The Irish Economy

I know some of our blog commenters are big fans of the idea of ending the EU-IMF deal and immediately running a zero deficit. I spoke with Kathy Sheridan from the Irish Times a while back about how this would be chaotic.

It’s interesting then to see US politicians apparently eager to try out this experiment on their own economy, pretty much for the hell of it. Here’s an interesting analysis of the decisions that could be facing the US Treasury on August 2. A corresponding analysis for Ireland would be really interesting.

I had missed last week that NTMA had released an information note on Ireland’s financing situation. The note clarifies that funds from the EU and IMF that had been earmarked for bank recapitalisation can be used to fund fiscal deficits if, as the government is currently assuming, there are no further recapitalisation costs. Based on these assumptions, and projecting that fiscal deficits come in on target, they note that Ireland can get to the end of 2013 with minimal new funding.

Worth noting, however, is that there is an €11.8 billion bond maturing in January 2014. So, it would seem likely that if market funding is not accessed at some time before summer 2013 (or perhaps earlier), then the government will have to open negotiations on a new funding deal from the EU and IMF. I doubt if letting the clock tick all the way down to December 2013 would be a good strategy.

The mid-year Exchequer Return released on Monday gives a somewhat noisy insight into the state of the public finances.  It is hard to draw exact conclusions about the behaviour of tax revenue and government expenditure because of the changes introduced in last December’s budget and the reporting of the relatively meaningless ‘net’ expenditure measure which was also affected by the Budget. 

Anyway, in this little poke into the figures we will just look at the Exchequer Balance which allows us to throw all these anomalies into the mix and focus on the final outcome.

Here are the cumulative Exchequer balances for the past five years.

At €10.8 billion, the Exchequer Deficit for the first six months of the year is better only than the €14.7 billion deficit recorded in 2009, but is worse than the €8.9 billion deficit recorded in 2010.  However, the Information Note which accompanies the returns tells us not to worry because:

The year-on-year increase in the deficit was primarily caused by the €3,085 million in non-voted capital expenditure Promissory Note payments to Anglo Irish Bank, INBS and EBS. Excluding these, the deficit fell by over €1 billion.

This is meaningless and should more appropriately be described as misleading. (more…)

If the objective is restored market access, the limits of exisitng crisis resolution arrangements were further exposed by Moody’s four-notch downgrade of Portugal.   The FT has the story here.   This bit is particularly important:

Moody’s cited the tortuous negotiations over Greece in its note, warning that although the likelihood of a restructuring in Portugal was lower than in Greece, the European Union’s “evolving” approach to providing further support “implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well.”

The full Moody’s statement is available via ft.com/alphaville.

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The Commission’s proposals for the EU budget’s next Financial Framework (MFF) for 2014-2020 can be found here. Judged against the parameters I proposed to evaluate the MFF proposal from an Irish perspective, then the proposal is as good as we could have hoped for. RTE reported that “The Government has given a cautious response to the European Commission’s proposed 2014 to 2020 budget” which, given that this is the start of a difficult set of negotiations, is about as close to saying “we are delighted” as you are likely to get.
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On Wednesday (June 29th) the Commission is scheduled to reveal its proposals for the next Multi-annual Financial Framework (MFF) which will set out the scale and composition as well as the proposed financing of the EU budget over the period to 2020. However, some reports suggest that Commission President Barroso is putting aside two days for the Commission College to agree the proposal so it may be later in the week before it sees the light of day. This is an important issue for Ireland, and this post discusses the issues to watch for in the Commission’s proposal.

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The Department of Finance is consulting on the potential economic impacts of amending property tax reliefs.

A paper and a spreadsheet model are available from www.finance.gov.ie.

Here.

Commenter Gavin Kostick has done impressive work on our behalf following up with Paul Krugman and Jean Claude Trichet on the austerity debate.   The fruits of his efforts are contained on the Paul Krugman: When Austerity Fails thread, but many readers will probably have missed them on this fast moving blog.

