For those who are interested, our article on the above topic is available here.
A report on Irish electricity and gas prices in the first half of 2009 was prepared by Martin Howley, Dr Brian Ó Gallachóir & Emer Dennehy for Sustainable Energy Ireland. For those readers interested in the topic they will find the report here.
The ESRI’s Quarterly Economic Commentary (QEC) by Alan Barrett, Ide Kearney, Jean Goggin and Thomas Conefrey, published in December, is now available to download free of charge from the ESRI’s web site here. This QEC contained a number of pieces of research which may be of general interest.
1. Measuring Fiscal Stance
In box 1, entitled “Measuring Fiscal Stance”, the stance of fiscal policy in every year since 1976 is analysed within a consistent modelling framework. This research shows that the 2010 budget, while definitely contractionary, was actually not one of the toughest budgets of the last half century. That “accolade” goes to the 1976 budget, with fiscal policy in 1983 and 1984 and in 1988 and 1989 coming in next in line. After that comes the series of budgets implemented for 2009 and 2010. However as is noted in the box, a futher contractionary budget is planned for 2011 so the cumulative contraction in these years may well ultimately exceed the cumulative contraction in the late 1980s.
This measure is obtained by running the HERMES model with taxation and welfare rates indexed and certain rules on public expenditure. This “budget” is taken to be neutral – generally under this rule the relative size of the public sector in the economy would change little in the long term. This result is compared with the actual outturn with the difference being attributable to discretionary fiscal policy.
This measure of fiscal stance tells us whether a particular budget is deflationary or inflationary. It does not tell us whether it is appropriate. However, as discussed in the box, more often than not the stance has been inappropriate – i.e. procyclical.
While not discussed in the QEC, I think that it is interesting that the day of the budget the Department of Finance published an alternative measure for 2010 using the EU standard methodology. This actually suggested that the budget for this year was stimulatory. This strange outcome arises from the inappropriate nature of the EU methodology. The Department of Finance understandably did not draw attention to this result as they clearly saw that it was not a sensible approach. This problem with the EU methodology is not unique to Ireland but affects its application to other EU member economies under current circumstances. I think that the EU approach was not designed to deal with a crisis of the kind experienced in Europe over the last two years. This issue merits further research to find a more robust approach which can be applied in a consistent way to different Euro area economies.
2. The Balance of Payments and the Flow of Funds
In box 4, entitled “Balance of Payments”, the implications of the economic forecasts for the capital side of the balance of payments is considered. With the government sector likely to borrow over 11% of GDP this year and with a prospective small balance of payments surplus, in 2010 the private sector will have a major net acquisition of financial assets abroad (more properly a repayment of net liabilities). Some of this repayment will not flow through the banking system. However, a significant part of it will affect the domestic banking system as households and companies increase savings or reduce borrowings from domestic banks. In turn, the banks are likely to reduce the size of their balance sheets and, hence, their net foreign liabilities. As shown in the box, there was a substantial reduction in these liabilities (largely to the ECB) in the second half of 2009. If this trend were to continue, with the prospective continuing large net repayment of foreign liabilities implied by the 2010 forecast, there should be a continuing substantial reduction in the banking system’s foreign exposure, especially in its exposure to the ECB. This will be important as the ECB begins to wind down its support for the Euro area financial system. Obviously this must be seen against the background of the government sector’s increasing foreign liabilities, a significant part of which will be needed to recapitalise the banking system this year.
3. Distributional Effects of Budgets
In Box 2 the distributional impact of tax and welfare policy changes in 2009 and 2010 was considered by Tim Callan, Claire Keane and John Walsh. They found that while Budget 2010 was clearly regressive, the combination of Budgets 2009 and 2010 placed most of the burden of fiscal adjustment on higher earners.
With three colleagues Seán Diffney, Seán Lyons and Laura Malaguzzi Valeri, we have recently published a series of papers on the economics of the electricity industry in Ireland. The conclusions are summarised in a Research Bulletin published today. There is also an article in today’s Irish Times.
The original papers are:
DIFFNEY, S., J. FITZ GERALD, S. LYONS and L. MALAGUZZI VALERI, 2009. “Investment in Electricity Infrastructure in a Small Isolated Market: the Case of Ireland,” Oxford Review of Economic Policy, Vol. 25, No. 3, pp. 469-487. Available here. We will release a working paper with additional results on this topic in the next few days.
MALAGUZZI VALERI, L., 2009. “Welfare and Competition Effects of Electricity Interconnection Between Great Britain and Ireland”, Energy Policy, Vol. 37, pp. 4679-4688. available here. An earlier version is available as a working paper.
Today Thomas Conefrey and myself publish a working paper entitled “Managing Housing Bubbles in Regional Economies under EMU: Ireland and Spain”. It is available here .
With the advent of EMU, monetary policy can no longer be used to prevent housing market bubbles in regional economies such as Ireland or Spain. However, fiscal policy can and should be used to achieve the same effect. This paper shows that the advent of EMU relaxed existing financial constraints in Ireland and Spain, allowing a more rapid expansion of the housing stock in those countries to meet their specific demographic circumstances. However, the failure to prevent these booms turning into bubbles did lasting damage to the two economies, damage that could have been avoided by more appropriate fiscal policy action.
The failure to tighten fiscal policy in Spain and Ireland in the early years of this decade laid the ground for the housing market bubbles in the two economies. The Stability and Growth Pact proved a distraction: government budgetary balance was not an appropriate fiscal target for those two economies. By contrast, Finland, having learned from its mistakes twenty years ago, ran substantial government surpluses to prevent domestic overheating. Specifically in relation to overheating in the housing market, we consider that a temporary tax on mortgage interest payments (first suggested in 2001) should have been used to target overinvestment in housing, investment which seriously crowded out the traded sector of both economies. This tax would have mimicked an increase in interest rates. Obviously it will be a very long time before such a tax might be needed in either Spain or Ireland to limit overinvestment in housing.
The paper shows that demographic circumstances in both Spain and Ireland meant that it was appropriate that investment in housing in those two economies should have been somewhat higher than in their neighbours. Even after the housing bubbles have burst, the relatively low endowment of housing infrastructure in the two economies (relative to adult population) means that there will be a need for additional investment in the next decade, when the current excess supply has been worked off.
In the paper we also include a graph taken from our paper “Recovery Scenarios for Ireland” published in May which, inter alia, considered likely housing demand over the coming decade. Our model included estimated 2009 population numbers which were quite close to the latest estimates published by the CSO. We assume that between 2009 and 2015 there will be cumulative net emigration of up to 120,000. Our analysis would suggest that the underlying population increase would lead to somewhat higher demand for housing than Brendan Walsh has estimated in a recent post for the period to 2015. In addition to the pure “demographic” effect we also factor in some increase in headship on the basis of the recent rise in the number of households, which possibly reflects falling rents.