Bad Weather and Q4 2010 GDP

The estimate for Q4 GDP in the UK has come in at negative 0.5 percent (well below expectations of mildly positive growth), with the deviation ascribed to the terrible December weather.

Ireland’s Q4 GDP number does not come out until March but we should not be too surprised if a similar undershoot happens here, in view of the similar weather in December.

Hump-Shaped Dynamics

A few weeks back, Harvards David Laibson gave a fascinating keynote lecture at the Geary Institutes Economics and Psychology Conference. A key theme was the way people form expectations when macroeconomic time series have what he calls hump-shaped dynamics. These dynamics and their implications for expectations are described in a recent paper for the Journal of Economic Perspectives:

Many macroeconomic time series have long‐horizon hump‐shaped dynamics – processes that show momentum in the short run and some degree of mean reversion in the long run.  Such dynamics will generally not be captured by simple growth‐regressions.  Hence, agents with natural expectations will make approximately accurate forecasts at short horizons, but poor forecasts at long horizons, because the economy has more long‐run mean reversion than the agents impute from their intuitive models. In other words, agents with natural expectations will overestimate the long‐term persistence of good news or bad news.

David explained how even a skilled econometrician facing relatively short time series will tend to miss the longer-term mean reversion. The difficulty of seeing the mean reversion can mislead us into believing that a string of good draws on the fundamentals reflects a permanent improvement with Irelands property bubble a good candidate. But equally a string of bad news can lead us to excessive pessimism Wolfgang Munchau’s expectation that Irelands nominal growth will not exceed 1 percent for a decade comes to mind as a possible example.

We have certainly experienced a string of bad news on both economic growth and fiscal cost of the banking losses. Just as during the boom, extrapolation has led to extreme expectations about the economy and solvency. Of course, this pessimism could turn out to be justified. But it is no harm to remember that mean reversion works both ways.

Todays Q3 growth numbers can be considered mildly good news. It is still too early to tell if we will be bumping along the bottom for some time or have turned the corner. (See here for graphs of real and nominal GDP/GNP based on todays release.) For a mild antidote to the competition for who can come up with the biggest number for the banking losses, it is worth taking a look at Ronan Lyons’ analysis of potential mortgage-related losses.


Many commentators have used the idea of “vicious cycles” or “feedback loops” to understand the virility of the financial and economic crisis.  (A nice example is this influential piece from last year by Larry Summers on the American situation.) 

This schematic attempts to capture some of the feedback loops operating between the Irish banks, public finances and growth.    One way to think about it is to view all three as facing some nasty headwinds.   For the real economy, growth is retarded by an impaired credit system, budgetary austerity and various multiplier/accelerator effects that intensify the recession.   For the public finances, it is harder to stabilise in the face of costly of automatic stabilisers, bank bailout costs and a self-fulfilling loss of creditworthiness as the risk premium on Irish debt rises.   And for the banks, they are strained by falling assets values, lost credibility of government guarantees and a slow motion run on wholesale deposits.    Everything seems to feed negatively on everything else. 

The adverse dynamics became overwhelming in recent months and international assistance has been required to prevent an effective collapse of the Irish economy.   The “bailout” means that the Government has time to implement a phased deficit reduction rather than face a sudden stop of funding, and the banks have access to recapitalisation funds and continued large-scale funding from the ECB.   This helps to ease some of the most virulent sources of negative feedback.  

The question now is whether it will be enough.    While in no way meaning to minimise the challenge, I think it is worth pointing out some potential sources of resilience in the system.   On growth, there are encouraging signs that despite severe headwinds the real economy is holding up surprisingly well (see here).   With capital spending 16 percent below profile, this is happening despite a fiscal adjustment this year that is not that much smaller than the €6 billion adjustment that the economy will have to bear next year.    

On the banks, a key point of contention is the likely future deterioration in loans, and especially mortgages.   Time will tell whether the resilience view of Elderfield/Honohan or the mass impairment view of Kelly/Matthews is correct. 

On the public finances, the key resilience factor is the capacity of the political system to generate the necessary primary budget surplus over the four- to five-year timeframe.    The coming months will be especially revealing on that score. 


Forfas: Review of Labour Cost Competitiveness

This report is available here.