The reply from the ECB and links provided by Paul Krugman are reproduced after the break.   Thanks Gavin.  (I also take back my dig from yesterday about the ECB’s poor communications.) (more…)

These are really awful numbers (H/T Eurointelligence).

Given that Irish politicians and media have decided that Leo Varadkar’s comments about Ireland probably having to get a second EU-IMF deal is some kind of faux pas, it is perhaps worth pointing out that this opinion is widely shared by pretty much everyone I have to talked to in recent months.

Anyway, given that this issue is being discussed, now might be a good time to put up a link to this talk that I gave at the IIEA a few weeks ago. I discuss the risks relating to the current EU-IMF plan the likelihood of the need for a new deal. The slides for the talk are also on the page.

Here’s a link to an article I wrote for Business and Finance that (somewhat belatedly) discusses the government’s jobs initiative and its financing. (The headline I had provided was the probably too obscure to be funny “A Worthwhile Irish Jobs Initative?”)

The ESRI held a conference on pensions policy this morning. Presentations from the conference are available here.

Here is a short article on crisis resolution strategies that I wrote for Eolas magazine.   It was written before the debate over Morgan Kelly’s new resolution proposals.    The piece contrasts a Plan A — involving a phased fiscal and banking adjustment, offiical assistance to cover funding shortfalls, and absorption of significant banking losses — with a Plan B that has an earlier focus on debt reduction.   Morgan’s proposals – a Plan C? – combine immediate elimination of the borrowing requirement with eschewal of both official assistance and responsibility for bank losses.

Much of the pessimism about Ireland’s predicament has centred on the challenge of stabilising the debt to income ratio.   Undoubtedly this will be challenging, with good outcomes on nominal GDP growth and fiscal adjustment capacity required.    Of course, it has been made much more difficult by the massive bank losses the State has had to absorb.   But I think a focus on the stabilisation challenge misses a critical issue, which is regaining market access at a high if stable debt to GDP ratio (probably somewhere in the region of 120 percent of GDP).   

Martin Wolf’s column from last week provides a useful starting point for a diagnosis of the problem – an article that garnered all of one comment on the blog (from DOCM).   It draws on Paul de Grauwe’s insightful work on the susceptibility of countries in a monetary union to a debt crisis (see here), where a country without its own currency and central bank to act as lender of last resort is vulnerable to self fulfilling expectations that it will not be able to roll over its debts.   The EFSF/ESFM/ESM were put in place to help fill this LOLR gap, but have so far proven to be a poor substitute.   It is understandable that Germany and other likely net funders want to eventually reinstate market discipline, and so demand losses are borne by private creditors as part of any new bailout.   It is also understandable that they want to protect themselves from losses under the permanent bailout mechanism (the ESM) by demanding preferred creditor status.   But it is becoming increasingly evident that crisis-hit countries will find it extremely hard to regain market access with a half-hearted LOLR facility in place given any doubts that they will not be able to pass a debt sustainability test under the ESM. 

The official funders have to be willing to take on some additional risk if a mutually damaging combination of default and ongoing dependency is to be avoided.   One element is to clarify the way the debt sustainability test will be applied.   A current problem is that austerity measures weaken growth, thus making it harder to pass the test.   A useful amendment would be to assess growth in the debt sustainability calculation assuming a neutral fiscal stance.   Another useful amendment would be to set a ceiling on the size of any haircut, thereby limiting the uncertainty faced by potential new investors.   

As a quid pro quo for these amendments the government could offer to speed up the fiscal adjustment (along the lines recommended by the ESRI in its Spring QEC).   Of course, more fiscal adjustment is the last thing the economy needs as it struggles to pull out of recession.   Yet a quasi-permanent loss of creditworthiness and dependency on unreliable official support looks to be the bigger threat, as it saps confidence and undermines the perception of the economy’s stability.   Those resisting fiscal discipline must realise that the situation changed profoundly when Ireland’s creditworthiness disappeared in the second half of last year.   Some observers are putting forward the same fiscal policy prescriptions as they did when bond yields were around 5 percent.   They must see that the ground has fundamentally shifted.  

