Banking Crisis

Pension Reserve Fund Set to Make €1.8 billion Loss on AIB Shares

NAMAWineLake blog performs yet another valuable public service and points out that Brian Lenihan’s statement of October 30 told us that “AIB’s upcoming €5.4 billion will be fully underwritten by the National Pension Reserve Fund Commission (NPRFC) at a fixed price of €0.50 per share.”  Unfortunately, the shares closed on Friday at €0.337.

This means the Pension Reserve Fund looks set to make an instant loss of €1.8 billion when it purchases these shares. There is, of course, an alternative. Cancel the underwriting, nationalise the bank and appoint an assessor to value the shares. If, for instance, the shares were valued at their closing price on Friday, this would cost us €364 million. Which sounds better? Losing €1.8 billion or losing €364 million. Is it worth €1.4 billion to retain a tiny private ownership share?

It is also worth raising the question of whether the current process we are going through with AIB is the right one. Rather than being so sure that the bank just needs another €5.4 billion to fix it, why not remove the current upper management immediately, introduce new management charged with fully assessing the bank’s loan book and then decide what to do with it?

If AIB is deemed to be deeply insolvent at that point, we are already (albeit slowly) developing a template for dealing with banks of this kind. This would involve splitting AIB into a good bank and a bad bank, leaving the €4.5 billion in subordinated debt in the bad bank and perhaps negotiating with with the holders of these securities to reduce the amount of public funds required to cover the losses.

If the losses at AIB are larger than the authorities currently envisage, then there are strong arguments against continually putting taxpayers money in to protect other providers of risk capital.

Fiscal Policy

Improving the Fiscal Trade-off

Apologies for what Paul Krugman would call a “wonkish” post. 

As we enter some critical weeks for Irish fiscal policy, there is still wide disagreement about the nature of the creditworthiness-demand trade-off facing the government.   At one of the spectrum are those who think Ireland is placed to have an “expansionary fiscal contraction”: a cut in the discretionary deficit would raise confidence and lower the risk preimum sufficiently so that we could simultaneously improve creditworthiness and demand.   At the other end are those who think that discretionary cuts will slow the economy so much that the actual deficit will rise, leading to both a shrunken economy and shrunken creditworthiness.   I think I share with most economists the view that we are actually in the boring middle – deficit cuts will slow the economy but will improve creditworthiness.

Readers might find this graphical representation of the trade-off useful in putting the different views in context.   It attempts to capture the potentially complex relationship between creditworthiness and demand, allowing for different trade-offs over different ranges.   (The “dismal” vicinity around point C has been subject to notable discussion on this blog, where the government is seen as effectively powerless to avoid bailout or default.   At least this is how I interpret commenters such as Simpleton, Paul Hunt and Tull Macadoo, though I’m sure they will correct me if I’m wrong.)

Fiscal Policy

Business and Finance Article: Focus on This Budget, Not 2014

Here‘s an article I wrote for Business and Finance on the current budgetary situation (complete with a nice picture of Mrs. Merkel). The article emphasises the importance of getting the upcoming budget right rather than worrying too much about the 3% target for 2014.


Review of the ESRI

The results of the review of the ESRI are here.


Successful Bond Auction

Details here.

Economic Performance

CSO: Institutional Sectoral Accounts

The CSO has released institutional sectoral accounts for 2009 – the release is here.  These detailed data provide a lot of useful information about the shifts in income and savings in recent years.  Among the highlights:

  • Household net saving ratio jumped from 3.9% in 2008 to 12.3% in 2009. Behind this ratio: net disposable income fell by €2.1 billion but consumption fell by €10 billion.
  • The Net Operating Surplus (profitability) of Financial Corporations and Non-Financial Corporations fell by over 22% and 6% respectively, between 2008 and 2009. Investment by Non-Financial corporations fell from €13bn to €7bn over the same period. Investment by Financial Corporations also declined – from €0.9bn in 2008 to €0.6bn in 2009

Cormac O Grada awarded RIA Gold Medal

Congratulations to Cormac O Grada who has been awarded 2010 Royal Irish Academy Gold Medal.  This is the premier Irish academic award and in Cormac’s case it is richly deserved.

PS: I released this yesterday but then quickly withdrew it as I thought it was embargoed!  But I think its OK to release the news now – just tell one person at a time!


What do markets want?

I have posted links to this piece in the comments section before, but never on the front page. This seems like a good time to do so, given that the question of what markets want is beginning to exercise people (see for example here, or here). The essential point is that markets understand that governments face political constraints, and take this into account when assessing the credibility of their economic policies. (And, moreover, market participants tend not to believe in tooth fairies or negative fiscal multipliers.)

