Banking & FinanceEconomyPolitics

Fiscal forecasts

In advance of Budget 2012, Meadhbh Monahan reports from the ESRI’s annual budget perspectives event, where economists debated the case for increasing the forthcoming adjustment and the need for certainty in the Government’s fiscal strategy.

John McHale Chair of the Fiscal Advisory Council

The fiscal stance, as outlined in the April 2011 stability programme update (SPU), is to reach a general government deficit to GDP ratio of below 3 per cent by 2015. It was judged as “broadly appropriate” when McHale and his four colleagues first began their work.

The SPU estimated that budget cuts and taxes totalling €6 billion in 2011 would bring the debt to GDP ratio down from 32.4 per cent to 10 per cent, while €3.6 billion in 2012 would reduce it to 8.6 per cent. Adjustments of €3.1 billion in 2013 and 2014 would see further reductions to 7.2 and 4.6 per cent respectively. Finally, a €2 billion cut in 2015 would see the deficit to GDP ratio decrease to 2.8 per cent.

However, the council updated these projections, taking account of:

• the reduced interest rate on the €85 billion loan from the EU-ECB-IMF, from 6 per cent to approximately 3 per cent (dependent on the cost of EU borrowing from the markets);

• the less than anticipated costs to the state of the bank recapitalisation scheme, from €24 billion to €16.4 billion;

• the upward revision of nominal GDP for 2010, from €153.9 billion to €156 billion; and

• the downward revision of nominal GDP growth, from 1.7 per cent to 0.8 per cent in 2011 and from 3.2 per cent to 2.5 per cent in 2012.

As a result of the above, McHale told delegates: “It looks like the target of 8.6 per cent of GDP for 2012 will not be met.”

Growth still faces risks, therefore the council advocates an adjustment of €4 billion (with a possibility of €4.4 billion) and a general government deficit target of 1 per cent rather than 3 per cent by 2015.

In addition, Ireland is under increased pressure following the ‘six pack’ of measures agreed by the European Council on 4 October, which will impose either a non-interest bearing deposit of 0.2 per cent of GDP or a fine of the same amount on countries with a gross debt to GDP ratio of above 60 per cent, if Europe’s recommendations for correcting the deficit have not been followed.

He told delegates, who included Department of Finance officials, that “by doing that little bit more [you will get] insurance that you will achieve debt sustainability.”

John FitzGerald ESRI economist

The current fiscal stance “would be enough to eliminate the budget deficit by 2015 to 2018,” John FitzGerald told delegates.

Policy-makers need to look beyond 2015. “By that date, Ireland’s balance of payment surplus could be under 5 per cent, thereby increasing consumer spending, with the surplus going towards government revenue expenditure,” he said. In addition, Ireland’s state-owned banks are expected to become more solvent, therefore, are more likely to be bought.

Despite the changes noted by the Fiscal Advisory Council (on facing page), FitzGerald contends: “There is no new information to suggest that the structure of the economy has been damaged worse than we anticipated.”

A key issue in forming fiscal policy is certainty, according to the economist. More information will be available after the four year plan on 30 November and “until then, it is too early to decide whether we adjust by €3.6 billion or €4 billion.”

Confidence is the main reason for frontloading the adjustment, he continued. Any measures to increase certainty could “hasten the economic recovery.”

FitzGerald initally agreed with the Fiscal Advisory Council’s argument that tax changes and cuts should be clearly outlined up until 2014-2015 so that people can accurately budget. However, when it was put to him by a delegate that opponents would have time to protest against the measures, he changed his mind, saying that “there would be two years of war” if, for example, a property tax was announced for 2013.

It is “imperative” that the forthcoming Budget should:

• be job-friendly (by implementing the 2009 Commission on Taxation proposals such as property and carbon taxes and water charges);

• bring about greater efficiency in public expenditure; and

• locate the cost of the adjustment among those who are best able to pay.

Philip Lane Professor of International Macroeconomics, Trinity College

The forthcoming Fiscal Responsibility Bill, which was part of the agreement with the EU-IMF, must make the law “less numerical [and] more politically accountable,” accoding to Philip Lane.

The IMF’s September 2011 fiscal monitor argued that if Ireland is to hit a gross debt to GDP ratio of 60 per cent in 2030, the cyclically adjusted primary surplus has to be 5.6 per cent of GDP between 2020 and 2030. Lane explained that once a primary surplus reaches 4.5 per cent “the fiscal rules are turned off.” In his opinion, “that is too low a ceiling” and should not be “the kind of territory in which fiscal decisions will have to be made.”

Instead, fiscal policy should be “solely focused on cyclically adjusted primary surplus and on fiscal politics.”

In order to achieve government accountability, a process approach should be taken whereby governments set out a longterm plan, including a target for a cyclically adjusted primary balance. An explicit target would also allow the Fiscal Advisory Council “to hold [the Government] to account.”

Cyclically adjusted balances will depend on the average interest rates and average growth rates, which are constantly in flux.

There is also a need to take account of “where we are” in terms of, not just the GDP cycle, but the inflation, current account and asset price cycles.

Department of Public Expenditure and Reform Secretary General Robert Watt questioned the usefulness of “a fiscal rule based on something we can’t measure.”

Lane responded that “the virtue of the cyclically adjusted primary balance over the cycle is that it leaves a lot of room for local management of the economy.”

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