FAC Report Post author By Seamus Coffey Post date April 10, 2013 The latest Assessment Report from the Fiscal Advisory Council can be accessed here. Categories In Fiscal Policy 23 Comments on FAC Report ← Reminder: Gaspar Lecture, TCD, 9am tomorrow → Eurostat: Labour Costs 23 replies on “FAC Report” Thanks for posting. P.13 ff 1.5 makes for fascinating reading. It tells how the Department of Finance goes about making forecasts. Loads to think about. One encouraging development has been real GDP growth in 2012, albeit at a modest pace, for the second year running.. To use a term popularised in 1986 by Robert Armstrong, Mrs Thatcher’s cabinet secretary, this is ‘economical with the truth.’ Service revenue diversions by MNCs for tax purposes are usually offset by big charges and royalties but this year a jump in computer services ‘exports’ by 15% resulted in net exports being the main contributor to growth. At low growth levels just the timing of an invoice charge can make a huge difference between bragging rights and breastbeating. Last week the independent Central Bank said the services rise reflected increased competitiveness. It doesn’t but at official level as during the bubble, that’s the current official narrative. IFAC refers to under estimating net exports – – it is far from rocket science. It’s depressing that it also is too timid to rock the boat. I’m awaiting a reply from the DoF on false claims attributing competitivness and services exports — just for form sake. Bruton’s department didn’t answer the question but refused to accept that the total headline value for exports in 2012 is what is in the national accounts. The CSO as usual adjusts the annual merchandise exports total to eliminate double-counting and mispricing. The total was reduced in March in the Balance of Payments calculations by €5.6bn — not small change as it amounts to a third of the value of indigenous exports. The Dept of Jobs, Enterprise and Innovation does not accept that the official headline total is €177bn rather than €182bn. http://www.finfacts.ie/irishfinancenews/article_1025829.shtml The minister at least is consistent in his exclusive devotion to tech jobs but do not believe the industry blarney about thousands of vacancies that have to be filled from outside the EU27. “The Chairman of the Fiscal Advisory Council, John McHale, has said there is light at the end of the tunnel and the difficult phase of austerity should be over by 2015. John McHale said by then, there should be some room for pay increases, or tax cuts and increases in social welfare benefits.” “the difficult phase of austerity should be over” is pure spin. The difficult phase will be repaying 200,000,000,000 euros. With respect to the learned Professor I think expecting tax cuts is naive..the Troika won’t allow it. They will still monitor to ensure the debt is repaid. And that is before the unknown unknowables hit. @Fiatluxjrn I agree with you about the absolute nonsense of talk of tax cuts in the next several years, but Richard Bruton was on TV last night, as was the economist from IBEC and they were both essentially rooting for the same. It makes one wonder if there is a parallel universe out there, although tax cuts for better paid and wage cuts for the lower paid seems to be the only constant in the Bruton philosophy. If only we could get to Spanish or Portuguese or Greek wage levels, I am quite sure ‘we’ would be on the road to heaven itself. http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-10042013-AP/EN/3-10042013-AP-EN.PDF (link from previous thread posted by Seamus Coffey) @Joseph It looks like we have a three speed world economy…with the euro zone at stall speed. http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9985280/Big-banks-more-dangerous-than-ever-IMFs-Christine-Lagarde-says.html She seems eminently sensible today in NY…. “Especially in the periphery, many banks are still in an early stage of repair – not enough capital and too many bad loans on their books. Even outside the periphery, there is a need to shrink balance sheets, reduce reliance on wholesale funding, and improve business models,” she said. Because the banks are broken, cheap credit is not getting through to the parts of the economy that need it. “Because of insufficient financial repair, monetary policy is “spinning its wheels” – meaning that low interest rates are not translating into affordable credit for people who need it,” she said.” It’s not only monetary policy that’s spinning….. @Gavin K “Thanks for posting. P.13 ff 1.5 makes for fascinating reading. It tells how the Department of Finance goes about making forecasts. Loads to think about.” Now I’m confused. Have they tried to head-hunt your envelope, or has someone just posted it? If Prof McHale is reading…. What do you want to bet that the shortfall on the NAMA/IBRC deal, presently projected by DoF at nil is actually €1-3bn, and that it hits the deficit this year? As you know NAMA has shelled out bonds to buy IBRC’s loanbook as part of the liquidation. The special liquidator will flog what he can above independent valuation levels. NAMA will pick up practically all that is left, probably in August 2013. If NAMA values the loans at less than the book value in IBRC in Feb 2013, then the Exchequer takes a hit, and knowing IBRC and its provisioning, the betting at NWL is that there is €1-3bn of a shortfall. Can’t see it in your report. Want to bet what the shortfall turns out to be? @ Jag, P.35 The Special Liquidators of IBRC will be obliged to dispose of the assets and apply