both demand and supply shocks, effects last for approximately 1 year; with reopenings ended at the end of 2022, New Zealand is currently experiencing the tail end impacts of pandemic-era inflation drivers.

### Migration and the Macroeconomy (Preview)
- Scope of migration analysis:
  - Uses a large panel of macroeconomic variables across 34 countries over 23 years with an instrumental variables approach to address endogeneity.
- Key migration findings (overview):
  - Supply-side benefits: migration is associated with higher productivity, higher capital usage, and no decline in native employment; output increases significantly.
  - Demand-side effects: migration is associated with demand-led inflation driven by higher consumption and higher housing costs.
  - Dynamics: impact on supply-side variables grows steadily over time yielding significant medium-term growth and productivity gains; impact on inflation peaks one year after the shock and is no longer statistically significant after four years. In countries with tight labor markets, inflationary effects of migration dissipate faster.

*Prepared by John Spray and Nour Tawk.*

### 14.      The impact of migration on the macroeconomy in New Zealand has long been a focus

### 14.      The impact of migration on the macroeconomy in New Zealand has long been a focus

### Migration trends and demographic context
- By 2016, roughly 25 percent of New Zealand’s population was estimated to have been born overseas.
- New Zealand’s fertility rate fell to 1.56 percent in 2023, below the replacement rate of 2.1 percent.
- Net overseas migration:
  - Contributed to about 40 percent of population growth between 2001 and 2019.
  - Explained the collapse in population growth during 2021.
  - Accounted for 82 percent of population growth in 2022 related to pandemic-related border closing.
  - Reached historical levels in 2023: 127,000 persons by November 2023, an estimated 2.4 percent of the 2023 population.
- Emigration to Australia:
  - Historically averaged around 40 thousand New Zealanders annually until the onset of Covid-19.
  - Reached 34 thousand in 2022.
- Composition of recent inflows:
  - Historically Australian and New Zealand citizens made about 35 percent of total migration; post-pandemic this declined to about 13 percent.
  - Work visas are currently the largest share of migrant arrivals, followed by visitor and student visas.
  - In 2023 migrants mainly came from the Philippines, India, China, and Pacific Islands (Fiji, Samoa).

### Migrant characteristics and skills
- Educational attainment:
  - 42 percent of migrants into New Zealand have achieved a tertiary-level education.
  - The gap in shares of tertiary-educated between native-born and migrant populations is 17 percentage points (one of the biggest among OECD countries).
- Literacy:
  - The difference in literacy mean scores between migrant-born and native-born populations is small, among the lowest across OECD countries.
- Implication noted in prior research:
  - The skill-level of migration can be very important to aggregate outcomes, especially when interacted with the business cycle.

### Methodology for identifying causal effects
- Analytical approach:
  - Focus on large immigration waves and use cross-country instrumental variable (IV) analysis to isolate push-driven migration shocks and mitigate reverse causality.
  - Sample: OECD panel database of 34 countries, with data from 1995 to 2018 (data points are yearly for 1996–2018 in estimations).
  - Identification: episodes of large immigration waves (large episodes defined per Engler et al. (forthcoming) criteria) combined with an IV based on the stock-share of past migrants and total outflows from origin countries (Beine, Docquier, and Ozden (2011) approach).
- Econometric specification:
  - Local projections methodology (Jordà, 2005) with 2SLS instrumental variables.
  - Baseline regression (equation (1)) models changes in macroeconomic outcomes (supply-side, demand-side, and net outcomes) as a function of immigrant flows ∆III_Ft relative to previous period employment S_F,t−1, with country and time fixed effects and lagged controls X_F,t−1.
  - Instrument (equation (2)): D̂t = Σj (I_jF,t−5 / I_jt,t−5) * ∆I_jt, where migration stock data are available only at five-year intervals; IV data winsorized at the top one percent.

### Supply-side effects of large inward migration shocks
- Empirical findings (average responses up to five years):
  - Labor productivity increases by almost 1 percent five years after a large migration shock.
  - Total factor productivity (TFP) increases following the migration shock.
  - Capital stock responds and capital-labor ratio increases in the short term.
  - Unemployment rate rises as migration inflows add to labor supply (WEO: Unemployment rate reported in figures in percent units).
  - Native employment:
    - Employment in the native population rises modestly five years after the shock, but the increase is not statistically significant.

### Demand-side effects and housing
- Housing and consumption responses:
  - BIS nominal house price index increases by 2 percent within four years (effect statistically significant at the margin).
  - House price-to-income ratio increases by about 2 percent within four years (effect not statistically significant by year 5).
  - House price-to-rent ratio increases but response is not statistically significant.
  - Real consumption increases consistent with population growth adding to domestic demand.
- Interpretation:
  - Housing affordability deteriorates in the near term as housing supply cannot react immediately.

