The Domestic Budgetary Rule and the Fiscal Stance in 2016

The Fiscal Council published its Ex-Post Assessment of Compliance with the Domestic Budgetary Rule in 2016.  The assessment is summarised in this table:

Main Assessment

The budget condition for 2016 was a structural balance of 0.0 per cent of GDP which was not achieved in 2016 as the structural balance was -1.7 per cent of GDP.

The adjustment path condition required an improvement of 0.6 percentage points of GDP in the structural balance.  This was not achieved as the improvement was 0.3 percentage points of GDP.

The expenditure benchmark is designed to give the real change for an adjusted measure of government expenditure (net of discretionary revenue measures) that corresponds to the required change in the structural balance.  Discretionary revenue measures (including non-indexation of the tax system) amounted to -€0.7 billion in 2016. The assessment is that Ireland was in compliance with the expenditure benchmark in 2016.

This contradiction between failing to achieve the required improvement in the structural balance yet complying with the expenditure benchmark is largely explained by a one-off transaction relating to AIB preference shares that took place in 2015.  As the AIB transaction was not repeated in 2016, the €2.1 billion from that transaction could be replaced with other government spending without breaching the expenditure benchmark.  The outturns show that around half of the €2.1 billion “space” was used for expenditure in 2016 (which will continue in subsequent years).

If this one-off item is excluded from the 2016 assessment of the expenditure benchmark then it would have been breached by 0.4 per cent of GDP.  The breach net of one-offs roughly corresponds to the shortfall in the required improvement in the structural balance (0.3 percentage points of GDP) which does take one-off items into account.

Under the 2012 Fiscal Responsibility Act the Fiscal Council is required to assess the fiscal stance using the structural primary balance.  That is, the general government balance excluding interest costs and one-off items and adjusted for the cyclical position of the economy.

Fiscal Stance

The primary balance itself is relatively straightforward to measure and the figures from the CSO show it to have been +0.7 per cent of GDP in 2015 and +1.7 per cent of GDP in 2016.

To get the underlying changes the impact of one-off items must be removed.  The Fiscal Council assesses that there were three such items in 2015 and 2016.  These were the AIB transaction in 2015, while in 2016 there was the return to Ireland of a pre-paid margin related to borrowing from the EFSF and part of the EU contribution assessed to Ireland that will be non-recurring.  Accounting for these, the table above shows that the primary balance net of one-offs showed close to no change in 2016 – it improved by 0.1 percentage points of GDP.

The structural primary balance depends on the cyclical position of the economy, that is the difference between the actual and potential growth rates of the economy.  The measurement and estimation involved in this are significant.  The CSO put the real GDP growth rate for 2016 at 5.2 per cent while the potential real GDP growth rate estimated using the method set out by the European Commission is 5.1 per cent.

These closeness of these numbers implies that the impact of the business cycle on the government balance in 2016 was relatively small.  The change in the primary balance net of one-offs and the change in the structural primary balance are pretty much the same.  The structural primary balance is estimated to have been unchanged in 2016 which would correspond to a “neutral” fiscal stance.

Your views on the fiscal stance will depend on how appropriate you think the 5.2/5.1 figures are as indicators of the real/potential growth rates of the economy in 2016.  Was the Irish economy growing above its potential in 2016?  What is the appropriate fiscal stance given the cyclical position of the economy? The Fiscal Council will assess these and other issues in its forthcoming Fiscal Assessment Report which is set to be published next week.

6 replies on “The Domestic Budgetary Rule and the Fiscal Stance in 2016”

Typo alert? “The get the underlying changes the impact of one-off items must be removed.”

Even if GDP was a secret, you would still conclude that economic activity grew strongly in Ireland last year. Employment grew by nearly 3% and tax revenues by 5%.

Was this a) this was an economy returning toward its underlying potential, or b) this was an economy beyond its potential, and beginning to overheat? The Fiscal council is obliged to use the EU assessment methodology which suggests that b) was the case.

This is despite no real evidence (yet) of much inflation or pay pressures which you would typically expect when firms are competing for workers and other resources. Unemployment has fallen quickly and by a lot, but is still comfortably above what was observed in the last boom. Likewise, labour force participation is still lower too .

Right now, the EU methodology is basically saying that the economy is slightly overheated, but will cool in the next year or two. While most people who look at the numbers would tell you that we are at capacity right now but at risk of overheating if current trends continue.

The EU methodology also means that potential output tracks actual output too closely, and told policymakers in 2006 that the economy was only slightly overheating, and by 2011 that it was operating only a small bit below potential. This was despite a reduction of one job in seven over those five years!

The case is as strong as ever for some kind of national consensus model of potential output. This would not be easy to achieve, but would surely be better than the EU methodology. Policymakers need a consistent, common-sense signal about how the economy is performing, and the current approach simply does not provide this.

G*P or similar such meaningless estimates are a modern form of ‘willy-waving’ by folk who may have a personal interest (often of a pecuniary nature) in such nonsense. But hey, just go with the flow here!

All modern economies – since the inception of the Industrial Revolution HAVE to expand or grow organically over the medium and long-terms. There has to be more and more and more of all sorts of stuff produced and consumed each year, every year. Where an economy does not, nor cannot, exhibit a positive Rate-of-Gowth, then bad things happen. Mind you, that RoG has not only to be in positive territory, but has to exceed 2.5% on an annual compounding basis – or else!

A constant feature of our modern economies is the steady upward trend in consumer consumption; or it use to be. Its somewhat early to judge whether or not a ‘growing’ economy is characterised by the steady increasing consumption of more and more goods and services (a physical or organic expansion) paid for out of current (disposable) incomes. Or is characterised by an increase in the consumption of credit – paid out of future (potential) incomes. I suspect that it may be this latter. But perhaps someone might enlighten me on this subject.

If the consumption of credit has or will overtake the consumption of real goods and services – then the economy may not be expanding organically. It may seem to be doing do if those conducting the measurement process keep looking in the same place and continue to neglect the increasingly negative effect on the annual, compounding RoG, of interest payments on personal, corporate and state debt liabilities. Most ordinary folk cannot (legally) create fiat currency to repay interest: they need to ‘earn’ it. So, if incomes (wages and salaries) do not increase proportionately over time, then either debt will go unpaid or organic consumptions will stagnate or decrease. Its not a zero-sum situation: its a negative sum. That is, in the circumstance described economic expansion is either retarded or it decrements.

Non ‘growth’ – of whatever variant, is not a viable economic option. If ‘global’ or EU regional ‘growth’ is by consensus, believed to be at or below 2% p/a – then how is it that Irish economic ‘growth’ is double this? Its not. So how are our economic estimates being computed? Are they reliable? I guess not. But hey, just go with the flow here!

Table1 shows the budget condition is a structural balance of 0.0% of GDP. The text says -0.5% of GDP. Is one of these a typo?

Good spot. The budget condition as it applied to 2016 was a structural balance of 0.0 per cent of GDP. The budget condition has since been revised and has been set at -0.5% of GDP for 2017 on.

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