We’ve known all along that fiscal adjustment here would be contractionary, and that our economy thus needed substantial export growth if it was to avoid falling into the hands of the IMF. That in turn requires a buoyant European economy; hence my alarm regarding austerity measures in countries like the UK and Germany. One of the key insights of Barry Eichengreen’s work is that you have to analyse international monetary arrangements as systems: it makes little sense to analyse policies in one country at a time as if countries are isolated from each other. Ireland has no choice right now concerning what policies to pursue, but other countries do, and if those with fiscal space (as measured by the interest rates at which they can borrow) choose to embark on contractionary policies now, for what appear to be nothing more than ideological reasons, then that is profoundly irresponsible from the point of view of the fragile system that is the European economy.

Banking Crisis

Dail Exchanges on Upcoming Budget

With consensus on the likely size of a four-year adjustment unlikely to emerge (and perhaps not particularly relevant anyway) the key fiscal policy question for now is what the size of the adjustment is going to be in the upcoming budget.

Yesterday’s Fine Gael Dail questioning on this subject was interesting. Deputy Noonan:

Now that we have agreed that 3% in 2014 is the finish of the race, what is the Minister’s starting point on 7 December? Will he go soft? Will the budget deficit be 11%, 11.5% or 10.5% of GDP? Will he go below 10%? He needs to come up with this figure pretty quickly. I will not press him any harder on this; I am simply speculating. I have no information as to his thinking on this but this is an essential piece of information. Unless we know the starting point we do not know where the Minister is going.

I’m pretty sure that Noonan knows that an adjustment of €7 billion would be required to reach the 10% target but hasn’t yet said that he would support it. His lack of enthusiasm for the €15 billion four-year adjustment figure suggests he wouldn’t be too keen.

However, others in Fine Gael are calling for the 10% to be met. Here’s Simon Coveney

My understanding from the briefing from the Department of Finance is that the key requirement from bond markets to allow Ireland to issue bonds is that we will need to bring our deficit below 10% of GDP next year from our current position. No Government speaker, including the Taoiseach and the Minister for Finance, addressed that issue as to what figure will be necessary in the 2011 budget to bring down the deficit to 10% or less of GDP. That is the guideline figure we have been given to issue bonds and raise money in order that we can keep Ireland functioning and keep our economic and political independence in terms of budgetary decision-making.

And here’s a bit of cat-and-mouse play from Damien English

Deputy Coveney is correct in stating that we must bring the deficit down below 10% of GDP next year, and I ask the Government to give us the figure now. Tell us what it is, whether it be €5.5 billion, €6 billion, €5 billion or €4.5 billion, and let us work to that.

Well, Deputy English, it’s not going to be €4.5 billion!

Labour’s participants in this debate seem to have stayed away from this issue. However, on the Vincent Browne show last night, Pat Rabbitte indicated he wouldn’t support more than €4 billion in adjustments. If this is the party line, then it means that Labour are not supporting reaching the 10% target.

Fiscal Policy

A Discouraging Dail Debate

Yesterday’s Dail debate shows that Fine Gael’s approach to the upcoming budget and four-year plan debates appears to be to emphasise the idea that economic growth may be higher in future years so that €15 billion in cuts will not be needed.  The ESRI’s high growth scenario gets a lot of play in these discussions.

From Enda Kenny’s speech in the Dail:

There are better possible outcomes. For instance, if the ESRI’s updated high-growth scenario of an average growth of 4.5% were to materialise, a smaller package of fiscal measures would be needed to hit the 3% target by 2014.

That is why Fine Gael believes it is necessary, over the coming weeks, to put a relentless focus on the ways to support growth and jobs as the country attempts to repair its public finances. That is why Fine Gael believes that any fiscal plan has to operate in parallel with a credible growth and jobs plan to turn the present downward vicious cycle into an upward virtuous cycle. We have a different approach from the Government. Fine Gael offers real hope that we can rebuild our economy and restore trust in politics and in Government.

This was backed up by Michael Noonan, who was pretty clear about the political costs to the opposition of agreeing to the €15 billion figure:

When the €15 billion is a forecast and when minor adjustments in the growth rate can make such vast variations, would we not be desperate clowns to tie ourselves in to the Minister’s figure, especially when the Taoiseach could not answer Deputy Gilmore this morning when he asked what was factored into the estimate of growth?  …. The key element is the forecast for growth and there is a vast variation between Davy’s forecast, which would take us over €20 billion, and the ESRI high growth forecast, which would bring us down to €9 billion.  The Minister is on the mid point so maybe he is right, but we are not buying in. We need more information.

I’m pretty sure that Fine Gael are aware that the previous budget’s growth projections are now considered to be highly aspirational by the European Commission and that any plan that is agreed will have to be on the basis of lower growth figures than contained in the ESRI’s high growth scenario.

You can call this unfair if you want (and some will—no doubt we’ll have comments here about the need to wear shades due to the brightness of our economic future.) However, that’s the way things are going to work and with the EFSF waiting in the wings to bail us out, the government probably doesn’t have a lot of bargaining power to make the case for a more optimistic scenario.

