Fiscal Rules and Required Post-2015 Austerity Measures

Thanks to Jagdip Singh for pointing to Michael Taft’s response to an earlier post of mine on the implications of fiscal rules – including the structural balance rule – on the need for additional austerity post 2015.  

It is worth reiterating two critical points before responding to Michael’s critique.   First, the Fiscal Compact does not imply additional constraints beyond what we are already signed up to under the revised Stability and Growth Pact.   Ireland already has a medium-term budgetary objective of a structural balance of 0.5 percent of GDP.   I believe the No campaign is being disingenuous on this point.  Second, the main driver of austerity measures in Ireland is not the fiscal rules: it is that Ireland has a large deficit, substantial debt that needs to be rolled over in the coming years, and is not creditworthy.   The only reason Ireland does not have substantially greater front-loaded austerity is that we have been able to obtain official-funding support at low interest rates.   However, this support is conditional on pursuing a phased deficit-reduction programme. 

Michael’s main objection to my post relates to the definition of the structural balance.   He claims that the only way to reduce the structural balance is through additional discretionary measures.  However, what he does not note is that his assumed baseline of “no policy change” involves expenditure rising at a rate equal to the underlying nominal potential GDP of the economy.   Assuming total tax revenue rises at the same rate as potential GDP growth, expenditure rising at this rate would keep primary structural deficit constant as a share of potential GDP.   Using the European Commission’s coefficient of 0.4, in the absence of expenditure growth, the nominal structural deficit would fall by 0.4 times the change in nominal potential GDP due to the rise in tax revenues at constant tax rates as the economy expands.   In my calculation, I allowed for expenditure increases equal to half the projected rise in tax revenues, so that the nominal structural deficit falls by 0.2 times the increase in nominal potential GDP.   I think most people view austerity measures as involving higher tax rates (or new taxes) combined with cuts in expenditure.   What my calculation shows is the even with nominal expenditure rising (though at a slower rate than nominal potential GDP), the structural deficit target could be met by around 2019.   As Seamus Coffey emphasises, the annual rate of improvement would be approximately 0.7 percentage points of GDP per year, which is above the SGP’s requirement of 0.5 percentage points. 

In sum, if your definition of austerity involves government expenditure – public-sector pay rates, social welfare rates, etc. – growing at a rate less than nominal potential GDP, then you should agree with Michael that hitting the structural deficit target will involve additional austerity measures.   However, if your definition is what I see as the more natural one of additional cuts and tax rises, then, even with relatively conservative assumptions about growth, moving back to structural balance would not require additional austerity.

13 thoughts on “Fiscal Rules and Required Post-2015 Austerity Measures”

  1. John, I’m rather amazed you wrote the following:

    Re “First, the Fiscal Compact does not imply additional constraints beyond what we are already signed up to under the revised Stability and Growth Pact. ”

    Here are a couple of additional constraints for your benefit and that of other posters:

    “Article 3

    (e) in the event of significant observed deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically. The mechanism shall include the obligation of the Contracting Party concerned to implement measures to correct the deviations over a defined period of time.

    Above Not in Stability and Growth Pact

    ARTICLE 6 With a view to better coordinating the planning of their national debt issuance, the Contracting Parties shall report ex-ante on their public debt issuance plans to the Council of the European Union and to the European Commission .

    Above Not in Stability and Growth Pact and worrisome

    ARTICLE 7 While fully respecting the procedural requirements of the Treaties on which the European Union is founded, the Contracting Parties whose currency is the euro commit to supporting the proposals or recommendations submitted by the European Commission where it considers that a Member State of the European Union whose currency is the euro is in breach of the deficit criterion in the framework of an excessive deficit procedure. This obligation shall not apply where it is established among the Contracting Parties whose currency is the euro that a qualified majority of them, calculated by analogy with the relevant provisions of the Treaties on which the European Union is founded, without taking into account the position of the Contracting Party concerned, is opposed to the decision proposed or recommended.

