Author: Seamus Coffey

Presentation to MacGill Summer School

Earlier in the week I contributed to a session at the MacGill Summer School on threats to the economy.  My speaking notes for the presentation are here though delivery may have been slightly different.

Conclusion:

We can build 40,000 houses a year, motorways between our regional cities, urban rail connections in the capital, and the roll-out of broadband across the country. We can reduce taxes, increase social transfers and public sector pay. We can spend all the benefits of the surge in Corporation Tax, ultra-low interest rates and the proceeds from the sale of the banks. They are our choices to make. But we cannot do it all and expect the benefits of prudent economic and budgetary management.

No lobby or special interest group sees their request for support as being the one that pushes the economy into the red. And they are right; but we have to watch the totality of what we are doing. If we try to do too much and fly too close to the sun we will fall to earth.

The biggest threat to the Irish economy may not be the decisions of Teresa May or Donald Trump; the biggest threat to the Irish economy are the choices we make ourselves. Let’s make a better fist of getting it right this time.

Annual Report on Public Debt

It seemed to slip under the radar but last week the Department of Finance published the first Annual Report on Public Debt Debt in Ireland.  It is a really useful publication and the first report reviews public debt developments since 1995 and particularly the huge build-up of debt since 2008.  The forward-looking analysis is also very good.

The report can be accessed here.

June 2017 Fiscal Assessment Report

The 12th Fiscal Assessment Report from the Fiscal Advisory Council is now available.  The report has a summary assessment and four in-depth chapters but here’s a summary of the summary to give a flavour of the analysis:

  • The economy is performing strongly and does not require fiscal stimulus.
  • It may be necessary for fiscal policy to “lean against the wind” (i.e be counter-cyclical) to offset overheating pressures and/or prepare for possible downside risks that may materialise.
  • No overheating pressures evident at present but likely if current high growth continues.
  • In the near term, growth may exceed government projections due to momentum from 2016 and possible increase in housing output.
  • Medium-term outlook is uncertain due to external risks such as Brexit, and a “hard” Brexit is used as the central scenario in the latest forecasts.
  • Debt levels remain high and the role of revised debt targets is unclear.
  • Fiscal rules breached in 2016 and likely to be breached again in 2017.
  • Unexpected revenue gains have been used to fund within-year increases in expenditure.
  • In 2016, government revenue (excluding one-offs) grew by 2.7 per cent and primary expenditure by 2.4 per cent; the underlying primary balance was essentially unchanged in 2016 with a similar outcome expected for 2017.
  • Fiscal stance is not appropriate for a rapidly growing economy that is close to its potential, that continues to run a deficit with a high debt levels and that has clearly identifiable risks on the horizon.
  • Fully adhering to the fiscal framework, including to the Expenditure Benchmark after the MTO has been achieved, would go some way towards avoiding fiscal policy that aggravates the boom-bust cycle.
  • The Council welcomes the commitment to develop an alternative to the Commonly-Agreed Methodology for supply-side forecasts.

There is much more detail on all of this in the report.  The report does not contain much about Budget 2018 because the government have not updated their “fiscal space” estimates.  These will be provided in the Summer Economic Statement to be published in a few weeks and will be assessed in the Council’s Pre-Budget Statement.

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.

Interpretation in fiscal space

The suspension of belief is commonly needed for science fiction.  Most space dramas require alien races to speak English or the existence of some form of instantaneous universal translator.  It now seems that something similar is required when moving in fiscal space.  Fiscal space is the money available for new measures while achieving minimum compliance with the rules.   Lots of words are being used to describe this but can we tell what they actually mean?

Continue reading “Interpretation in fiscal space”

Producing Short-Term Forecasts of the Irish Economy: A Suite of Models Approach.

A new working paper from Niall Conroy and Eddie Casey of the Fiscal Council Secretariat.

Abstract:

The Council’s mandate includes endorsing, as it considers appropriate, the official macroeconomic forecasts of the Department of Finance on which the annual Budget and Stability Programme Update are based. As part of the endorsement process and for the purposes of its ongoing monitoring and analysis of the Irish economy, the Council’s Secretariat produces its own Benchmark macroeconomic projections. This paper describes the short-run forecasting models used by the Secretariat for producing these projections. The general forecasting approach can be described as follows. Equations are used to forecast each component of the expenditure side of the Quarterly National Accounts. Multiple models are estimated for most components, with the simple model average used as an initial input into the formulation of the Benchmark projections. The out-of-sample forecasting performance of these models is assessed at each endorsement round. In addition to these model-based projections, other elements are considered. Discussions with the Council and other forecasting agencies help to guide any judgement that may be applied before arriving at the final Benchmark projections.