Indeed, I’m sure even the ESRI don’t believe that their high-growth scenario is the appropriate basis for fiscal planning over the next few years. Recall that the Recovery Scenarios document gingerly raised the question as to “whether a more rapid fiscal adjustment than currently planned would have a more beneficial outcome for the economy.” Note also that, on its own, the news about €1.5 billion per year in promissory note interest would take us to €9 billion even on the basis of the government’s December 2009 calculations. 

What this emphasises, I’m afraid, is that the current political situation makes a cross-party consensus on multi-year budgeting essentially impossible. Opposition parties do not want to campaign at the next election on the basis of €15 billion in adjustments and who can blame them?  However, this will gravely undermine the credibility of any four-year plan introduced by the government and will also worry financial markets. 

Environment Fiscal Policy Higher education

McDonald and Cuffe on Metro North

On PrimeTime last week, Sean Barrett and Edgar Morgenroth cast severe doubt on the wisdom of Metro North. They are now joined by Frank McDonald.

Cairan Cuffe’s response starts with “[n]ow is the time to invest”. That says it all really. You can read the rest for yourself.

The Green Party is apparently still oblivious to the situation with the economy and the public finances. Cuffe wants to invest billions of euros in a project with a doubtful return. Gormley wants to spend unnecessary hundreds of millions of euros on waste disposal, despite warnings of his own EPA.  Ryan invests ESB’s money in electric cars and continues a subsidy scheme that does not deliver according to his own SEAI.

It is never wise to waste money, but now is a particularly bad time.

Dublin is badly served by public transport at present. Liberation of the bus market is the way forward.

UPDATE: Metro North got planning.

Banking Crisis Fiscal Policy

Address by Governor Patrick Honohan to Institute of Certified Public Accountants in Ireland

His speech is here.

Fiscal Policy

Ireland’s Experience in the Bond Markets

Oliver Whelan of the NTMA gave a presentation on this topic to the IIEA last week. His slides are available here.

Economic growth Fiscal Policy

What sort of four-year plan?

While there has been much comment about the four-year fiscal plan since the government announced it last month, it is still not clear what sort of plan they have in mind.  At one end of spectrum (the relatively useless end) would be new targets for current spending, capital spending and tax revenues, with possibly a listing of realistic options for achieving those targets.   At the other end of the spectrum would be a true multi-year budget, with detailed phased measures that are legislated where possible. 

The governments statement yesterday hardly suggests that a proper multi-year budget is what they have in mind:

The purpose of the Four Year Plan for Budgets and Economic Growth is to chart a credible way forward for this country. The size of the adjustment for 2011 and the distribution over the remaining years will be announced in the Four Year Plan. The Plan will contain targets for growth and strategies for the achievement of those targets.

When exactly did the four-year plan become a plan for economic growth?   While returning the economy to growth is a critical part of the overall challenge, the four-year plan had a specific and urgent goal: to convince potential buyers of Irish debt that Ireland could lower its borrowing requirement sufficiently to avoid a bailout or default.   Of course, decent economic growth will make this challenge easier, but I cant see how the year-by-year, sector-by-sector fiscal plan expected by the EU Commission is the place for growth targets and strategies.  We have to worry that the targets and strategies are filler to distract from the paucity of the fiscal plan itself. 

Minister Lenihan also confirmed yesterday a nominal cumulative deficit adjustment target of €15 billion by 2014.  The debate has now switched to how much to frontload this adjustment in 2011.   Of course, the necessary front-loading depends on the credibility of the overall plan.   The more investors have doubts that we can make good on our promises, the more they will need to see the money taken out up front that is, the more the adjustment must be inefficiently concentrated at the time when our anticipated output and employment gaps are at their largest.   Having to frontload because the government (and opposition) cant or wont deliver a true multi-year plan would be a serious policy failure. 

Economic Performance

University Rankings

This is a guest post by my colleague John O’Hagan of TCD Economics Department:

The recent ranking of world universities was given considerable prominence in the Irish Times. Seán Flynn in his piece of September 11th (“Why Irish universities should take world rankings seriously”) argued that the fall of Ireland’s top universities in the world rankings should not be dismissed?.

I do not wish necessarily to disagree with this argument or to open up here the debate about the merits of rankings. As Mr Flynn states they do matter, if only because they influence the choice of academics/researchers concerning where to work, and the choice of students, graduate students in particular, with regard to study location. In the absence of other more reliable information, upon what else can such matters be decided?

It appears that the QS World University Rankings are now the most reliable guide to the overall performance of a university, although Times Higher Education (THS), with even more recent rankings and which used to work jointly with QS, might challenge this. I do not desire to get into this discussion either, but wish to point out some important other issues that must be borne in mind when considering the rankings. I will make these points in relation to the recent QS rankings.