This report examines the scale of the competitiveness challenge facing Irish firms and considers the reasons and implications for the deterioration in Ireland’s cost base over recent years. It looks at recent labour market developments in terms of employment and earnings trends including setting earnings trends against the international context and wage movements in key competitor locations. The report also provides an overview of the key drivers of labour costs and the impact of a range of factors on Irish wage levels is assessed. Drawing all of this analysis together, the report identifies a set of actions designed to improve the efficiency of the labour market, facilitating employment creation and protecting real incomes.

Taking Stock

It is a day for taking stock after an extraordinary week.   On Wednesday, the Government unveiled its four-year plan for stabilising the debt ratio with about as much political acceptance as could be expected.   Yet by the end of the week the expected probability of default on sovereign debt implied by bond yields had increased, and that was despite the imminent announcement of the details of an international rescue package.    It was also a week in which those advocating sovereign default—on State guaranteed bank debt and State bonds—were advancing, while those arguing that creditworthiness could still be restored were in retreat.   I think it is worthwhile to reflect on the two broad views.  Continue reading “Taking Stock”

The Four-Year National Recovery Plan

You can read my view on the Four Year Plan here.

My comment included two additional paragraphs which were cut, I suppose due to space constraints:

“The current economic and financial crisis has slowed down economic growth in the advanced economies which are Ireland’s main trading partners. Against this background, the assumption of a strong export-led growth might be too optimistic. In addition, improving price competitiveness and reducing the debt burden are two conflicting objectives.   

Operational measures are to be discussed at a later stage and there is little information about the measures to be taken beyond 2011. It is not clear when and how the plan will be reviewed, enforced, and monitored. There is no clear sequencing of the reforms to ensure that short term negative effects on demand are minimised.”

The sputtering foreign engines of assumed Irish growth

The four-year plan assumes that Irish GDP will grow in real terms by around 2.75% per annum over the next four years. For good measure, it throws in a little bit of assumed inflation as well (0.75%, 1%, 1.25%, 1.5% — a suspiciously smooth progression, would you not say?).

In the context of the proposed austerity package, this seems wildly over-optimistic to me, and it would appear that several market analysts hold the same view. Here’s one quote from the foreign press, but you can easily find more of the same:

Analysts questioned whether the plan was credible. Stephen Lewis, chief economist at Monument Securities, said: “It doesn’t seem all that realistic to me. It seems they’re planning very stringent fiscal measures and yet they expect the economy to grow against that background. That seems highly unlikely.”

Needless to say, I would love to be proved wrong, and the third quarter GDP statistics will be revealing one way or the other.

Optimists point to the growth in Irish exports as the route to our recovery. Since we can’t devalue, we will be relying on foreign income growth more than on relative price shifts to achieve this happy outcome. So it seems worth pointing out that the Dutch CPB’s September data on world trade and industrial production were released yesterday. They confirm a trend which has been there since January: the momentum of the world recovery is steadily decreasing.

Supply side rabbits (or, the optimists need to decide on a party line)

How do you try to convince markets that an economy is going to grow even in the face of serious budget cuts, at a time of already high unemployment? You produce some supply side structural reforms from a hat, et voila! This is how the IMF envisages getting growth in Greece, for example, and it is now being suggested that structural reforms will be a means of getting growth in Ireland as well:

Together with the structural reforms that will be announced in the strategy, this budgetary adjustment should allow Ireland to return to a strong and sustainable growth path while safeguarding the economic and social position of its citizens.

I am a little confused by this. After all, it just a couple of months since Morgan Stanley provided a completely contrary reason for being bullish about Ireland:

Clearly, Ireland is facing major challenges in the quarters and years ahead.  But, if there is one economy in the euro area that could meet such challenges, it is probably the Irish economy, in our view. Mind you, these strong preconditions are not a guarantee that Ireland will be able to overcome the challenges that lie ahead easily.  But we believe that Ireland is fundamentally different from the other peripheral countries in that it is a fully deregulated, fully liberalised market economy.  Hence, it should be able to adjust to the new environment and work its way out of the current situation more quickly.

The reason for my confusion is that if we are indeed fully deregulated and fully liberalised, it is hard to see where the Irish supply side rabbits are going to come from.