    Above Not in Stability and Growth Pact and invokes ‘qualified majority’ clause against member states. Won’t work as the ‘majority’ will not pay the bills of the ‘minority’ and could lead to deep divisions

    Article 8 1. The European Commission is invited to present in due time to the Contracting Parties a report on the provisions adopted by each of them in compliance with Article 3(2). If the European Commission, after having given the Contracting Party concerned the opportunity to submit its observations, concludes in its report that such Contracting Party has failed to comply with Article 3(2), the matter will be brought to the Court of Justice of the European Union by one or more Contracting Parties. Where a Contracting Party considers, independently of the Commission’s report, that another Contracting Party has failed to comply with Article 3(2), it may also bring the matter to the Court of Justice. In both cases, the judgment of the Court of Justice shall be binding on the parties to the proceedings, which shall take the necessary measures to comply with the judgment

    Above Not in Stability and Growth Pact and invokes The Big Stick of the European Court of Justice tricked onto the side of the ECB usury laws, whereas its true role should be defending the rights of members against such usory laws

    2……..it may impose on it a lump sum or a penalty payment appropriate in the circumstances and that shall not exceed 0,1 % of its gross domestic product. The amounts imposed on a Contracting Party whose currency is the euro shall be payable to the European Stability Mechanism. In other cases, payments shall be made to the general budget of the European Union. within a period to be decided by the Court of Justice.

    Above Not in Stability and Growth Pact. Who is to say such sanctions will not be increased, will not involve asset stripping of members

    I’ll not bore you all by going into the deeply additional restraints, eg membership charge circa ¢1.3 bn, plus the undertaking of additional charges should the funding requirements of ESM go up. Plus the unelected committee system whose procedures and accountability and transparency are set above the law.”

    Blinkers, myopia, no excuse. The lack of “additional constraints” I’d discounted as simplistic and ludicrous govt propaganda, until reading the above !

    Re “Ireland has a large deficit..” Sure it has by undertaking 40% GDP of banking debt and rolling it up with casino banks to 120% GDP.

    Re “The only reason Ireland does not have substantially greater front-loaded austerity is that we have been able to obtain official-funding support at low interest rates.”

    You are being disingenuous about the odious bank debt ! “official-funding support at low interest rates” ……sure?….to pay back 40% GDP of banking debt Irish taxpayers do not owe in the first place, debt that ECB has refused to write down through restructuring of Promissory Notes and ELA.

    The rest of your argument is built with opportunistic estimates based on false assumptions re growth and GDP that are being fed into the figures to give the answer you want.

    By your own admission these are potential figures, guesstimates. They are being revised downward as we speak.

  2. John – thanks for constructively taking up this issue. I would like to point out that, first, my main objection is not your definition of the structural balance (though we may differ how robust this hypothetical is). My main objection is your use of a 0.4 co-efficient – which I take to be the cyclical sensitivity measurement which is used to decompose the deficit into its cyclical and structural parts. I remain open to correction if this co-efficient relates to something else. My concern is that you may be using the wrong instrument to measure the sensitivity of the structural deficit to growth. Could you clarify where you derive your 0.4 co-efficient.

    Second, I did not state that the only way to close the structural deficit is through fiscal adjustment. Indeed, I specifically refer to ‘policy actions’. If potential GDP rises at a faster rate than actual GDP, the output gap closes and the structural deficit shrinks. However, as I pointed out, the Government is revising downwards – substantially – potential GDP growth rates. But what should we expect – they will be cutting public investment next year and the following year again, while they are increasing cuts in domestic demand (public services, social protection) which is not designed to maximise labour and capital mobilisation. That the IMF shows Irish investment levels at half the Eurozone average up to 2017 should caution us about the role of current policy. What this all means is that the relationship between growth and the structural deficit is also rooted in potential GDP and the output gap.

    I’m sure you are as frustrated as I am frustrated (as the Department of Finance itself is also frustrated) with the EU Commission methodology for parsing all this out. They show that we are ‘over-heating’ in 2014. Imagine, we’re growing too fast in relation to our productive capacity.

    To get another perspective, we can turn to the IMF. They show that with a minimal output gap closing to zero between 2015 and 2017, the nominal structural deficit is frozen even with nominal growth rates of 5%. This is the result we should expect.