The first issue is the variation in the ?scores? attached to each university. Cambridge, the highest ranked university in the 2010 rankings, was given a score of 100. The tenth-ranked university, Princeton, was assigned a score of around 96, that is, just four points below Cambridge. Trinity, ranked at 52, had a score of 75. This figure for Trinity is well below that of Princeton, but not much below the university say ranked 39th, namely Brown University in the US (score 80.5).

But it is not much higher either than the score of the university ranked 100th (Oslo with a score of around 64). Thus very little can sometimes divide the universities separated in rank by 30 to 50 places. As such, it might be best to use three/five-year averages rather than the score for one year. Bearing this in mind, UCD has moved very considerably up the rankings in the last five years (over 100 places between 2006 and 2010), despite the slippage in 2010.

The second point to make is that a university ranking can vary significantly by academic area. Taking UCD as an example again, it ranked 89th in Arts and Humanities but 261st in Natural Sciences. The variation in Trinity was less marked: 52nd in Arts and Humanities to 99th in Engineering and IT. Harvard, the second ranked university overall, had a rank of 22nd in Engineering and IT but 1st in the Social Sciences and Life Sciences/Biomedicine. It could be argued that it is these discipline rankings, and not the overall rankings, which really matter to academics/researchers and graduate students (and possibly even more disaggregated rankings, like for economics or sociology say within the Social Sciences).

The third point to make is to advocate caution with regard to explanations for variation in rankings. There may for example be too much of a readiness to attribute a fall in ranking to a drop in public funding. There is in fact little evidence as far as I know linking public funding and the ranking of a university. If so, how then can the very low ranking of some French and German universities be explained? How can we, in the Irish context, explain the 9 and 25-places fall in the Trinity and UCD rankings in 2010 and the 23-place rise in the UCC ranking? Universities should perhaps also look at their own performance and operation (e.g. salary levels and structures, promotions, governance), as well as highlighting any funding deficiencies, in responding to changes in ranking.

In this regard, one must also remember that in an Irish context it is GNI (Gross National Income) and not GDP that is the more appropriate benchmark to use in assessing total state expenditure on education. When using GDP, Ireland comes out below the OECD and EU averages, but is about average when GNI is used.

The fourth and final point I wish to make is what appears to be a strong bias in the rankings towards the English-speaking world. Of the top 30 universities using the GS ranking, 26 are in the English-speaking world. Is it really believable that the UK has eight universities in the top 30, whereas developed countries of similar size and maturity such as France and Germany have none? The caution in this regard is borne out when looking at other, more Europe-based rankings, such as the Leiden Rankings. While their rankings are based on research alone, the listings are more in line with what one would expect. On one of their rankings, the University of Göttingen in Germany is ranked first in Europe (including the UK), with Lausanne (Switzerland) ranked second, and generally their top-50 rankings include a large number of Continental European universities.

It might then be more appropriate to compare Irish universities to UK universities in the GS rankings; on this basis, Trinity ranks 9th in the British Isles and UCD ranks 20th. These are not poor rankings, as for example in the case of Trinity they put the College ahead of universities such as Warwick, York, Durham and St Andrews, all very reputable institutions. Trinity though ranks well behind Bristol and Edinburgh universities and does not come near the scores assigned to the top four UK universities, namely Cambridge, University College London (UCL), Imperial College London, and Oxford (all with scores of around 98 or higher). So while the slippage in the rankings this year may be a legitimate cause for some concern, the more pressing question perhaps is can an Irish university ever get into the Top 5 rankings in these islands , and if so how?

Fiscal Policy

Government Statement: €15 billion target

The government statement reads:

The Government has today decided that an overall adjustment of €15 billion over the next four years is warranted in order to achieve the target deficit of 3% of GDP by 2014. The key reasons for the significant increase from the figure announced in Budget 2010 are lower growth prospects both at home and abroad and higher debt interest costs.

The purpose of the Four Year Plan for Budgets and Economic Growth is to chart a credible way forward for this country. The size of the adjustment for 2011 and the distribution over the remaining years will be announced in the Four Year Plan. The Plan will contain targets for growth and strategies for the achievement of those targets.

The Government realises that the expenditure adjustments and revenue raising measures that must now be introduced will have an impact on the living standards of citizens. But it is neither credible nor realistic to delay these measures. To do so would further undermine confidence in our ability to meet our obligations and responsibilities and delay a return to sustainable growth and full employment in our economy.

Our obligations are clear. We must demonstrate that we are bringing sustainability to our public finances. We must stabilise our debt to GDP ratio over the period of the Plan. And we must set out our strategy for returning our economy to growth.

Higher education Knowledge economy

Business schools and scholars (2)

I decided to give an interim update of the assessment of business schools and scholars on the island of Ireland, because things have changed. Latest results are here.

The records of 18 people have been double-checked and corrected where appropriate. More significantly, I had overlooked a department in Maynooth which has been added. Another department employs two high performers without listing them on their front page.

As a result, the preliminary ranking has changed: TCD, (UCD, QUB), (NUIG, UU, NUIM), (DCU, UL), DIT, NCI. Brackets indicate institutions whose performance is similar.