### Net impact on output and inflation
- Output:
  - Economic output increases by 1.2 percent by the fifth year following a migration shock.
- Inflation:
  - Peak impact on inflation occurs 1 year after the shock, where inflation increases by 0.2 percentage points.
  - The inflation effect declines over time and is no longer statistically significant after four years.
- Overall dynamic:
  - Large migrant waves are associated with short-term demand-led inflation but raise productive capacity over the longer term, implying more favorable dynamics for output and productivity over a five-year horizon.

### Role of labor market tightness
- Sub-sample results for countries with tight labor markets:
  - The initial inflationary impact of migration waves is smaller and turns deflationary from year 2 to year 5.
  - By year 2 the point estimate for inflation is negative; by year 5 it is negative and statistically significant.
  - Impact on output follows a similar trajectory to the full sample but with a somewhat lower point estimate.
- Relevance to New Zealand:
  - Important given the recent migration wave occurred amid extremely tight labor markets in New Zealand.

### Robustness checks
- Robustness exercises performed:
  - Remove all lagged controls from the baseline specification (Annex Figure A1): most results remain consistent.
  - Include only the lagged dependent variable as a control (Annex Figure A2): results remain largely consistent.
  - Results also robust to changing the lag structure in regressions (results available upon request).

### Conclusions and policy-relevant implications
- Drivers of New Zealand’s inflation dynamics:
  - Expansionary fiscal and monetary policy, high global commodity prices, exchange rates, transport costs, and pandemic-era demand shocks.
  - International demand factors account for approximately 20 percent of the total demand shock.
  - Slower inflation dynamics in New Zealand were likely influenced by later reopening and delayed demand shock.
- Expected trajectory and risks:
  - Migration is likely to have major macroeconomic impacts: higher output, higher productivity, increased capital usage, and short-term increases in inflation driven by higher real consumption and housing costs.
  - On the sample of OECD countries, dynamics are expected to be largely favorable over the next five years because supply-side benefits take longer to materialize than demand-driven effects.
  - This favorable outlook is especially pronounced among countries with tight labor markets.
  - New Zealand needs to stay vigilant to upside inflation surprises or an unruly pick-up in house prices or housing costs.

*Source: IMF staff estimates and analysis in the provided chapter content.*

### References

### References

### Selected references
- Armstrong, Jed and Chris McDonald. 2016. “Why the drivers of migration matter for the labour market”. Reserve Bank of New Zealand Analytical Note Series
- Beine, M., F. Docquier, and C. Ozden. 2011. “Diasporas,” Journal of Development Economics, 95(1): 30–41.
- Card, David. 2001. “Immigrant Inflows, Native Outflows, and the Local Labor Market Impacts of Higher Immigration.” Journal of Labor Economics 19(1): 22–64.
- Chau, V., Conesa Martinez, M., Kim, T. and J. Spray. Forthcoming. “Global Value Chains and Inflation Dynamics”. IMF Working Paper.
- Engler P., MacDonald M., Piazza R., and Galen Sher, Forthcoming. “The Macroeconomic Effects of Large Immigration Waves”. IMF Working Paper.
- Grogger, Jeffrey, and Gordon H. Hanson. 2011. “Income maximization and the selection and sorting of international migrants.” Journal of Development Economics 95(1): 42-57.
- International Monetary Fund, 2020. “The Macroeconomic Effects of Global Migration.” IMF World Economic Outlook, Washington, DC.
- Jordà, Òscar. 2005. “Estimation and Inference of Impulse Responses by Local Projections.” American Economic Review 95(1): 161–82.
- McDonald, Chris. 2013. “Migration and the housing market”. Reserve Bank of New Zealand Analytical Note Series
- NZIER. 2024. “Inflation and migration: Theory, evidence and implications for the Monetary Policy Committee”
- Peri, Giovanni, and Chad Sparber. 2009. “Task Specialization, Immigration, and Wages.” American Economic Journal: Applied Economics 1(3): 135–69.
- Smith, Christie and Christoph Thoenissen. 2019, ‘Skilled migration and business cycle dynamics’, Journal of Economic Dynamics and Control
- Vehbi, Tugrul. 2016. “The macroeconomic impact of the age composition of migration”. Reserve Bank of New Zealand Analytical Note Series

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### Mitigation options to meet New Zealand's climate goals

### Overview and headline commitments
- New Zealand’s Nationally Determined Contribution (NDC) set a headline target of a 50 percent reduction of net emissions below gross 2005 level by 2030.
- Separately, New Zealand has committed to reach a series of domestic emissions budgets and net zero emissions of all greenhouse gas (GHG) except biogenic methane by 2050.
- Given New Zealand already has a high percentage of energy from renewables and given that New Zealand's largest emitting sectors are difficult to abate, the country has planned on meeting its NDC through a combination of domestic net emissions reductions and offshore mitigation. So far, no offshore mitigation has taken place.