the proceeds of the sale to discharge the creditors of IBRC including NAMA. Any assets not sold to third parties will be acquired by NAMA. Any resulting losses for NAMA will be compensated by the Government. The full impact on the Government accounts will, therefore, not be known until the final required transfers to NAMA are concluded. Why would the size of the resulting losses be important in the context of the report? @Jagdip Singh I bet you he doesn’t take you up on it. +1 good post and good question. p.s. even my 6 year old can read something then copy it down accurately: http://www.telegraph.co.uk/finance/currency/9986003/Irelands-central-bank-misquotes-James-Joyce-on-limited-edition-coin.html I think the stock of DoF envelopes can be retired. From the recent Two-Pack agreement announcement Importantly, the Two-Pack will also enhance the soundness of national budgetary processes by obliging Member States to base their draft budgets on independent macroeconomic forecasts and ensure independent bodies are in place to monitor compliance with national fiscal rules. @John McHale Given the above, who is going to be doing the independent macroeconomic forecasts e.g. the IFAC, some non-governmental Irish body, an Ireland-based EU Commission group, one based in Brussels etc. While I have scanned the report, rather than read it in detail, it didn’t seem clear how the DoF choose the multiplier to use to figure out the impact of consolidation measures on future GDP, and how this was factored back into their forecasts. In addition the multiplier by itself seems an inadequate metric. From some IMF reports I’ve seen they model the impact as a curve – i.e. in the short-term, GDP dips and then gets worse, then recovers to get back to the original point, then improves. However the length of time before the “break-even” point varies a lot with the type of economy, and in one analysis I read Ireland was right out on the edge – i.e. it would take longer for Ireland to break-even – up to 4 or 5 years per consolidation measure. So a sharp drop that quickly reversed itself could have less overall impact that a moderate drop that took 4-5 years to revert. It seemed that “the area under the curve” was what mattered rather than just the maximum drop from the starting point. In the new 2-pack world, who is going to be responsible for defining the multiplier/shape of this curve? @Seamus, Let’s say for sake of argument that NAMA’s valuation of the loans it acquires from IBRC in August 2013 is €3bn less than the IBRC book value in February 2013, then that €3bn should hit the deficit in 2013 as the Govt shovels €3bn additional funding into IBRC to pay off its creditors. Why would that be important in context of report. It would hit the Maastricht deficit in 2013. It would push up the 2013 borrowing requirement and debt. Yes, its a one-off and doesn’t affect the deficit in 2014 and 2015, but it might blow our deficit out of the water in 2013 and stick another 2% on our debt. @ Jagdip Maastricht deficit is rather meaningless at the moment, no? Troika EGB is all that matters ad it would strip out bank recap/liquidation costs. @ Jag, In 2011 the ‘Maastricht’ deficit was 13.1% of GDP. But we still met the ‘Troika’ deficit target of 10.6% of GDP. In fact the relevant deficit (i.e. excluding banking measures) was 9.4% of GDP. We have had “one-off” banking measures since 2009 but they are not included in the EDP targets. There may be a loss on the IBRC transfers. It is an unknown. But it is a cost, if it exists, that was going to arise at some stage anyway given that the IBRC was 100% state-owned. @ grumpy, Bryan G, et al If the issue is that a new independent forecaster is coming in, then it is still worth looking at the way things are done now to see if one can find any insights that might be useful. Some thoughts arising from section 1.5. “The Department of Finance forecasts are prepared by a small team of about four economists.” It would be interesting to know the gender split on this, and possibly class and geography. Asmussen of the ECB is now arguing for greater female representation. In playwriting I keep a track of developments in gender. One observation is that male playwrights tend to write plays with more parts for men and women for women. I ask about it and it is usually done unconsciously. In the cool technical world of this paper, things like that are not supposed to matter but I think they do and that is my general thrust today. They matter if you are taking a judgement based approach: “For the three Irish forecasting agencies considered here,the approach to short-term forecasting can be characterised primarily as being judgement based rather than model based.” And “Summing the forecasts for exports, investment, consumption, government expenditure and subtracting imports, generates a forecast for GDP. However, if the value for GDP that emerges from this process is implausible (on the basis of the most recent trends or forecasts from other agencies), the forecasts will typically be reassessed and the components of expenditure revised as appropriate.” What that suggests to me is that the four economists get their number, look nervously at each other and at what other forecasters are saying and lose faith in their work and move their forecasts to be more average so as to fit in. Kahneman in ‘Thinking Fast and Slow’ essentially points out that this is a recipe for disaster. Here’s an experiment I am going to try out on some students next week. Take a jar of sweets and ask them to guess how many are