So: are you optimistic because Ireland is a lean green market machine, which will adjust flexibly and push our (practically vertical) aggregate supply curve out to the right at a rate of knots? Or, on the contrary, are you optimistic because we are a eurosclerotic mess, whose rigidities imply a fruitful pro-growth structural reform agenda?

What sort of four-year plan?

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 governments 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 cant 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 frontload 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 frontload because the government (and opposition) cant or wont deliver a true multi-year plan would be a serious policy failure. 

Abandoning the four-year plan

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.   

QEC Autumn 2010

The latest QEC is here. Here’s the press release:

  • We expect that GNP will contract by 1½ per cent this year. For GDP, we expect a decline of ¼ per cent. For 2011, we expect GNP to grow by 2 per cent and for GDP to grow by 2¼ per cent.
  • We expect that employment will average 1.86 million this year, down 68,000 from 2009, a fall of 3½ per cent. We expect the rate of unemployment to average 13¼  per  cent. For 2011, we expect the number employed to average 1.85 million and the rate of unemployment to average 13½  per cent.
  • In the year ending April 2010, the CSO recorded net outward migration to have been 34,500. This was well below our forecast of 70,000. We discuss how this figure of 34,500 seems to be a conservative estimate of the rate of outflow when compared with estimates of migration contained in another CSO publication, namely, the Quarterly National Household Survey. We expect the net outflow in the year ending April 2011 to be 60,000. This is an increase of 10,000 on our earlier forecast for the year ending April 2011.
  • The General Government Deficit is expected to be 31 per cent of GDP this year, a truly dramatic figure. Of course, almost two-thirds of this is a one-off extraordinary item related to the banking bailout. For 2011, we expect the deficit to be 10 per cent of GDP, based on a budgetary package of €4 billion in savings.
  • In our General Assessment, we look at the budgetary challenges facing the country and in particular at the prospects of bringing the deficit down to sustainable levels in a reasonable timeframe. Using the “Low Growth” profile as published by the ESRI in July 2010, we assess what level of savings will be required to achieve a deficit of 3% by 2014. Our calculations suggest that savings of up to €15 billion could be needed, i.e., twice the sum that was under discussion at the time Ireland and the Commission agreed to the 2014 deadline.
  • We express a concern over the potential negative impact on the economy of this scale of adjustment over this period of time.
  • While the 2014 date strikes us as worryingly ambitious, we are mindful that an extension is highly unlikely and so we must operate within the constraints as presented. Although we have based our forecasts on a budgetary package of €4 billion of savings, it could well be that a higher amount will be sought. Whatever it is, the scale of the task is such that there will be a need for adjustments in current and capital spending and in taxation.

Don’t forget to read the articles in the Research Bulletin.

Are the GDP numbers surprising?

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.

No Planned Revision to 2010 GDP

There have been a number of comments over the last few days regarding CSO revisions to nominal GDP.  This has been explained in the Irish Independent today as resulting from a change in the way CSO calculate the size of the economy.   Apparently, there were other comments at Kenmare over the weekend also
suggesting that a downward revision to GDP for 2010 is being contemplated by CSO.

I have been talking to CSO and they inform me that there has been no change in how they estimate GDP.   CSO has already published the first two quarterly estimates for GDP in 2010.  Q3 is scheduled for 16 December.

FDI in Ireland

Goerg, Hanley and Strobl write about FDI policy at Vox EU. Here’s the summary:

A chief concern for countries aiming to attract investment is how it will trickle down to the local economy. This column presents evidence on the effect of government grants to foreign companies investing in Ireland between 1983 and 2002. It finds that the grants had little effect on generating supply links with local firms and argues that governments should instead work towards reducing partner search costs.

QNA Release for 2010:Q2

The quarterly national accounts for 2010:Q2 have been released. They show seasonally adjusted GDP declining 1.2% quarter over quarter and seasonally adjusted GNP down 0.3%.  Year over year, real GDP is down 1.8 percent and GNP is down 4.1 percent. Nominal GDP is down 3.6 percent year over year while nominal GNP is down 6.2 percent over the same period.

There were also revisions to the first quarter figures. Seasonally adjusted quarter on quarter growth in GDP was revised down from 2.7 percent to 2.2 percent, while the decline in GNP was revised from 0.5 percent to 1.2 percent.