### Baseline projections and modelling approach
- IMF staff projections using the Climate Policy Analysis Tool (CPAT) assume no tightening of existing policies and no new policies; these projections are more conservative than the official projections published by New Zealand Ministry for the Environment (MfE).
- MfE estimates that with implemented and adopted policies as of 1 July 2023 gross and net (target accounting) emissions will fall by 16 and 31 percent respectively by 2030 from 2021 levels, in line with domestic emissions budgets.
- CPAT projections account for pre-existing policies whose impacts are already implicit in currently observed fuel use and emissions, including carbon pricing, regulations, and fuel taxes/subsidies, with the current level or stringency of these policies held fixed.

### Implications if domestic emissions remain at baseline
- If domestic emissions continue as expected, New Zealand would need to partake in a substantial international mitigation effort in order to meet its NDC.
- Alternative: enhance the ambition of domestic mitigation. IMF research suggests gradual adjustment minimizes adjustment costs by allowing firms and workers more time to retrain and to invest in green technology, and by allowing capital in high emissions sectors to be gradually decommissioned avoiding stranded assets.

### Two illustrative policy scenarios using the ETS and methane pricing
- Scenario 1: Raise the ETS effective carbon price on gross emissions by US$50 in 2024 and then gradually increase by an additional US$50 over the next six years.
  - Mechanism: could be achieved through lowering the number of available units (modeled as a de facto carbon tax calibrated to act like an increase in the effective emissions price of an ETS targeting gross emissions).
  - Result: emissions begin to gradually decline across several sectors, but emissions from the agricultural sector remain constant because agriculture is not included in the ETS; agriculture makes up approximately half of all emissions.
- Scenario 2: Combine the increased effective carbon price on gross emissions with a methane price of US$50 rising to US$100 by 2030.
  - Mechanism: methane fee could be based on farmer self-reporting and could be a pilot for larger administrations.
  - Result: this doubles the reduction in emissions relative to baseline as all sectors contribute, including agriculture.

### Qualitative conclusion on policy effectiveness
- Effective abatement can be achieved through the ETS, but this is most effective when combined with pricing agricultural emissions.
- Exact quantitative results should be considered with caution given uncertainties such as New Zealand’s high marginal abatement cost, non-linearities in availability of forestry credits, and complexity of New Zealand’s ETS.

### Additional policy options and considerations
- Feebates: apply fees on deforestation and rebates for afforestation or changes in forest management that sequester carbon.
- Strengthening incentives for gross emissions reductions in the ETS: focus on lowering gross emissions to avoid environmental integrity risks, the need to indefinitely sequester carbon, and operational risks such as wildfires.
- Incentivizing R&D: especially technology to lower methane emissions from cattle and sheep, for example by switching to higher-productivity livestock and enhancing livestock feed through additives (for example, seaweed), which could lower mitigation costs and provide wider global externalities.
- Consider lowering the value of future forestry credits or decoupling forestry from the ETS; if decoupled, continue to incentivize afforestation because it has been an important part of New Zealand’s emissions reduction strategy.

### Box 1 — Differences between CPAT and MfE modelling (key contrasts)
- Baseline definitions:
  - CPAT: includes pre-existing policies implicit in observed fuel use and emissions, holds current level/stringency fixed, does not assume announced policy tightenings or increased sectoral coverage.
  - MfE: baseline includes implemented and adopted policies as of 1 July 2023, including stipulated strengthening of existing policies (the ‘with existing measures’ scenario).
- Sectoral assumptions and examples:
  - LULUCF: CPAT assumes continued carbon sink with sector unresponsive to major changes; MfE uses a granular approach and a target accounting framework that does not include all forms of LULUCF.
  - Transport: MfE assumes a higher rate of adoption of electric vehicles and incorporates EV subsidies in place as of 1 July 2023; CPAT is more conservative.
  - Industry, power, residential: CPAT assumes no future tightening of the ETS whereas MfE assumes a rising ETS price and scheduled closures or transitions; IMF estimates are more conservative on technological progress relative to MfE.
  - Agriculture: MfE assumes agricultural pricing will start in 2025 (policy at the time of projections in mid 2023); agricultural pricing is not included in CPAT baseline.

*Source: "References" and "Mitigation options to meet New Zealand's climate goals" (IMF staff material).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1nzlea2024002.pdf_