Eamon Quinn interviews Brian Hayes – article is here.
Year: 2012
A group of Irish economists have an interesting joint article in today’s Irish Times. It is available here. It usefully goes beyond the rather sterile austerity/no austerity debate to focus mainly on the mix of adjustments.
Drawing on the available evidence, the article notes that fiscal consolidation measures lead to slower growth and job losses.
The evidence is clear: contractionary fiscal policy does indeed restrict economic activity and employment.
The austerity-focused policies being pursued in Europe and in Ireland will continue to drive down employment and living standards, while embedding high levels of long-term unemployment in the economy.
However, the article does not claim that consolidation is unnecessary (though it does not offer a preferred time path for bringing the deficit down), but rather focuses on the mix of consolidation and financing measures. The authors argue for a mix that involves higher capital spending and higher taxation aimed primarily at higher income individuals. (For the medium term, they also argue for higher social expenditures financed partly by increased PRSI contributions.)
Such an investment programme must be accompanied by “smart” fiscal consolidation, focusing on the least contractionary forms of fiscal adjustment. This requires progressive and equality-proofed taxation targeting high-income groups, property assets, unproductive activity and passive income, as well as environmental measures.
In the medium term, we should explore the potential of social insurance and local taxation to broaden the tax base while providing real benefits in return. PRSI can be expanded and combined with general taxation to provide free universal healthcare and earnings-related pensions. Stronger local taxation has the potential to be more accountable while providing investment in services responsive to local needs.
The mix of adjustments is also receiving recent attention in the international debate. For differing perspectives on the most effective mix from a macroeconomic perspective see Alberto Alesina and Francesco Giavazzi here and Simon Wren-Lewis here.
A recurring question in the treaty debate is whether each country must accept the European Commission’s own estimate of the output gap and the structural component of the budget balance. For some countries, it may be fine to just take the European Commission’s estimates. However, this is not a requirement under the evolving economic/fiscal governance reforms (by the way, this is a handy summary page of the set of inter-linked regulations etc).
The “six pack” Council Directive 2011/85/EU of 8 November 2011 on requirements for budgetary frameworks of the Member States (available here) has the following sections
(11) Forecasts by the Commission and information regarding the models on which they are based can provide Member States with a useful benchmark for their most likely macrofiscal scenario, enhancing the validity of the forecasts used for budgetary planning. However, the extent to which Member States can be expected to compare the forecasts used for budgetary planning with the Commission’s forecasts varies according to the timing of forecast preparation and the comparability of the forecast methodologies and assumptions. Forecasts from other independent bodies can also provide useful benchmarks.
(12) Significant differences between the chosen macrofiscal scenario and the Commission’s forecast should be described and reasons therefore should be given, in particular if the level or growth of variables in external assumptions departs significantly from the values contained in the Commission’s forecasts.
(13) Given the interdependence between Member States’ budgets and the Union’s budget, in order to support Member States in preparing their budgetary forecasts, the Commission should provide forecasts for the Union’s expenditure based on the level of expenditure programmed within the multiannual financial framework.
(14) In order to facilitate the production of the forecasts used for budgetary planning and to clarify differences between the forecasts of the Member States and those of the Commission, each Member State should, on an annual basis, have the opportunity to discuss with the Commission the assumptions underpinning the prep aration of macroeconomic and budgetary forecasts.
(15) The quality of official macroeconomic and budgetary forecasts is critically enhanced by regular, unbiased and comprehensive evaluation based on objective criteria. Thorough evaluation includes scrutiny of the economic assumptions, comparison with forecasts prepared by other institutions, and evaluation of past forecast performance.
In addition, the European Commission has elaborated on how it envisages the monitoring and correction process will operate – importantly, it does allow for a role for domestic independent forecasts. From its proposed “two pack” regulation (November 23 2011)
Article 5.3 (e)
(e) the main assumptions about expected economic developments and important economic variables which are relevant to the achievement of the budgetary targets. These assumptions shall be based on independent macroeconomic growth forecast;where Article 2.1.2 provides the definition
“independent macroeconomic forecasts” means the macroeconomic and/or budgetary forecasts produced by an independent body or a body endowed with functional autonomy vis-à-vis the fiscal authorities of the Member State;
So, my understanding is that credible, independent domestic forecasts can be used as an alternative to the European Commission forecasts. This requires Ireland to build the local capacity to produce such estimates, using models that can rival (or demonstrably improve upon) the European Commission model.
A related point is that the European Commission’s resources for macroeconomic forecasting are quite limited. A major advantage of domestic fiscal frameworks is that the primary responsibility for holding governments to account is local, with the political system supported by analysis and forecasting from independent domestic institutions that have the expertise and (modest) resources required to build tailored models of the domestic economy and domestic fiscal system.
The new bulletin is here.
The readership may be interested in this new report.