there. They guess by writing the number quietly without showing. Take the numbers and find the average. Show another jar of sweets and allow them to discuss how many they think there are so each can have the information of their own eyes, plus what other people think. More information is better, right? Then make an average of those guesses. Kahneman suggests that the average from the first method will be *closer* to the real answer than the second. The opportunity for discussion moves people *further away*. I’ll let you know how this turns out. What is happening is that people who think, oh ‘I’m way off’ shift plus more importantly, people unconsciously want to agree with people they like and want to move away from people they don’t. Grumpy has observed before that actually positions held by antipathetical bloggers are close than they care to admit. In this case the danger is: (a) Between the four there is a hierarchy/set of friends that skews judgement (b) The desire to please (‘we can’t tell the Minister that’), also skews, and (c) The fear of being an outlier – let’s have a quick look at what the EC/IMF are saying – also skews. The fear of being wrong is encouraging them to agree with other wrong people: safety in numbers. These are all forms of ‘discussion’ and, I suggest, tend to make all forecasters prioritise ‘agreeing’ over sticking to their own ideas. One simple way to test this would be get all four to focus on one figure two different ways by doing the ‘sweet jar’ experiment with them and see what they get. Also note that the team use EU Commission date to inform their forecasts for exports – so the poor forecasting of the commission does have an impact. The report also discusses models and suggests that the various agencies are trying to combine an improved model (eg HERMES – guide of the dead souls to the underworld), with judgement. The report also says: “Macro-modellers internationally have increasingly devoted resources to the development of Dynamic Stochastic General Equilibrium (DSGE) models, in which more microeconomic theoretical considerations (including rational expectations) are built into the structure of the model.” In as far as I understand this I have the following problems with this: (1) What if economic development does not tend towards an equilibrium, but is more Minsky-esque (or indeed Marxist), with a long term inevitable set of crises? This model will likely break down just when you need it most – see for example the (still inadequate IMO) change in forecasts for Cyprus. (2) Related, I know there is work on this, but the financial sector does not seem adequately represented. A model that does not build in banking and shadow banking seems unlikely to be robust. (3) Also related, the notion of return to a long-run growth trend seems to be a weaker proposition even than that the sun will rise tomorrow which Berkeley objected to. (4) The ‘rational expectations’ model is much disputed. See, for example, recent work by de Grauwe. There is something attractive about the ‘ever improving model’ combined with an ever improving process, approach but if you look at the sheer computational power required to even predict the weather two days ahead, perhaps this is like putting one ladder on top of another and claiming to be nearer the moon. But some models have done better than others so far in the crisis so I’m not saying discard them. Also, as paul quigley, would remind us, the economy is not an impersonal system like the weather, so the actions of agents and individuals need to be taken into account. Finally, if you look at ‘Figure A4: Unemployment Forecast Errors’, top P.13 this suggests to me that the issues I’ve outlined above have some validity. In the boom, one two and particularly three years ahead the level of employment was underestimated, whilst the opposite was true in the bust. This suggests that the current system is not just skewed towards optimism (telling the pols what they want to hear) as the envelope suggests, but bad at dealing with extremes and crossovers. I’d be very interested in grumpy’s, Bryan G’s, paul quigley’s and other interested commentators thoughts – particularly as there seems to be the possibility of contributing to a new system. For the moment, I’d say if any economics lecturer got up in a hall of students, showed them simple data (say GDP, GNP, unemployment), asked them to write down their guesstimes privately for next year, hand them up and take an average that would be more accurate than the current system. Worth a go? On the issue of tax cuts – I don’t think that idea is as unlikely as some people here are making out. Assuming the exchequer remains on target for a 3% deficit in 2015, then by budget 2016 (i.e. Oct 2015) we could see a cut in USC. Reasons for thinking this: 1. It will be the last budget of this government’s term 2. The USC is unpopular 3. By reducing the lower rate, you help those on lower incomes and increase the gap between lower paid work and the dole. Labour will like this. 4. You may also be able to get the higher marginal rate below 50% which is an important psychological hurdle. FG will like this. 5. Cutting income taxes would be as good a signifier as you can give that the age of austerity 2008-2015 has passed and you can go out and spend your savings again! Of course there are a lot of ifs and buts there, but it is not out of the question. @ Gavin One reason for judgment-based rather than model-based short-term forecasting is that many macroeconomic models perform worse than a random walk/coin flipping