It is hard to see how further public sector pay cuts could not be part of any balanced additional adjustment.   A credible new regime for long-run fiscal discipline is also essential.  

The government should take the offensive in pointing out the incoherence of the current international support approach, while avoiding playing a self-defeating grievance card.   What is needed is a hard-headed look for a mutually advantageous set of policies that allow Ireland to shed its dependency.    The first step is a proper diagnosis of creditworthiness challenge. 

Here’s an article I wrote for Business and Finance on the question of whether Ireland’s fiscal debt is sustainable.

One correction I’d add to the article is that I miscalculated the average interest rate on existing Irish debt and reported it in the article as about 3 percent. The correct figure, as calculated by the EU Commission, is 4.6%.

One of the problems that plaugues discussion of the Irish public finances is there is a fairly widespread confusion over how much the government takes in as revenues and how much it spends.

Many people know that the figure for “tax revenues” has been about €30 billion in recent years, via press coverage of the monthly exchequer returns. (See here for the 2010 end of year exchequer returns showing €31.7 billion in tax revenue.) Many people also know that we have run deficits of close to €20 billion in recent years.

Together, these two facts have lead to the wide repetition of statements along the lines of “we are taking in €30 billion and spending €50 billion.” Often, a particular item of government expenditure, such as public sector pay or social welfare is then compared to the revenue take of €30 billion to illustrate the huge fraction of government revenues that it takes up.

It turns out however that a more accurate description of the Irish public finances has been the government has been taking in about €50 billion and spending about €70 billion. This pattern is hard to assess from looking at the Exchequer statements because, for example, they do not count the €11.4 billion in “social contributions” such as PRSI as taxes. Indeed, the whole definition of tax revenues is a bit arbitrary. I believe the USC is being counted as tax revenues, while various levies that it replaces were not.

The most useful description of the state of the Irish public finances is the materials provided to the European Commission, for example in Friday’s Stability Programme Update. Go to the second last page and you’ll see a useful breakdown of exactly how the General Government Deficit of €49.9 billon was determined. Take away the promissory note worth €30.8 billion and this deficit would have been €19.1 billion, determined by spending of €72.4 billion and revenues of €53.3 billion. (The last page contains a description of the relationship between the Exchequer Balance and the General Government Balance.)

Unfortunately, this simple and clear presentation of the public finances is not emphasised in the materials regularly released by the Department of Finance. Perhaps one of the reforms that the two new minsters in charge of spending and taxation could agree to would be to release regular clear presentations of the tax and spending figures underlying the general government deficit.

John Bruton writes today on the downside of grievance and the upside of a positive surprise on the deficit-reduction effort: Irish Times article here.

The report of the Review Group on State Assets and Liabilities has been published here. While some of the key recommendations had been signalled over recent days in the media there is a lot of detail in the report. Apart from the recommendations on asset disposal there are lots of recommendations on the regulation and governance of state bodies. 

Minister Brendan Howlin on RTE’s The Week in Politics has said the government are preparing a “stimulus package that is fiscally neutral”.  As a macroeconomist, this strikes me as a pretty strange concept. Pretty much everywhere else in the world, a stimulus package implies a set of measures that cut taxes or raise spending and are not “fiscally neutral.”

Still, one can hardly argue that the current set of tax and spending policies are optimised to generate as much employment as possible, so it may be possible to adjust policies to generate additional employment and I’d be interested in people’s suggestions for fiscally neutral measures that can boost employment. But shouldn’t we stop calling such changes “stimulus packages”?

The Sunday Business Post carries an interesting opinion piece by Paul De Grauwe in today’s paper.   Although articles are not available on the paper’s website until the Monday after publication, Cliff Taylor has kindly given us early access to article. 