Note that Cork is still missing.

I’ve added sex and rank where known. The sex results are not good. The rank results are roughly as they should be: professor > reader > senior lecturer > lecturer > junior lecturer.

There are two exceptions, however: Associate professors perform on par with full professors, and post-docs perform on par with lecturers. I would expect there to be progression from the former to the latter.

While looking at the ranks, I came across all sorts of weird stuff. Full professors without a doctorate. Teaching assistants with a doctorate. Lecturers of French (in a business school!). Senior teaching assistants. And one of the department runs a restaurant — ostensibly for experimental purposes.

Fiscal Policy

Puzzling Budgetary Reporting

I’m having trouble making sense of most of the reporting of the budgetary discussions.

Two issues are particularly puzzling. The first is the consistent referencing of the idea that the higher requirement for budgetary adjustment is due to a relatively recent worsening in the forecasts for the Irish economy. (Indeed, a number of government politicians have also made reference to the idea that this worsening stems from a recent downgrading of the outlook for the international economy.)

The second is the dismissal of the €7 billion figure for budgetary adjustment mentioned by Michael Noonan and the lack of reference to the 10% deficit target that had been set for 2011.

Fiscal Policy

How Big (Small?) are Fiscal Multipliers?

Ethan Ilzetzki, Enrique G. Mendoza and Carlos A. Végh provide new empirical evidence (using a different method to the recent IMF study). The paper is here and the abstract is below.

Abstract: We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.

Fiscal Policy

Self-defeating deficit reduction?

Karl’s post yesterday led to an important exchange about the possibility of self-defeating deficit reduction, with particularly important contributions from Michael Burke and Michael Taft.   If multiplier and automatic stabiliser effects are sufficiently large, the understandable concern is that cuts in the discretionary deficit could actually raise the deficit overall.  We end up with the worst of both worlds – a deeper recession and a larger deficit. 

Effectively, the argument is that the deficit reduction measures slow the economy, and this leads to automatic stabiliser effects (falling tax revenues and rising expenditures) that offset the discretionary effect (i.e. the underlying change in the deficit holding GDP constant).  

While plausible, I believe the claims for self-defeating deficit reductions are wrong – or at least wrong in the context of the simple (and I believe essentially correct) model that I think all the main participants in the debate are using.   I sketch this model here.   Using the model, it can be demonstrated that a discretionary deficit cut will lower the overall deficit for any (non-negative) values of the deficit multiplier and automatic stabiliser coefficient.   Moreover, it can be shown that the deficit as a share of GDP also falls with a reduction in the discretionary deficit, even as this reduction slows the economy through a multiplier effect. 

Of course, a simple model cannot provide the last word on the issue.   But hopefully it will at least help us pinpoint better the sources of the disagreement. 

Those arguing against the need for austerity point out that the underlying deficit has grown with previous rounds of austerity.   While I agree that these measures have slowed the economy, I do not believe that they have actually caused the deficit to rise.   Unfortunately, there are other contractionary forces at work, not least the overhang of debt that is curbing business and household spending and also bank lending.   With bond yields where they are, I assume we all agree that we cannot avoid a bailout/default without putting the deficit quickly on a downward path.   I don’t see we have any choice now but to pursue tough deficit reduction measures.   It is not going to be pleasant. 

Banking Crisis Fiscal Policy

Sticking to 2011 Deficit Goal of 10% Requires €7 Billion Adjustment

Despite all the focus in the past few days on 2014 and European Commission, the key issue facing us right now is the how to convince sovereign bond markets that we are back on a stable fiscal path. Without access to the bond markets, you can be sure that the EU will be imposing the 3% target on us whether we like it or not.

Last December, the government told the EU that our general government deficit would be 11.6% in GDP in 2010 and 10.0% in 2011. So the questions we should now be asking are whether we should still aim to achieve the 10% target and, if not, what are the consequences of missing this target.

Michael Noonan appears to have said yesterday that the Department of Finance briefings called for €7 billion in adjustments. The department is now saying that “Given the current working macroeconomic forecast, indicative deficits were set out for consolidation packages of the order of €3bn, €4.5bn and €7bn.”

Fair enough, they could have set out a no-billion in cuts scenario for all it matters. However, as far as I can see, only the €7 billion scenario sees us meeting the 10% target and this likely explains why Noonan emphasised the €7 billion figure.

This isn’t rocket science. There are four elements to this calculation, none of which are complex or require access to secret figures:

1. Lower GDP: Last year, the government projected that €3 billion in adjustments would get the deficit to 10% of GDP. However, they were projecting GDP in 2011 to be €170 billion. Now, both the Central Bank and the ESRI are projecting GDP in 2011 to be closer to €160 billion. So, hitting the 10% target now requires a deficit of €16 billion rather than €17 billion. Hence, an additional €1 billion in adjustment, bringing the total required adjustment to €4 billion.

