The ESRI’s Quarterly Economic Commentary
This post was written by John Fitz Gerald
The ESRI’s Quarterly Economic Commentary (QEC) by Alan Barrett, Ide Kearney, Jean Goggin and Thomas Conefrey, published in December, is now available to download free of charge from the ESRI’s web site here. This QEC contained a number of pieces of research which may be of general interest.
1. Measuring Fiscal Stance
In box 1, entitled “Measuring Fiscal Stance”, the stance of fiscal policy in every year since 1976 is analysed within a consistent modelling framework. This research shows that the 2010 budget, while definitely contractionary, was actually not one of the toughest budgets of the last half century. That “accolade” goes to the 1976 budget, with fiscal policy in 1983 and 1984 and in 1988 and 1989 coming in next in line. After that comes the series of budgets implemented for 2009 and 2010. However as is noted in the box, a futher contractionary budget is planned for 2011 so the cumulative contraction in these years may well ultimately exceed the cumulative contraction in the late 1980s.
This measure is obtained by running the HERMES model with taxation and welfare rates indexed and certain rules on public expenditure. This “budget” is taken to be neutral – generally under this rule the relative size of the public sector in the economy would change little in the long term. This result is compared with the actual outturn with the difference being attributable to discretionary fiscal policy.
This measure of fiscal stance tells us whether a particular budget is deflationary or inflationary. It does not tell us whether it is appropriate. However, as discussed in the box, more often than not the stance has been inappropriate – i.e. procyclical.
While not discussed in the QEC, I think that it is interesting that the day of the budget the Department of Finance published an alternative measure for 2010 using the EU standard methodology. This actually suggested that the budget for this year was stimulatory. This strange outcome arises from the inappropriate nature of the EU methodology. The Department of Finance understandably did not draw attention to this result as they clearly saw that it was not a sensible approach. This problem with the EU methodology is not unique to Ireland but affects its application to other EU member economies under current circumstances. I think that the EU approach was not designed to deal with a crisis of the kind experienced in Europe over the last two years. This issue merits further research to find a more robust approach which can be applied in a consistent way to different Euro area economies.
2. The Balance of Payments and the Flow of Funds
In box 4, entitled “Balance of Payments”, the implications of the economic forecasts for the capital side of the balance of payments is considered. With the government sector likely to borrow over 11% of GDP this year and with a prospective small balance of payments surplus, in 2010 the private sector will have a major net acquisition of financial assets abroad (more properly a repayment of net liabilities). Some of this repayment will not flow through the banking system. However, a significant part of it will affect the domestic banking system as households and companies increase savings or reduce borrowings from domestic banks. In turn, the banks are likely to reduce the size of their balance sheets and, hence, their net foreign liabilities. As shown in the box, there was a substantial reduction in these liabilities (largely to the ECB) in the second half of 2009. If this trend were to continue, with the prospective continuing large net repayment of foreign liabilities implied by the 2010 forecast, there should be a continuing substantial reduction in the banking system’s foreign exposure, especially in its exposure to the ECB. This will be important as the ECB begins to wind down its support for the Euro area financial system. Obviously this must be seen against the background of the government sector’s increasing foreign liabilities, a significant part of which will be needed to recapitalise the banking system this year.
3. Distributional Effects of Budgets
In Box 2 the distributional impact of tax and welfare policy changes in 2009 and 2010 was considered by Tim Callan, Claire Keane and John Walsh. They found that while Budget 2010 was clearly regressive, the combination of Budgets 2009 and 2010 placed most of the burden of fiscal adjustment on higher earners.
January 28th, 2010 at 7:30 pm
The section on the distributional effects of recent budgets is interesting. I suggest that free copies of this section, in large black type and all figures heavily underlined, be sent to Vincent Browne, Fintan O’Toole and Gene Kerrigan. It completely knocks for six their repeated claims that the lower-income groups are being disproportionately hit during the recession or that a low-tax economy inevitably has a high (relative) poverty rate.