The European Stability Mechanism will not not lead to more stability

After much hesitation and a lot of pressure exerted by financial markets, European leaders finally decided at the end of March to set up a permanent financial support mechanism which was given the name of European Stability Mechanism (ESM). From 2013 on, Eurozone countries will pool financial resources to be disbursed to member-countries in times of crisis. This historic decision illustrates the painful and slow way the Eurozone moves in the direction of more political integration in Europe.

Will the establishment of the ESM shield the Eurozone from future crises? My answer is unambiguous. It will not. In fact it is worse than that. Some of the features that have been introduced in the functioning of the ESM will make it more difficult for a number of countries, in particular Ireland, to attract funds in private markets.  These features will have the effect of increasing rather than reducing volatility in the financial markets. (more…)

I’m going to Florence this afternoon to present at a workshop on “Life in the Eurozone With or Without Sovereign Default?” that will be taking place tomorrow at the European University Institute. The program looks interesting and there will be a live web stream of the event. The slides for my presentation are here in Powerpoint 2007 format and here in a somewhat grimier PDF.

The new Fiscal Monitor is available here.   Required reading in order to understand the scale of the fiscal adjustment required in Ireland and other advanced economies.

One of the frustrating things about doing macroeconomics during the crisis is that it is so hard to pin down key empirical parameters.    The size of fiscal multipliers is probably the main case in point.   The combination of short time series and a wide range of conditioning factors – confidence effects, the state of credit markets, import leakages, etc. – make it hard to identify the causal impacts of changes in taxes and government spending.  

While there is a widespread view that Irish fiscal multipliers are small (mainly due to the openness of the economy), I have always believed this is exaggerated given offsetting factors such binding credit constraints, an almost completely accommodating monetary policy and a large negative output gap.  At a time when I thought Ireland could retain its creditworthiness, this led me to believe we should pursue as gradual a fiscal adjustment as the State creditworthiness constraint would allow.    But with creditworthiness proving more fragile than expected, there is now little choice but to move expeditiously to close the deficit. 

With significantly more fiscal adjustment to come – probably at a minimum the €9 billion planned for in the EU/IMF programme – there is an obvious reason to hope fiscal multipliers are small.   But there is also a reason to hope they are large.   With the IMF reducing its growth estimate for 2011 and the exchequer returns hinting at a weaker than expected recovery, we would be better off if the fiscal adjustment is a significant source of the observed weakness in domestic demand.  

It is the underlying rate of potential output growth that really matters for Ireland’s debt sustainability.   Uncertainty about this rate is a significant part of our creditworthiness problem.    As others have pointed out, there are competing narratives about Ireland’s medium-term growth potential.   On the positive side is the strong growth in net exports (which added about 3.5 percentage points to Ireland’s real GDP growth in 2010).  On the negative side is the combined impact of the fiscal austerity and the drag from impaired balance sheets (which subtracted about 4.5 percentage points from growth in 2010).  

While unfortunately we are in for a good deal more austerity, it will eventually end; the more of the current drag on domestic demand that is coming from the austerity, the higher is the implied underlying potential growth rate.   Even if the fiscal adjustment is making less headway now in reducing the deficit due to relatively high multipliers, the large changes in taxes and social welfare rates should allow for a rapid improvement in the deficit once the austerity ends and decent overall growth returns.    The hoped for growth narrative – which I think we have good reason to believe is true – is that Ireland has an economy with a strong underlying export-driven growth potential that is being temporarily held back by unavoidable fiscal adjustment. 

I give my views in this IT article.