    By all means, yes, let’s debate how we can boost our potential GDP and productive capacity. But let’s also acknowledge the short-comings of current policy. And let’s seriously consider whether it is possible to expand our productive base under conditions of tight fiscal policy.

  3. “And let’s seriously consider whether it is possible to expand our productive base under conditions of tight fiscal policy.”

    It’s both fascinating and dispiriting to observe the surreal engagement between the disingenuous and evasive, on one side, and those constrained by the combination of an official capacity, a disciplinary specialism, the deficiencies of this discipline and an innate politeness, on the other.

    So much of what passes for ‘debate’ is conducted in this manner. It’s little wonder that so many people are either confused or turned off – or so easily get the wrong end of the stick and beleive their prejudices are being confirmed.

    So, for example, why not consider releasing the large volume of state equity tied up, unproductively and inefficiently, in the semi-states? Why not consider reforming economic regulation and ensuring the effective representation of the collective interests of consumers? The CER, for example, is unfit to regulate the electricity and gas networks. It would be a total travesty to give it regulatory responsibility for the water industry. Why not reform economic regulation to ensure it strikes a balance between investor and producer interests and the collective interests of consumers?

    But that bird has flown. The managements and staff in the affected parts of the public and semi-state sectors have spend the best part of the last 18 months straining every sinew, in a concerted fashion and behind-the-scenes, to obstruct or minimise any reforms in these sectors. And they have been almost completely successful.

    In this context calls by those either involved or supportive of this effort to consider expanding the productive base of the economy are totally hypocritical and disingenuous.

    I hope it stays fine for them because very soon, as the late Jim Callaghan once put it, the sky will be dark with chickens coming home to roost.

  4. @Michael

    Thanks for the response. (Paul would like to see us in a bare-knuckle brawl; but I don’t think that is necessary — though it might get us on the Week in Politics.)

    On your point about the 0.4 coefficient: I do think that coefficient is useful when considering the effect of potential GDP growth with constant nominal spending. Much the same forces that lead to the cyclical effect are present, notably the positive impact of potential growth on tax revenues. However, I do agree that the coefficient is a bit too high for the calculation I am making for the following reason: One of the factors behind the cyclical effect is that that unemployment falls (and thus unemployment benefits fall) as output rises. In standard models, the equilibrium rate of unemployment is assumed to be unaffected by growth in potential output (though part of the reason is that unemployment benefit rates rise along with potential output, which is not relevant to this calculation). So, yes, the relevant coefficient may be less than 0.4. This was partly behind why a chose a coefficient of 0.2 for the calculation. I probably should have pointed this out in the original post, but did not want to litter it with too many technicalities — people think I already stray towards the esoteric. However, this does not affect the basic conclusion.

  5. @ Colm,

    This year the Department of Finance are projecting a general government deficit of €13.1 billion equal to 8.3% of GDP. You can get details of the 44.1% of GDP figure that will be government expenditure and the 35.8% of GDP figure that will be government revenue on page 49

    How much of the €13.1 billion deficit will be as a result of the bank bailout?

  6. @John McHale,

    I’m sure you’re very well aware of the distinction between a ‘bare-knuckle brawl’ and robust adversarial disputation based on relevant facts, evidence and analysis.

    The excessive focus on fiscal adjustment is very convenient for the ‘raid, tax and spend’ brigade. The EU-IMF support programme has three key sunsidiary programmes – fiscal adjustment, bank re-structuring and structural reforms. The last was intended to counter-act the inevitable detrimental impacts of fiscal adjustment – and, in a sense, are two sides of the same coin.

    A focus on fiscal adjustment without proper consideration of structural reform is totally futile and counter-productive – which is why the ‘raid, tax and spend’ brigade just love digging in to the minutiae of fiscal adjustment.

    For example, it is just over a year since the State Asset Report was published – and it was close to finalisation at the end of 2010 but had to be aligned with the structural reform programme in the EU/IMF support package. Michael and his comrades refuse to engage constructively on these issues, but you can be absolutely sure that many of his comrades in the affected sectors (and the managements in these sectors) spent the best part of the last 18 months straining every sinew to ensure that any structural reforms proposed in these sectors have been whittled down to almost nothingness.