with the last period’s figures. This probably relates to many forecasts erring towards soft landings and small swings. The reference to Kahneman is interesting, but I’d respectfully suggest that it doesn’t apply equally to all forms of pooled estimation. Contrary to some perceptions, the information available to economic forecasters is not really akin to people’s guesstimates of how many sweets are in a jar. When the margin of error is very large, more information of equal uncertainty is reasonably likely to lead to a less accurate pooled response, whereas more better information should have better accuracy than your suggestion. @Seamus, The original plan (or at least the version of the plan after the EC looked at it!) was to run down IBRC by 2020, and the bank had that period to maximise returns, and although none of us has a crystal ball, the general hope and expectation is that after 2015 we start getting back to c3% GDP growth and that there is a recovery of sorts. What will now happen is NAMA will crystallise the losses at IBRC in 2013. The State meets that loss in 2013. We don’t know what the loss will be, that is true. And that is why I offer the bet, because you can see day-in, day-out the market values of loans, particularly those secured on property, and with 67% impaired loans at H1,2012 for IBRC, the estimate here is a €1-3bn loss when NAMA acquires the loans at current market value. If this loss crystallises then it is real money, it has to be found and added to national debt. @ Kevin Timoney “The reference to Kahneman is interesting, but I’d respectfully suggest that it doesn’t apply equally to all forms of pooled estimation.” You may well be right. My thought is that there is a relatively easy experiment to do (and which is repeatable) that would give a concrete outcome to compare with DoF predictions. You would have to be careful about which sweets to put in the sweet jar and how the students were talked too. Kahneman also talks about the impact of setting – so if you began by saying, ‘well 2011’s GDP figures were awful but they were much improved in 2012’, you’d already have influenced the outcome. @ Jag, The loss is not necessarily being crystallised. NAMA will be compensated if the IBRC book value is less than the current value it puts on the loans. But, in NAMA, the loans are being transferred to another state entity. So if there is this ‘recovery of sorts’ you refer to it wouldn’t really make a difference if the assets were in NAMA or remained in the IBRC. The final loss should largely be the same. I agree that this is a live issue but I’m not sure it has much significance in relation to the FAC report. @ Jagdip “If this loss crystallises then it is real money, it has to be found and added to national debt.” It has to be found? I reckon it’ll be found via a cashless transaction. It wont affect Troika targets (which are what actually count), and the true crystalisation of the loss will only occur when the underlying assets are sold into the private sector. This is the transfering and marking-to-market of assets held by one effective arm of the state vs another. Maybe it’ll impact on headline debt/GDP, but anyone taking that as the key metric to watch is missing half the story. This just in an in support of my observation above: “Business Eurozone crisis Cyprus forced to find extra €6bn for bailout, leaked analysis shows” “Crisis-hit Cyprus will be forced to find an extra €6bn (£5.1bn) to contribute to its own bailout under leaked updated plans for the rescue. “In total, the bill for the bailout has risen to €23bn, from an original estimate of €17bn, less than a month after the deal was agreed – and the entire extra cost will be imposed on Nicosia.” Do they want Cyprus out of the euro? http://www.guardian.co.uk/business/2013/apr/11/cyprus-bailout-leaked-debt-analysis-bill @ Gavin ‘(1) What if economic development does not tend towards an equilibrium, but is more Minsky-esque (or indeed Marxist), with a long term inevitable set of crises? This model will likely break down just when you need it most – see for example the (still inadequate IMO) change in forecasts for Cyprus. (2) Related, I know there is work on this, but the financial sector does not seem adequately represented. A model that does not build in banking and shadow banking seems unlikely to be robust. (3) Also related, the notion of return to a long-run growth trend seems to be a weaker proposition even than that the sun will rise tomorrow which Berkeley objected to. (4) The ‘rational expectations’ model is much disputed. See, for example, recent work by de Grauwe’ That’s downright charitable. You are a gentleman, a scholar, (and an excellent judge of whiskey) Ireland is a state where divorce and contraception have only recently been permitted. Our native institutions are still doxic, that is to say, they have not yet arrived at the historical stage where the ebb and flow of orthodox and heterodox thought is normal. You will seek in vain for original thinking, with, as always, the exception of individual genius, and the madness near allied. TCD is a British institution with an Irish address, and so requires a different analytic frame. Its alumni heave to the Irish mainstream, nonetheless, and have duly profited thereby. As Bourdieu might put it, we are dealing with learned, necessary, ignorance. Luckily they have Gurdgiev, who serves it up clean and clear. Here is one of his 19th c countrymen, and a rollicking companion he is too. http://en.wikipedia.org/wiki/Alexander_Herzen Comments are closed.