The new government’s difficult navigation through the crisis took significant steps forward last week with the stress tests and strengthened lender of last resort commitment.   While we can hope for some easing of the bailout terms, the next milestone is likely to be the upcoming “jobs budget”.   For a new centre-right/centre-left coalition government, this will be an opportunity to demonstrate political capacity on the fiscal side.  Unfortunately, market assessments of Ireland’s chances of avoiding default are less favourable than we might have hoped when the EU-IMF programme was agreed (see Colm McCarthy’s post and article below).   With this inescapable reality in mind, it is worthwhile considering case for sending a strong signal on adjustment capacity by accelerating some of the planned deficit reduction. 

I do not make this suggestion lightly.   As Karl Whelan has emphasised, Ireland has already engaged is a truly massive discretionary adjustment (roughly €20 billion euro, or about 13 percent of GDP), involving huge sacrifice.   I have also no doubt that the austerity measures have deepened the recession.  Additional austerity is thus doubly unwelcome.  However, a demonstration of adjustment capacity by a new government that is still being assessed by markets and official funders could be a well-timed “investment” at this stage.   This could be combined with the planned improvement in the mix of policies designed to spur growth and employment, though realistically these measures would probably only the edge off any accelerated austerity.    A “jobs and creditworthiness special budget” (it clearly needs a better name) would allow the new government to show it is taking control of the situation, rather than passively following a course laid down by its predecessor, and build the sense that the adjustment-with-assistance strategy provides a clear path to exiting the crisis. 

In today’s Irish Times, Garret Fitzgerald dons the green jersey and bravely confronts Public Enemy Number One: Celebrity economists who “talk down the economy” and “scare the horses”.

The conservatism of the assumptions that underpin this study certainly ought to command the respect of the markets. It remains to be seen, however, to what extent it actually does so.

Factors that could work against this include last year’s undermining of confidence in our banking system; the lack of any specialised knowledge of the Irish economy both on the part of those who rate our debt and those who buy sovereign bonds; and the damage done to our financial reputation by some of our more vocal domestic commentators.

Part of our problem has been, and regrettably still is, the fact that “the markets”, (ie the international firms which evaluate credit risks as well as those which buy bonds issued by sovereign states), lack the capacity to assess adequately the financial situation of smaller states like Ireland. It is only in relation to larger sovereign borrowers that these firms employ specialists with detailed knowledge of the economy of a particular state.

For smaller states like Ireland they depend on second-hand information. This includes often ill-informed media reports, which in our case have involved reports of some of the “celebrity economists” who have been seeking publicity by claiming that our problems are so great that we will eventually have to default.

Some have indeed proposed that we should take that course now despite the impact this could have on our only current source of future borrowing – the EU-IMF bailout.

The damage to our standing abroad by such irresponsible statements has been incalculable. It is difficult enough for our own people to distinguish between serious economic commentators in Ireland and irresponsible voices – it is impossible for foreign observers of our finances to do so.

Frankly, I have no idea why Dr. Fitzgerald thinks that “the markets” lack capacity to assess the Irish financial situation. This has not been my experience over the years when dealing with ratings agencies or financial market investors: I have come across many international market investors who have a detailed knowledge of the Irish economy and financial situation.

And indeed, it’s not too hard to figure out why this is. Ireland’s gross government debt is over 100% of GDP, so the stock of outstanding debt is now over €150 billion. At current exchange rates, this means that the stock of outstanding debt is now larger than the market capitalisation of Microsoft or IBM. Does Dr. Fitzgerald think that financial markets consider these companies too small to bother collecting information on?

Over the last few years, Irish economic policy has been based on systematically overly-optimistic premises and Dr. Fitzgerald has supported these premises throughout. That Ireland’s debt situation is now extremely serious is simply undeniable. Attacking those who believe Ireland will default as trouble-making publicity seekers is pretty risible.

The Department of Finance has released this paper.

This morning’s WSJ notes that Portugal’s 2010 fiscal deficit will likely be revised upwards due to a shift in Eurostat’s rules concerning the accounting treatment of problematic assets. The March 16 Eurostat guidance note is here.

Jeff Sachs weighs in on the corporate tax rate question in a Financial Times op-ed.