Constantin Gurdgiev and I offer different views on Ireland’s capacity to avoid default in today’s Irish Examiner. Articles here. The articles follow an introductory piece by the paper’s political reporter, Mary Regan.
While there has been much comment about the four-year fiscal plan since the government announced it last month, it is still not clear what sort of plan they have in mind. At one end of spectrum (the relatively useless end) would be new targets for current spending, capital spending and tax revenues, with possibly a listing of “realistic options” for achieving those targets. At the other end of the spectrum would be a true multi-year budget, with detailed phased measures that are legislated where possible.
The government’s statement yesterday hardly suggests that a proper multi-year budget is what they have in mind:
The purpose of the Four Year Plan for Budgets and Economic Growth is to chart a credible way forward for this country. The size of the adjustment for 2011 and the distribution over the remaining years will be announced in the Four Year Plan. The Plan will contain targets for growth and strategies for the achievement of those targets.
When exactly did the four-year plan become a plan for economic growth? While returning the economy to growth is a critical part of the overall challenge, the four-year plan had a specific and urgent goal: to convince potential buyers of Irish debt that Ireland could lower its borrowing requirement sufficiently to avoid a bailout or default. Of course, decent economic growth will make this challenge easier, but I can’t see how the “year-by-year, sector-by-sector” fiscal plan expected by the EU Commission is the place for growth targets and strategies. We have to worry that the “targets and strategies” are filler to distract from the paucity of the fiscal plan itself.
Minister Lenihan also confirmed yesterday a nominal cumulative deficit adjustment target of €15 billion by 2014. The debate has now switched to how much to front–load this adjustment in 2011. Of course, the necessary front-loading depends on the credibility of the overall plan. The more investors have doubts that we can make good on our promises, the more they will need to see the money taken out up front – that is, the more the adjustment must be inefficiently concentrated at the time when our anticipated output and employment gaps are at their largest. Having to front–load because the government (and opposition) can’t or won’t deliver a true multi-year plan would be a serious policy failure.
The publication of the Autumn QEC certainly has created a stir this morning. Having been an advocate of front-loading the adjustment – albeit with nuance – the ESRI have now expressed doubts about the four-year time frame.
I am bit puzzled by the shift in their position. Based on the Institute’s evolving view of the economy, I would have thought the case for back-loading was actually stronger a year ago. While already stressed, international credit markets were then more favourable to the “peripherals” than they became after the Greek crisis. In addition, the ESRI were then forecasting what was effectively a V-shaped recovery. This suggested room to avoid an excessively pro-cyclical adjustment. (A basic principle here is that there is more scope to smooth temporary growth shocks than persistent shocks.)
Now that credit markets have turned extremely unfavourable and the underlying output path looks closer to the dreaded L-shape, I actually see less room for manoeuvre. (It is interesting that the ESRI are now focusing on their low-growth scenario from their Recovery Scenarios update, which itself might be viewed as in line with a modest V-shaped alternative, with average real growth of 3.2 percent between 2011 and 2015.) Moreover, the need to establish credibility around a focal adjustment path has if anything increased – the most obvious being the 4-year path already agreed with the European Commission and the major political parties.
From media reports, it appears that outside observers consulted by the ESRI are increasingly concerned by the poor outlook for growth. But the main reason for the worsened outlook is the drag caused by Ireland’s balance-sheet recession. While a contractionary fiscal policy will slow growth even further, I can’t see how extending the adjustment period is the best route to convincing investors that we can steer our way through this without default.
The latest QEC is here. Here’s the press release:
Don’t forget to read the articles in the Research Bulletin.
The main article in today’s Irish Times highlights the gap between the GDP estimates in the December 2009 plan and current thinking:
The department confirmed last night that it believed gross domestic product (GDP) this year would be 2.5 per cent below its projected level at the time of the last budget.
In December 2009, the Government believed that spending in the economy, or GDP, would amount to €161 billion this year.
Owing to statistical revisions to GDP for 2009 and 2010, it now believes that the figure this year will be €4 billion lower, at €157 billion.
This means that without any change in the budget deficit in absolute terms, the deficit will be higher than projected when expressed as a percentage of GDP.
The department also confirmed that its July 2010 GDP growth projection of 1 per cent has been revised downwards to “marginally” above a no growth position of 0 per cent. Servicing cost of the bank bailout at about €1.5 billion a year will add to the problem.
What explains this gap?
1. In December 2009, the plan forecast that nominal GDP would be €164.6 billion in 2009 and €161 billion in 2010. These forecasts were fairly close to the projections in the ESRI’s Autumn 2009 QEC (released on October 13 2009).
2. The first preliminary data from the CSO on 25th March 2010 put 2009 nominal GDP at €163.5 billion.
3. The revised data from the CSO on 30th June 2010 put 2009 nominal GDP at €159.6 billion. This is the ”news” event.
4. The July 7 2010 mid-year update from the Department of Finance does not discuss the revision to the 2009 GDP figure. In line with general views at the time, it improved its 2010 forecast for real GDP growth. It also highlighted that the GDP deflator was undershooting and pointed out that nominal GDP growth would be adversely affected – but did not quantify this effect. It also re-iterated that real GDP growth of 3.25 percent in 2011 was attainable and that an average real GDP growth of 4 percent during 2011-2014 was viable. It did not discuss prospects for nominal GDP over 2011-2014.
5. The Article IV IMF report on Ireland was published in July 2010. It reported negative nominal GDP growth of 10.1 percent in 2009 and projected negative nominal GDP growth of 2.6 percent in 2010.
6. The Summer QEC from ESRI was published on 14 July 2010. It projected 2010 nominal GDP at €158.9 billion.
7. On October 4 2010, the Autumn Bulletin from Central Bank projected 2010 nominal GDP at €157.018 billion.
Summary: the downward revision to 2009 GDP has been known since end June 2010. The €157 billion projection for 2010 was announced in the October 4th Central Bank bulletin and is in fact a bit more optimistic than the nominal GDP projection in the July IMF report.
An central element in the new 2011-2014 fiscal plan will be to provide a reasonable estimate for nominal GDP growth over this period. This involves two components – prospects for real GDP growth and prospects for the GDP deflator. Providing a detailed explanation for these projections will be an important element in communicating the plan.