    And they have been successful beyond their wildest dreams. What has emerged in terms of restructuring or re-financing is pathetic and ineffective almost beyond belief.

    It is farcical replay of the ’82-’87 government. Then Labour prevented FG pursuing the fiscal adjustments that the incoming FF government were compelled to implement. This time Labour has swallowed – or been compelled to swallow – the required fiscal adjustment. But it has dug in its heels on meaningful structural reform.

    The irony is that it is doing it no good. Its support is evaporating like a puddle on a hot summer’s day and migrating to the ‘raid, tax and spend’ brigade.

    If it had had the guts and gumptions to implement meaningful reforms – and to remove the restraints it is imposing on FG – the inevitable furore would have died down by now and the economic benefits would be coming through and building up well before the next election. Indeed FG might also have been encouraged to go after the monopoly- profit gougers in the private sheltered sectors (and which tend to be in its constituency).

    Stupidity is an inadequate word to describe it.

  7. @ Paul Hunt

    and ensuring the effective representation of the collective interests of consumers?

    Ha. You’re always good for a laugh, at least.

    So you’re now up for collective representation, eh? And not a glimmer of doubt that the “consumers” we’ll be treated to in this context won’t be Joe Citizen, but IBEC and their like.

  8. Ah, yes, reform reform REFORM. The meaningless big squishy pink marshmallow of a word that neoliberals everywhere drag around until it resembles whatever bits of dust may stick to it. As Henry over on Crooked Timber puts it, the use of this word is just a reflex at this point, a progressive-sounding buzzword for the same old “free market” and anti-social-democratic snake oil that got us into this mess.

  9. @EWI,

    In your haste to have a personal swipe – and to avoid engaging with the substance of my comments – you seem to have tripped over your feet. IBEC and the unions might have their set-piece confrontations for the optics, but they both represent producer interests – to the detriment of the interests of the vast majority of citizens and consumers.

    Oh, Ernie. Have you given any further thought to or done some research on why ‘Ireland is such an expensive place to live’?

  10. @ Paul Hunt

    In your haste to have a personal swipe – and to avoid engaging with the substance of my comments – you seem to have tripped over your feet.

    Really? It’s amusing to be accused of such by someone who was so eager to provoke the gentlemanly Mr. Taft that you recycled your “‘raid, tax and spend’ brigade” muck-slinging in the thread so that we could all enjoy your cleverness twice. I hope you got your money’s worth of satisfaction.

    Nobody is really fooled at this stage (between Eircom and the examples in the UK, right on our doorstep) that privatisation will lead to anything other than plundering of accumulated public value to the detriment of the country. IBEC pigs at the trough.

  11. @EWI,

    The ‘gentlemanly’ Mr. Taft deliberately chooses not to recognise the dysfunction in the energy sector I decribe – or the requirement for major re-structuring and re-financing. I once offered to exchange e-mail contact details with him so that I could send him some quantitative analysis I had performed – in fact I recall I did send it to what I thought was an appropriate address. But, not surprisingly, I got no response.

    That’s quite a while back and the analysis would have to be updated. However, the CER has been forced to publish some data in the last couple of years which it had spent the most part of the 2000s trying to suppress. These confirm a key part of the case I have being making, but it seems to be a case of ‘being hidden in broad daylight’. There are none so blind as those who refuse to see.

    In any event, you have little need to worry. The management, staff and unions of the ESB and BGE (aided and abetted by other ‘interested’ parties in the government-machine – and outside) have played a blinder and have beaten the Government into submission over the last 18 months. What has emerged in terms of reform and privatisation is ineffective, inefficient and dangerous. Though it might generate a small (€1 bn) ‘slush fund’ (Strategic Investment Fund) for Labour to reward its clientelist network, it will provide no relief for hard-pressed consumers – and may even add to their burdens, and looks like it was designed to confirm the most lurid scare-mongering about privatisation.

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