The (relative) poverty rate in Ireland peaked at 21.9% in 2001. Since then it has fallen every year, reaching 14.4% in 2008. These figures are from the annual SILC surveys conducted by the CSO and Eurostat. However, that was largely pre-recession. What is new information from this ESRI report is that, if what ESRI now say about the distributional effects of the 2009 and 2010 budgets is correct, then the trend is continuing during the recession and the (relative) poverty rate in Ireland will likely fall to the range 10%-12% in 2010. This would be well below the EU average, which is about 16%, and far below that in the UK, which is about 20%. It would be very close to the levels of (relative) poverty in the Nordic countries, generally around 10%, but with a much lower tax take as a percentage of GDP. The priority should now be to keep the (relative) poverty rate in Ireland at this low level during the next surge of economic growth, which more and more economists predict will start later in 2010.
This highlights an important difference between Ireland and the UK. The two are often lumped together as pursuing the low-tax Anglo-Saxon economic model. The ‘Boston or Berlin’ debate and all that. And there is some truth in that as both have much lower tax takes as a percentage of GDP than the continental countries. However, a major difference is that in Ireland the low-income groups have very low direct tax burdens, whereas in the UK the low-income groups often pay a larger proportion of their income in direct tax than the high-income groups do. Not to mention council tax, water tax and abysmally low social welfare benefits. As a result, while the (relative) poverty rate in Ireland has tumbled in the past decade (14.4% in 2008) under a series of ‘right-wing’ governments, the caring sharing Labour government in the UK has actually increased the (relative) poverty rate (20% in 2008) from that which they inherited from the Tories in 1997. This is rather ironic, as one of the main arguments against a United Ireland that unionist politicians in Northern Ireland use is the supposed greater inequality south of the border. But, its a total myth.
January 29th, 2010 at 7:31 am
Thank you for John for publishing this very interesting ESRI report.
1. It seems to me that a popular apprehension of the term “fiscal thrust” (for those who previously knew nothing of the term) might be the appropriateness of fiscal policy.
The definition used by the ESRI could thus cause problems where there has been a lasting improvement or disimprovement to our national finances. For example, our national finances appeared to have suffered a lasting disimprovement when oil prices rose sharply in 1976: in that context a sharply contractionary budget (using your fiscal thrust measure) was appropriate. Conversely, our national finances appeared to have enjoyed a lasting improvement during the early years of the last decade: in that context expansionary budgets (using your fiscal thrust measure) were appropriate.
The real question is what fiscal policy is appropriate.
2. We have pooled our monetary policy sovereignity with our EMU partners in Frankfurt. This has profound implications for our fiscal policy as we should use fiscal policy to lean against any monetary policy bias which may emit from Frankfurt.
Using a Taylor Rule approach to estimate the appropriateness of EMU base rates for Ireland would have indicated that they were extraordinarily stimulative over the decade 1997 - 2007. The implication is that fiscal policy should have been deeply contractionary in order to lean against the highly expansionary monetary policy.
Applying a Taylor Rule approach to base rates today indicates that EMU interest rates are likely to be structurally too high for Ireland’s needs going forward as (a) our inflation rate has fallen well below the Eurozone average and (b) our unemployment rate (and thus presumably our output gap) has risen well above the Eurozone average. The implication is that fiscal policy should be highly expansionary in order to lean against the deeply contractionary monetary policy.
The real question is how do we, in real time and without use of subjective measures, identify the appropriate fiscal balance.
January 29th, 2010 at 9:49 am
@JohnTheOptimist
“The (relative) poverty rate in Ireland peaked at 21.9% in 2001. Since then it has fallen every year, reaching 14.4% in 2008. These figures are from the annual SILC surveys conducted by the CSO and Eurostat. However, that was largely pre-recession. What is new information from this ESRI report is that, if what ESRI now say about the distributional effects of the 2009 and 2010 budgets is correct, then the trend is continuing during the recession and the (relative) poverty rate in Ireland will likely fall to the range 10%-12% in 2010.”
No, this is not true. Remember that the poverty number comes from a combination of the distribution of earnings - and the weight in the bottom of that distribution in particular - and redistributive policies. The fact that the redistribution favours the bottom may or may not be enough to counter the effect of the recession on earnings.
Many people are losing their jobs and unemployment is one of the strongest predictors of being in poverty. The fact that the social welfare that they’re now relying on is being cut by less than the wages of those at the top is unlikely to stop the move into poverty for many unemployed. Average wages are falling, which will lower the poverty line, and this will serve to lower the relative poverty rate. However, the fact that many more people won’t be earning any wages will work strongly against this. I would be very surprised if the recession doesn’t result in an increase in the poverty rate. That doesn’t take from the fact that the rise would have been even higher if the redistribution had been against the bottom. But don’t expect a Nordic paradise at the end of our crisis.
