"Even with the currently minor outbreak of swine influenza, there is evidence of people being more reluctant to travel, with consequent impacts on industries such as aviation and tourism," Treasury macro policy manager Mark Sowden said.
"Our observation is that public expectations matter hugely and that, in the event of an actual pandemic, policies that aim to restore confidence, maintain normal commercial relationships and promote a quick return to work when safe to do so are likely to be the most effective in mitigating economic impacts of a pandemic."
The report, prepared for Finance Minister Bill English, outlined two scenarios based on a severe infection rate of 40% and a mild rate of 30%.
The severe pandemic would wipe 5% to 10% off real GDP in the first year and a cumulative reduction of up to 15% over four years.
The milder pandemic would take 1% to 2% off real GDP in the first year and 1% to 3% over four years.
The number of people infected with the influenza A (H1N1) virus in New Zealand is rising sharply: yesterday, the numbers of confirmed cases jumped to 153, up 26 from Wednesday, with a further 19 cases regarded as "probable".
The extra cases confirmed yesterday included two clusters in Canterbury and Wellington, with a dozen patients in each.
Westpac chief economist Brendan O'Donovan said swine flu was bad news for the economy, but exactly how bad it would prove to be was hard to know.
"The main issues will be disruption to labour supply, the extent to which people start trying to avoid each other and the impact on business and consumer confidence."
So far, New Zealanders seemed to be treating the outbreak as an inconvenience rather than a catastrophe, suggesting the labour supply impact from illness would bethe main issue.
If fear grew, the latter two impacts would come to the fore, he said.
Mr Sowden said considerable uncertainty remained around the severity and duration of the economic impact of a pandemic.
One reason for uncertainty was that the outbreak of swine flu was occurring in an economic environment already under more stress than assumed in the modelling adopted in 2006 which formed the basis of the latest report.
Another reason was the high level of uncertainty around how the present minor outbreak of swine influenza might evolve.
"At this stage, a pandemic influenza is not inevitable," he said.
A severe pandemic would pose challenges to macroeconomic stability, the report said.
The broad frameworks in place, in relation to monetary policy, the exchange rate and fiscal policy, contained enough flexibility to weather short-term negative shocks.
A fall in the exchange rate would be likely, although since a serious pandemic was likely to be a global event, relative movements in exchanges rates were hard to predict.
A severe pandemic could see default rates on household and commercial loans rising.
House prices could be adversely affected if household income was disrupted for an extended time.
"A severe pandemic could result in a large number of firms facing some degree of financial stress, given the likely fall in demand and high levels of staff absences."
Sectors dependent on international trade and travel, the hospitality and accommodation sectors, entertainment, retail and personal services would be most affected.
Small businesses were likely to be particularly vulnerable as they might lack the human and financial resources to prepare for, or cope with, a shock of that nature, Mr Sowden said.
Firms with large office environments, or other heavily populated working environments, would find it difficult to maintain usual work practices.
If a severe pandemic developed, the challenges of the adverse global economic and financial situation would be amplified, he said.
Most central banks had little scope to cut interest rates further to offset the losses of output or further falls in confidence.
Even in New Zealand, the scope was much less than it was previously.
"The financial system worldwide is still under severe pressure and it would be possible that markets, including the funding markets that New Zealand relies upon, could seize up again."
Depending on the severity and duration of any pandemic, and how the economy recovered afterwards, the Government might want to consider exercising existing or new emergency powers to manage the economy.
That could include assuming a role in distributing some goods and services, controlling prices for those goods and services and suspending or overruling commercial contracts.
In the event of a serious pandemic, it would be critical that the Government's financial system remained intact, and that Treasury and agencies, such as the Reserve Bank, Inland Revenue and Ministry of Social Development, were able to maintain their core functions, Mr Sowden said.
Treasury report
> A swine-flu pandemic in NZ is not inevitable.
> Policies to restore public confidence likely to be most effective.
> Government might want to control supply and price of some goods and services.
> Small businesses particularly vulnerable to pandemic.