2. Promissory Note Interest: The 2009 budget figures did not include the interest on the promissory notes, which appears to be 5% on average. This adds €1.5 billion to next year’s deficit, bringing the total required adjustment to €5.5 billion.

3. Lower Tax Revenues: Tax revenues for 2010 are on target. However, last year’s budget projected a €9 billion increase in nominal GDP in 2011. The Central Bank are currently projecting a €5 billion increase in nominal GDP next year while the ESRI are projecting an increase of only €3.6 billion. Undoubtedly, any credible projection for next year will feature lower tax revenues. In my ongoing calculations (updated here to also include the ESRI’s GDP forecast) I’ve subtracted €1 billion from tax revenues next year. This brings the cumulative adjustment required up to €6.5 billion.

4. GDP Effects of Larger Adjustment: Unfortunately, if additional adjustment of this magnitude is required, then the GDP baseline in the ESRI and CB forecasts are probably too high. Hitting the 10% target will probably require about €7 billion in adjustment.

I’m happy to be corrected about any of these above points but, particularly when one factors in Noonan’s comments, I think it’s reasonable to assume that €7 billion is required to meet the original 10% target.

Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan?

It might be but then again it might not. I’d be inclined to recommend assuming the latter. The current EU-agreed plan is already our second plan (there was a previous one in which we reached 3% in 2013). Ripping up this one, so we can start again with a third plan where, after years of cutting, we’ve still only got as far as a 12% deficit next year, doesn’t sound to me like the kind of plan that’s going to work.

So, that’s the debate that needs to be had. Wishful thinking involving only €4 billion in adjustments and still hitting the 10% target just isn’t helpful.

A side-issue in all of this is what exactly the government is (and has been) up to in relation to the budget figures. In relation to point one above, as Philip has pointed out, most of this downward revision in GDP stemmed from the CSO’s annual revision released this summer. Indeed, the Central Bank were projecting nominal GDP in 2011 of €163.7 in July, already over €6 billion short of the original budget projection.  So the government has presumably known the 2011 adjustment requirement was drifting outwards due to this factor for a number of months.

On the second point above, since the government started issuing the magic promissory notes early this year, they will have known about the effect of this on the budget figures for some time.

It seems clear, then, that the government were clinging publicly to a figure of €3 billion in adjustments long after they must have known that this figure wasn’t tenable (e.g. as late as the mid-September Fianna Fail think-in the €3 billion figure was being held to).

Equally, it could be argued that yesterday’s dismissal of Noonan’s comments from, among others, the Taoiseach, also served just to obscure the full scale of the fiscal problem that we face.

Update: I’m not sure if this story pre- or post-dates what I wrote above. It says that “Government sources have firmly ruled out a €7 billion adjustment for 2011.” If so, it looks like they have ruled out meeting their previous target for next year of a deficit of 10% of GDP, though it may be some time before they admit this.

Environment Regulation

Climate Change Bill

In Q4 2009, the Dept Environment published a Framework for the Climate Change Bill 2010 promising a Heads of Bill by Q1 2010. The Oireachtas Joint Committee on Climate Change and Energy Security decided not to wait for that and published a draft bill. This was “published” to members of the press last week, and has been made available to all this week.

There are two significant differences between the Government’s sketch and the Oireachtas’ draft. First, the Oireachtas sets a target for energy efficiency whereas the Government does not. Second, the Oireachtas puts an Taoiseach in charge whereas the Government puts the Minister of the Environment in charge.

Energy efficiency is a means to an end. Setting an energy efficiency target is therefore inappropriate. Greenhouse gas emissions are primarily from agriculture, energy and transport — that is, beyond the control of the Minister of the Environment. It is therefore appropriate to put an Taoiseach in charge.

The Oireachtas’ draft is considerably more detailed and specific than the Government’s sketch (as you would expect). It is long on creating bureaucracy but short on details how emissions would be cut.

Oireachtas and Government agree that the target for greenhouse gas emissions in 2050 is 20% of the 1990 level.

If we run Hermes/IDEM/ISus out to 2025 and extrapolate trends from there, assuming a 2% annual growth of the economy between 2025 and 2050, we find emissions of 49 million metric tonnes of carbon dioxide equivalent in 2050 — 87% of 1990 levels. 60% is from fossil fuel combustion, and 36% from agriculture.

If we double the rate of decarbonisation of the economy (3.3% for energy, 2.8% for construction, 0.2% for methane, 0.9% for nitrous oxide between 1990 and 2025 in the baseline), 2050 emissions fall to 44% of their 1990 levels.

If we triple the rate, emissions go to 29%. If we quadruple the rate, emissions go to 22%.

Quadrupling the rate of technological progress (broadly defined) is very hard — particularly since Ireland’s baseline rate is rather high compared to other countries.

If we do away with agriculture, 2050 emissions would be 56% of 1990 levels. Doubling the rate of progress in energy and construction would reduce emissions to 17%.

