A delay in opening up borders and a crash in house prices are the main risks facing the New Zealand economy, an OECD report shows.
The Organisation of Economic Cooperation and Development's (OECD) survey of the country said the economy is starting to overheat having been supported by government support measures to counter the pandemic.
But it said the free spending measures which supported wages, jobs and various parts of the economy, and the supply of cheap money through the Reserve Bank need to be reined in to counter strong inflation and rampant house prices.
"New Zealand's coronavirus elimination strategy has paid off so far," the OECD report said.
"The elimination strategy and significant macroeconomic stimulus enabled the economy to bounce back quickly to the pre-Covid level."
"However, policy stimulus has contributed to overheating the economy, a house price boom from already elevated levels and substantial increases in household and government debt."
It said the steps by the Reserve Bank of New Zealand (RBNZ) to start raising interest rates were necessary, while the government also needed to bring down its debt levels, which would slow growth.
"While the fiscal deficit has begun to fall from the highs reached during the first wave of the Covid-19 shock, additional consolidation measures will be needed to put public finances on a sustainable path, including an increase in the pension eligibility age."
It expected economic growth of 4.7 percent in 2021 falling to 2.6 percent in 2023, with inflation falling back into the the RBNZ target band by 2023.
But the report signalled risks to economic recovery, ranging from continued closed borders, a housing crash, and a slowdown in the Chinese economy.
"A delayed border reopening would postpone the entry of migrants needed to ease skills shortages as well as recovery in the tourism sector," the report said.
"On the other hand, the removal of border restrictions in other countries, especially Australia, could encourage New Zealand residents to emigrate, aggravating skills shortages, especially in the construction sector."
"There is also a risk of a large fall in house prices from current elevated levels, given the outlook for an easing in shortages, higher interest rates and more restrictive prudential policies... Were this to occur, there would be a large negative effect on private consumption owing to the high level of household debt."
It said the government needed to remove obstacles to more house building and improve affordability, while it also backed the introduction of a social insurance scheme for workers who lose their jobs.
Other recommendations included improving competition in the grocery sector, further research and development assistance, bring in congestion charging for Auckland, be ready to increase the price of carbon to meet climate change goals, and make it easier to develop and enhance digital technologies to improve productivity.
Govt responds to OECD report recommendations
Finance Minister Grant Robertson has taken the OECD report as an affirmation of the government's approach to the pandemic and measures to support the economy.
He said the report recognised the government's pandemic response, noting New Zealand had one of the lowest mortality rates in the world, while the economy proved strong and resilient, and had already moved to cool the housing market.
However, Robertson rejected the OECD's suggestion of raising the age of eligibility for superannuation as a long term measure to control government spending and restrain debt, saying it was a firm promise that would not be broken.
"I certainly respect the view of the OECD in proposing this but it is a clear policy commitment that New Zealand heard from our government and it won't be one that we're going back on."
Robertson said the government aimed to keep debt in reasonable limits but it was reasonable that it should borrow for long term projects to boost growth.
The OECD also urged the government to proceed with a proposed social insurance scheme outlined last year, and Robertson said a discussion document would soon be issued on it.
But the opposition finance spokesperson and an independent economist said the government needed to listen to the OECD on spending.
"I hope he doesn't say I know everything, my borrow and spend model is just fine," National Party spokesperson Simon Bridges said.
He said short term issues of inflation and rising interest rates needed to be tackled, as well as longer term matters such as the age of superannuation.
And Bagrie Economics managing director Cameron Bagrie said the report had a clear message for the government.
"They're telling the government to rein things in and if they don't rein things in then we're going to see more pressure on monetary policy, that's the Reserve Bank going to raise interest rates," Bagrie told RNZ's Nine to Noon.