Avoiding confusion on the structural deficit

It appears the government will formulate its fiscal adjustment plan around a target path for the structural deficit.  This is a good idea in principle.  But unless carefully managed it could be a recipe for confusion in practice, especially if assumptions differ from those in the Commission’s Stability Programme (March 2009). 

At present, there are differences in estimates of the structural deficit between the Department of Finance’s Addendum (January 2009), the Commission’s Stability Programme Opinion (March 2009) and the recent ESRI analysis.   Such discrepencies are not surprising given the difficulty of measuring potential output and the rapidly evolving revenue estimates.  Although the Commission’s estimates of potential output strike me as overly pessimistic, it would be wise to use Commission’s figures (suitably updated to incorporate revised tax projections) to anchor the fiscal plan.

The important point is that the government should try to achieve as much clarity as possible on its analysis of and projections for the structural deficit.  

Illustratrive contours of a possible plan:  The Commission projected a deficit of 9.5 percent of GDP for 2009.  They also estimated a structural-cyclical split of 8.1-1.4.  I assume the recent disappointing revenue numbers have added 2.5 percentage points to the ’09 projection.   In addition, the real GDP growth forecast for ’09 has been revised from -4 percent to -6.5 percent.  Using the standard methodology, the new structrual-cyclical split is 9.6-2.4. 

It is useful to distinguish between two elements in the fiscal plan.  First, the adjustment required to correct for the slippage in the structural deficit from the 8.1 percent target.  This is 1.5 percent of GDP.   Second, the plan for reducing the structural deficit from the 2009 target of 8.1 percent to 3 percent by 2013.