Category: Economic Performance

Stimulus for Development


Commentators across the spectrum have worried that the April budget will tax and cut so much money out of the economy that we will face serious deflation. There has been a shift in emphasis from the over-riding importance of minimizing the budget deficit to recognizing the need to minimize the deflationary effects of fiscal measures. We are seeing an increasing number of proposals in that regard.

This is not unrelated to a second major political shift – the re-opening of partnership discussions and the potential for working through more complex and multi-layered ways out of this crisis. I can’t see any other institutions that can put together a combination of measures to promote a growth strategy that would accompany fiscal measures.

Without that growth strategy, the fiscal measures will not achieve their desired goal. We will simply end up chasing our tails, raising tax rates on a declining tax base and promoting deflation by combining tax increases, employment reductions, spending and wages cuts in a single year. Immediate measures to restore a degree of fiscal stability and reduce the budget deficit are necessary – but require a strong countervailing growth policy to restore the economy, and even to maintain those narrow fiscal goals.

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The IMF and the Global Financial System

The first week of April sees two big economic events:  the April 7th Irish budget is preceded by the G20 summit on April 2nd.  There is an interesting article by Simon Johnson on The Atlantic’s website: you can read it here.

Greenspan on Irish Economic Recovery

Ronald Greenspan of FTI presented this paper to a Dublin conference this morning, with Brian Cowen in the audience:FTIgreenspandublin


Improving the fiscal tradeoff

I apologise for yet another post on fiscal policy.  But it is better to err on the side of too much with crunch-time less than two weeks away.  I sense wide agreement on the two most pressing goals for the April 7 budget: minimise the contractionary impulse; and maximise the positive impact on creditworthiness.   Unfortunately, these goals tend to pull apart in terms of their implications for the optimal size of the adjustment.   I read much of the recent fiscal-related discussion on the blog as exploring ways to lessen this tradeoff.  It seems worthwhile to gather a number of the ideas together. 

(1)  Emphasise Type-1 adjustment (wage bill and transfer reductions) over Type-2 adjustment (tax increases and deferrals of positive net-benefit capital projects.  The international evidence (and arguably Ireland’s own experience) shows that Type-1 adjustments are better sustained and less contractionary.  This would allow either a smaller overall adjustment for any given target for creditworthiness, or a greater boost to creditworthiness for any given size of adjustment. 

(2)  Front-load certain structural deficit reduction measures but combine them with a temporary stabilisation offset.   Take immediate actions to lower the structural deficit to boost credibility.   Such actions could include increases in income tax rates or decreases in public-sector wages.   Combine these measures with explicitly temporary stimulus measures.   Possible measures include temporary reductions in VAT rates (which should move some expenditure forward in time) or temporary reductions in employer PRSI rates. 

(3) Pre-announce detailed plans for back-loaded structural deficit reduction measures.  In a post some time back I advocated a degree of “constructive ambiguity” on the details of out-year plans to raise taxes and cut spending.  I was rightly chastised for this economics heresy.   A detailed plan is critical to the credibility of the programme.  (I now put my hopes in liquidity constraints rather than myopia to lessen the contractionary effects of lower expected after-tax/benefit incomes.) 

(4) Reform fiscal institutions to enhance the credibility of future deficit reduction.   In general, credibility is improved by emphasising fiscal rules over annual discretion.   (An example would be a requirement to keep the pension system in balance over a long-time horizon.   Imbalances would require currently legislated actions such as indexing retirement age to longevity.)  It would also help to move to a system of multi-annual budgets. 

(5) Introduce a notional defined contribution (NDC) pension pillar.   This provides a long-lasting revenue injection with relatively benign demand- and supply-side effects.   Properly designed, it would not add to long-term fiscal imbalances.   It also meets a pre-existing need to improve retirement income security.   It should be a valuable component of an overall package from a union perspective.

(6) Formulate the plan in terms of a revised Stability Programme for the European Commission.  The plan should focus on achieving a 3 percent target for the structural deficit by 2013.   A focus on the structural deficit allows for a more politically robust programme and thereby enhances credibility.   It would also help to signal that the government takes its obligations under the SGP very seriously.

Implications of QNA Release for 2009

As I noted before, the Irish media and forecasters tend to focus on the year-average over year-average figure for GDP growth (averaging the four quarters of 2009 and comparing that to the average of the four quarters of 2008).   This figure is important for thinking about things like income tax revenue, which is levied on a calendar-year basis, but it can be misleading as an indicator of the economic growth taking place in the economy during a particular year.  This is because if GDP has fallen a lot coming in to the year, then the average level may be lower than the previous year, even if GDP starts to recover.

This situation exactly applies to measuring the Irish economy right now.  In news that will hardly be surprising to anyone who reads a newspaper, today’s QNA release shows that Irish GDP fell off a cliff in 2008:Q4, with seasonally adjusted real GDP falling 7.1% in 2008:Q4 relative to 2008:Q3—not at an annual rate.   This “base effect” will make the average-over-average figure for 2009 a very poor measure of underlying economic growth.  Here’s some quick calculations.  If Irish GDP stays at its 2008:Q4 level throughout the year (i.e. if we hit bottom in 2008:Q4 and managed to stay there for the year), then average-over-average GDP growth for 2009 would be exactly -5%.

Of course, all the incoming statistics suggest that the economy continued to contract rapidly in the first quarter this year—At 10.4 percent in February, the umployment rate has already risen by 1.8 percentage points since the December level, compared with an increase of 1.4 percentage points between September and December.  If GDP posted another 7 percent decline in 2009:Q1, then even a flat level of GDP for the rest of the year would imply an average-over-average growth rate of -11.6%.

An optimistic scenario would hope that the unemployment figures in the first quarter represent more of a lagged effect and hope to limit declines in the first half of the year to two percent in each of the first and second quarters, followed by a return to growth at, let’s say, a 3 percent annual rate.  This would still imply an average-over-average growth rate of -7.8% for 2009.

I think it’s time for those that use the average-over-average figures to revise their forecasts down.