Doubling the rate of technological progress is hard. Methane- and nitrous-free agriculture is not easy either.

It strikes me that 80% emission reduction by 2050 is on the ambitious side.

I would think that it is better to implement realistic policies than to set unrealistic targets.


He_who_shall_not_be_named pointed out that the Oireachtas draft also has a target for 2020: -30%. We have repeatedly pointed out that the -20% target for that date cannot possibly be met without draconian measures such as a prolonged depression or a ban on cows. -30% is, of course, even more difficult.

Environment Regulation

Covanta writes off Poolbeg investment

(H/T to Joe & Valerie)

Covanta has written off its entire investment on the Poolbeg project in its 3Q results, citing the “political and regulatory environment” in Ireland. That’s just the sort of language we want in a SEC filing.

According to RTE, Covanta still intends to build the incinerator but does not feel bound to do so.

I’m not sure whether this is more bluff by Covanta, prudent accounting on their part, or a sign that Minister Gormley will after all waste a substantial sum of money, raise waste charges for everyone, and condemn the country’s waste to landfill for years to come.

Banking Crisis

Ghost Estate Report

From the Department of the Environment “Mr Michael Finneran, T.D., Minister for Housing and Local Services, and Mr. Ciarán Cuffe, T.D., Minister of State, with Special Responsibility for Planning, Sustainable Transport & Horticulture’, today (21 October, 2010) published a National Housing Development Survey.”

In other words, the Ghost Estate report has been published. For reasons best known to themselves, the DoE has only released a summary (link to a Word document here) so far. Is it so difficult to generate a PDF and stick it on the website?

Banking Crisis

Anglo SubDebt Buyback Offer Announced

Anglo Irish Bank have announced buyback offers for their subordinated bonds. The holders of the €1.5 billion in dated subordinated notes have been offered 20c on the euro, so this will cost the bank €300 million. The holders of the undated perpetual preferred securities (about €700 million outstanding according to page 56 of Anglo’s interim report) are being offered 5c on the euro, at a cost of about €35 million.

It appears that those signing up for the offers also have to vote to give the bank “the right to redeem all, but not some only, of the Existing Notes of each Series at an amount equal to €0.01 per €1,000.” In other words, if a majority of the bondholders acccept the deals on offer, then those who don’t accept will get essentially nothing.

It is disappointing that there has been no statement explaining this decision on the Department of Finance website. With €335 million of taxpayer funds being offered, the public should get a full explanation of why this is money well spent.

Economic growth Fiscal Policy

Abandoning the four-year plan

The publication of the Autumn QEC certainly has created a stir this morning.  Having been an advocate of front-loading the adjustment albeit with nuance the ESRI have now expressed doubts about the four-year time frame.

I am bit puzzled by the shift in their position.  Based on the Institute’s evolving view of the economy, I would have thought the case for back-loading was actually stronger a year ago.   While already stressed, international credit markets were then more favourable to the “peripherals” than they became after the Greek crisis.   In addition, the ESRI were then forecasting what was effectively a V-shaped recovery.   This suggested room to avoid an excessively pro-cyclical adjustment.   (A basic principle here is that there is more scope to smooth temporary growth shocks than persistent shocks.) 

Now that credit markets have turned extremely unfavourable and the underlying output path looks closer to the dreaded L-shape, I actually see less room for manoeuvre.   (It is interesting that the ESRI are now focusing on their low-growth scenario from their Recovery Scenarios update, which itself might be viewed as in line with a modest V-shaped alternative, with average real growth of 3.2 percent between 2011 and 2015.)  Moreover, the need to establish credibility around a focal adjustment path has if anything increased – the most obvious being the 4-year path already agreed with the European Commission and the major political parties.   

From media reports, it appears that outside observers consulted by the ESRI are increasingly concerned by the poor outlook for growth.   But the main reason for the worsened outlook is the drag caused by Ireland’s balance-sheet recession.   While a contractionary fiscal policy will slow growth even further, I can’t see how extending the adjustment period is the best route to convincing investors that we can steer our way through this without default.   


Tropics even more sad if the Earth heats up

Last year, La Stampa published a rather skeptical article on climate change under my name. It was not written by me, as discussed here and here. Today, the record is set straight (original). The piece calls for a carbon tax in Italy.