January 30th, 2010 at 12:06 pm
@Aedin Doris
While I would never claim that these things are predictable in advance, past experience doesn’t support your argument.
First, between 1994 and 2001 the number in employment in Ireland rose at an unprecedented rate, up 100k in some years, and the unemployment rate fell from around 15% to 5%. Yet, during that time the (relative) poverty rate rose from around 15% to over 21%.
Second, you could equally well have written your post this time last year and predicted that the (relative) poverty rate would rise in 2008, as the recession began in early 2008 and unemployment was rising rapidly from late 2007 on. Yet, according to SILC, the (relative) poverty rate fell from 16.5% in 2007 to 14.4% in 2008.
January 31st, 2010 at 4:15 pm
@John Fitzgerald
Does anyone ever listen? (other than, hopefully, you know who!) ….. over the past 15-20 years or so ….. how many PRO-CYCLICALS and REGRESSIVES …………… have the various ESRI quarterly summaries noted? - may one assume, for the non-specialist, that a touch of the Contra-cyclical and a touch of the Progressive are what economists regard as Appropriate?
January 31st, 2010 at 9:02 pm
@Cormac Lucey
You are quite right that measuring the fiscal stance does not tell you whether fiscal policy was appropriate to the needs of the economy at any point in time. However, establishing the current stance of fiscal policy is essential in determining whether fiscal policy is appropriate to the needs of the economy.
The Stability and Growth Pact is also not an appropriate guide to what fiscal policy should be adopted. The advent of EMU means that fiscal policy has to play a rather different and more complex role than in the past. In particular, it has to be used to prevent bubbles occurring in property markets in regional economies within EMU. I will publish a paper on this topic next month.
February 1st, 2010 at 6:54 pm
@Aedin Doris
Analysis of the ESRI’s opinion on the fiscal impact of the budget has been critical:
“I am struck (by) just how thin the evidence is. The [ESRI] Winter 2009 QEC is 76 pages in length. The claim with regard to the scale of contractionary impact is discussed in Box 1 on three pages only: 21-23. Three figures are contained in this Box (A, B and C). ‘Own Estimates’ is mentioned at the foot of each Figure (A, B an C) in Box 1. There is no citation of working papers or other published research apart from a paper written in 2000 (Assessing the Stance of Irish Fiscal Policy)…
…The ESRI estimate – however it was derived and whatever assumptions were made in its generation via the Hermes model is uncanningly the same as the Department of Finance (DOF) estimate of the contractionary impact of last month’s budget….
Demands for ESRI to end its secrecy:
“I suggest that:
The inner workings of the HERMES be made public and available to other researchers to explore different scenarios and possible model specifications;
A full set of working papers be provided on the ESRI website including the work underlying pages 21-26 of the Winter 2009 QEC.
More caution be adopted in regard to any big claims about the scale of fiscal stance and its estimated impact on GDP, unemployment and borrowing.”
http://www.progressive-economy.ie/2010/01/mirror-mirror-on-wall-who-is-most.html
February 1st, 2010 at 7:19 pm
@Aedin Doris
Analysis of the impact of the distributional recommendations of the ESRI report has also been highly critical.
http://www.progressive-economy.ie/2010/01/ireland-now-needs-to-generate-internal.html
The ESRI cheerleads for cuts in wages/social welfare and prices, and claims to be even handed. It is fully aware though that the government is only interested in driving wage and welfare cuts and not in cutting prices, because it wants to protect the wealth and the income of the have mores. The ESRI’s behaviour is therefore fundamentally dishonest and deeply reprehensible.
February 1st, 2010 at 10:41 pm
@Oliver Vandt
I listened to that economist from the central bank on TV the other day - struck me that he ONLY spoke about WAGES and wage RESTRAINT: Yet he said ABSOLUTELY NOTHING/ZILCH about PRICES.
February 2nd, 2010 at 10:33 pm
@John F
It’s published - any link to the working paper? I’m working on figuring out me ‘fiscal stance’ at the mo!
February 2nd, 2010 at 10:50 pm
found it ….
http://www.esri.ie/publications/search_for_a_working_pape/search_results/view/index.xml?id=2853