All in a Day, a Guest Post by Ciaran O’Hagan

Ciaran O’Hagan is head of rates research at Société Générale in Paris

Risk aversion has picked up in Europe over the past weeks. The debate over the fiscal and banking outlooks in Ireland needs to be placed in this context. While Irish credit is under pressure, it is also against a backdrop that favours risk aversion.

The flavour of Wednesday’s press alone gives a good idea of the headwinds facing any country wanting to grow itself out quickly from public debt. 

The ECB’s chief economist, Mr Stark, is warning of a slowdown in growth,  Meanwhile the Bundesbank’s Weber is cautioning that the global financial crisis is not yet over and setbacks in financial markets cannot be ruled out.  Behind this talk is of course the cautioning of governments that they need to show long-term commitment towards fiscal consolidation, or else brave the consequences.

Unfortunately several governments are non-existent. Belgium’s mediators warn there will be no announcement in relation to a new government this week, and there is no quick progress in the Netherlands either. Italy’s finance minister affirmed that there’s no autumn emergency. In France, the unions are trying to complicate very necessary – if still modest – pension reforms.

Even what should just be simple procedure is becoming problematic. Comments from the ECB, as reported by government sources in Berlin, suggest ongoing frustration with the IMF over how to deal with the challenges posed by Greece. And Eurostat is reported as saying it is frustrated as it can’t get all the Greek documentation on debt that it wants.

Moreover in Brussels, we have the overriding impression of cacophony from the latest Ecofin and Eurogroup meetings. We had the spectacle of head of the Commission, Mr Barroso, calling on the governments to reform. That absence of reform leads to titles in the press Wednesday like “Europe is Acting as Though it Wants to be Left Behind” (the WSJ) and “Realisation has dawned that sovereign credits cannot survive unless banks are recapitalised (the FT).

Even in AAA land, we read titles like “German banks are in reality the Achilles’ heel of the European banking system” (FT). The Bundesbank’s Weber affirmed that higher capital requirements for banks won’t curb economic growth. However even Mr Weber would probably agree that without strong banks, there will be no robust recovery. Unfortunately Europe won’t allow banks fail, and yet at the same time, many governments treat them as taxable cash cows and excuses for a lame recovery.

Last but not least, Mr Lenihan, the Irish finance minister, extended the guarantee for deposits at domestic banks and laid out plans for the dénouement of Anglo. These were necessary actions. However they unfortunately raise the contingent liability for the Irish state still further.

All this is just in a day’s news. It provides an unfortunate backdrop for any country wanting to grow itself out of public debt quickly. Ireland’s growth rate is probably more elastic than most with respect to global prospects. Unfortunately fiscal consolidation elsewhere in Europe over 2011 and beyond faces strong headwinds. That is helping make investors ever more averse to taking on risk, even among sovereigns, traditionally regarded as among the strongest of all credits. Continue reading “All in a Day, a Guest Post by Ciaran O’Hagan”

De Volkskrant on Ireland

De Volkskrant has a piece on Ireland, transgoogled here.

They start by saying that Ireland was a role model for austerity at the start of the year, but is now a reason for concern. They give two reasons, the first of which is the unknown but large cost of saving the banks. Secondly, they do not believe that the government will deliver in the next budget.

After catch-up

The Economist’s bloggers have a piece on China today which is relevant to Ireland. They ask what happens to an economy’s growth rate, in the long run, once it has caught up to the technological frontier. Their answer, correctly, is that “Historically speaking, the answer is clear—growth slows to 2-3% per year.”

This is a point which Cormac Ó Gráda and I made in a textbook chapter on long run Irish growth a decade ago. Very high growth rates characterise economies catching up to the frontier — Western Europe or Japan in the 1950s and 1960s, the Asian Tigers in the 1960s and 1970s, ourselves in the 1990s. Once you have caught up, 2-3% per annum is about as good as it gets. Allowing a bubble to inflate can obscure this reality over the short to medium run, but in the long run you won’t manage to grow more rapidly than the United States has done over the past century or so: to do so is a sign of an economy that is still in some sense backward.

These are relevant considerations when thinking about what sort of growth rates Ireland can reasonably be expected to achieve over the next decade or two.