Economic growth Fiscal Policy Migration

QEC Autumn 2010

The latest QEC is here. Here’s the press release:

  • We expect that GNP will contract by 1½ per cent this year. For GDP, we expect a decline of ¼ per cent. For 2011, we expect GNP to grow by 2 per cent and for GDP to grow by 2¼ per cent.
  • We expect that employment will average 1.86 million this year, down 68,000 from 2009, a fall of 3½ per cent. We expect the rate of unemployment to average 13¼  per  cent. For 2011, we expect the number employed to average 1.85 million and the rate of unemployment to average 13½  per cent.
  • In the year ending April 2010, the CSO recorded net outward migration to have been 34,500. This was well below our forecast of 70,000. We discuss how this figure of 34,500 seems to be a conservative estimate of the rate of outflow when compared with estimates of migration contained in another CSO publication, namely, the Quarterly National Household Survey. We expect the net outflow in the year ending April 2011 to be 60,000. This is an increase of 10,000 on our earlier forecast for the year ending April 2011.
  • The General Government Deficit is expected to be 31 per cent of GDP this year, a truly dramatic figure. Of course, almost two-thirds of this is a one-off extraordinary item related to the banking bailout. For 2011, we expect the deficit to be 10 per cent of GDP, based on a budgetary package of €4 billion in savings.
  • In our General Assessment, we look at the budgetary challenges facing the country and in particular at the prospects of bringing the deficit down to sustainable levels in a reasonable timeframe. Using the “Low Growth” profile as published by the ESRI in July 2010, we assess what level of savings will be required to achieve a deficit of 3% by 2014. Our calculations suggest that savings of up to €15 billion could be needed, i.e., twice the sum that was under discussion at the time Ireland and the Commission agreed to the 2014 deadline.
  • We express a concern over the potential negative impact on the economy of this scale of adjustment over this period of time.
  • While the 2014 date strikes us as worryingly ambitious, we are mindful that an extension is highly unlikely and so we must operate within the constraints as presented. Although we have based our forecasts on a budgetary package of €4 billion of savings, it could well be that a higher amount will be sought. Whatever it is, the scale of the task is such that there will be a need for adjustments in current and capital spending and in taxation.

Don’t forget to read the articles in the Research Bulletin.

Banking Crisis Fiscal Policy

Promissory Notes: We Need A Powerpoint Presentation!

Okay, here’s a real treat for all our fans of all things promissory-note related. A classic Burton-Lenihan exchange in the Dail today. My favourite bit:

Deputy Joan Burton: We need a PowerPoint presentation on this.

Deputy Brian Lenihan: We do not.

Deputy Jim O’Keeffe: We need lots of money for this.

Full text below the fold.

Economic growth Fiscal Policy

Are the GDP numbers surprising?

The main article in today’s Irish Times highlights the gap between the GDP estimates in the December 2009 plan and current thinking:

The department confirmed last night that it believed gross domestic product (GDP) this year would be 2.5 per cent below its projected level at the time of the last budget.

In December 2009, the Government believed that spending in the economy, or GDP, would amount to €161 billion this year.

Owing to statistical revisions to GDP for 2009 and 2010, it now believes that the figure this year will be €4 billion lower, at €157 billion.

This means that without any change in the budget deficit in absolute terms, the deficit will be higher than projected when expressed as a percentage of GDP.

The department also confirmed that its July 2010 GDP growth projection of 1 per cent has been revised downwards to “marginally” above a no growth position of 0 per cent. Servicing cost of the bank bailout at about €1.5 billion a year will add to the problem.

What explains this gap?

1.  In December 2009, the plan forecast that nominal GDP would be €164.6 billion in 2009 and €161 billion in 2010.   These forecasts were fairly close to the projections in the ESRI’s Autumn 2009 QEC (released on October 13 2009).

2.  The first preliminary data from the CSO on 25th March 2010 put 2009 nominal GDP at €163.5 billion.

3.  The revised data from the CSO on 30th June 2010 put 2009 nominal GDP at €159.6 billion.  This is the ”news” event.

4.  The July 7 2010 mid-year update from the Department of Finance does not discuss the revision to the 2009 GDP figure.  In line with general views at the time, it improved its 2010 forecast for real GDP growth.  It also highlighted that the GDP deflator was undershooting and pointed out that nominal GDP growth would be adversely affected – but did not quantify this effect.  It also re-iterated that real GDP growth of 3.25 percent in 2011 was attainable and that an average real GDP growth of 4 percent during 2011-2014 was viable.  It did not discuss prospects for nominal GDP over 2011-2014.

5.  The Article IV IMF report on Ireland was published in July 2010.  It reported negative nominal GDP growth of 10.1 percent in 2009 and projected negative nominal GDP growth of 2.6 percent in 2010.

6.  The Summer QEC from ESRI was published on 14 July 2010. It projected 2010 nominal GDP at €158.9 billion.

7.  On October 4 2010, the Autumn Bulletin from Central Bank projected 2010 nominal GDP at €157.018 billion.

Summary:  the downward revision to 2009 GDP has been known since end June 2010.  The €157 billion projection for 2010 was announced in the October 4th Central Bank bulletin and is in fact a bit more optimistic than the nominal GDP projection in the July IMF report.

An central element in the new 2011-2014 fiscal plan will be to provide a reasonable estimate for nominal GDP growth over this period.  This involves two components – prospects for real GDP growth and prospects for the GDP deflator.  Providing a detailed explanation for these projections will be an important element in communicating the plan.