Fall in Retail Sales halts for now

The release of the October Retail Sales Index by the CSO has been largely overshadowed the dramatic economic developments elsewhere.  The headline figures are positive with October retail sales up 0.5% by volume and 0.7% by value on September.  Annual sales by volume are up 2.0% and sales by value are down 0.1% reflecting the deflationary pressures that persist in the economy.

As is usual we will focus on the Retail Sales Index that excludes the motor trades.  In October the motor trades make up 18.2% of the index.   Here are the value and volume indices excluding the motor trades.

After recording monthly falls by value and volume, both indices were largely unchanged in September.  Here are the monthly changes since January 2009.

This moderated the annual decreases that have been recorded in retail sales for all months since July 2008 (bar April 2010 for the volume index).

For the five-month period from December 2009 to April 2010 the retail sales index did exhibit some “turning the corner” momentum.  This has subsequently been reversed.  Between December 2009 and April 2010 both the volume and value indices excluding motor trades rose by about 3.5%. 

We are unlikely to see a similar upswing this year as reduced social welfare and increased taxes reduced household disposable incomes.  When we get the releases of the Retail Sales Index we will see an increase in the annual declines in the indices.

Tweet

Surely, something is wrong with this picture

Taken from Bloomberg.  Irish 10-year bond yields Monday 29th November.

The one positive to be taken from this is that the average interest rate on the EU/IMF package of 5.83% is lower than the 9.25% it appears we would apparently have to pay if we were borrowing from bond markets.  But surely the release of the details of the EU/IMF package should have brought yields down and not sent them up.

And stop calling me Shirley!

Tweet

Cash transfers

According to the Household Accounts, disposable income in 2009 was supported by record payments of €26.3 billion in direct cash transfers from the State.  This represents 29.3% of the €89.6 billion net disposable income that households had in 2009 and 15.4% of GNP.  Here is a breakdown of the €26.3 billion in cash transfers provided by the State in 2009.

The €26.3 billion paid out by the State to supplement the incomes of those in need (or not in some cases) exceeds the €20.6 billion collected in Income Tax and PRSI contributions from those with earned income. 

Over the past ten years the proportion of Income Tax and PRSI contributions to GNP has remained relatively stable, and at 15.7% in 2009 were actually greater than then the 15.0% figure of 2000.  On the other side, cash transfers from the State have increased from 9.8% of GNP in 2000 to 20.1% in 2009.

We now have apparently “high-cost” services in a so-called “low-tax” economy.  Much as we’d like, we cannot have both.  I would like to hear social and economic reasons to justify why we should try to balance this inequality rather than have the outcome the result of a piece of arithmetic.  Social welfare recipients and tax payers deserve more than that.

Tweet

Pension rates

In 1997 the contributory old-age pension was £80.30 per week (€101.96).  As of today the contributory old-age pension is €230.30.  This represents an increase of 126%.  The progression of this payment is shown below. 

Here is the same data in a table with some additional CPI inflation numbers.

Prior to 2010 there was only one year since 1998 when the increase in the contributory old-age pension was less than the rate of inflation.  This was in 2000 when the pension was increased by 5.1% while inflation was running at 5.6%.  In each subsequent year to 2009 the increases in the pension outstripped inflation.

We can also see that the total amount paid by the State in contributory old-age pensions has increased from €413 million in 1997 to €3,340 million in 2009 – an increase of 709% which is driven by demographic changes as well as increases in the rates.

Here is a graph comparing the contributory pension rates to the consumer price index can be seen here. 

This comparison is similar to a previous comparison we did with one public sector worker’s salary.   Some of the same caveats to that comparison also hold in this instance.

First, the CPI is a price index and not a cost-of-living index.  Second, we are not making a judgement on what the “right” weekly pension rate is.  The pension could have been “too low” in 1997 just as easily as it might be “too high” in 2010.  These are judgement calls.  Here we just make a comparison of two series.  Make of it what you will.

Tweet

Sums

Some sums by Brian Lucey on last night’s Tonight with Vincent Browne seemed designed to spook people.  You can watch the show here.  But don’t.  The question Prof Lucey was asked was “put together the total state debt after this EU bailout”.  This table summarises his answer.

During this segment I heard the word “trillion” used in the Irish context for the first time. (How big is a trillion?).  Further scaremongering ensued when the calculators hummed into life and suggested that the annual interest bill on this debt would be somewhere of the order of €14 billion.  That is more than we collect in Income Tax in a year.  How do the sums stack up?

The first item is correct. Per the NTMA we have €89.7 billion in outstanding government bonds.

The way I see it, the second item is incorrect.  This €20 billion is money the NTMA has borrowed therefore should be part of the €90 billion in the first item.  Thus it should be not added in this calculation.  In fact this €20 billion is an asset we have on deposit somewhere.  Not only should it not be added, it is possible it should be subtracted! Anyway even if this €20 billion is in addition to the €90 billion national debt figure, it must be netted against the asset of the €20 billion on deposit somewhere. 

Of course, this isn’t the first time Prof. Lucey has struggled with the difference between assets and liabilities.  See here.  “Anglo can be wound up cheaply -- here's how. Sell the €28bn deposit book.”  Discussion here.

The third item is also incorrect.  First of all, we have  €16 billion in bonds maturing in the period 2011-2013 so I cannot see where the €23 billion number comes from.  See the document from the NTMA linked above.  But redeeming bonds does not add to our debt.  We have to borrow the money, but we use it to pay back the maturing bonds.  The net debt position at the end of the process is exactly the same.

Item four on the ongoing funds required to recapitalise the banks is still a shot in the dark and it is difficult to argue with any quoted figure.  This may or may not be true.

Item number five looks ok.  We have a €19 billion annual fiscal deficit.  Assuming an average of €15 billion per annum for the next three years seems plausible and will add €45 billion to the national debt.  Some of this will also be funded by the  €20 billion on deposit we have because of item two above.

Items six and seven are debt but it is a bit of a stretch to include them in the same category in a question on “state debt”.  These funds (and it is difficult to verify the actual amounts) are being provided to Irish banks by the ECB and ICB to keep the banks open.  In “normal” times this money would be sourced from inter-bank markets.  The problem is that Irish banks do not have access to these funds in current circumstances. 

This money is not going into a black hole to fund the recapitalisation of the banks.  This money is used to finance the assets the bank have – interest earning loans to borrowers.  The interest cost of this ECB and ICB money will be subtracted from the profits of the banks.  Remember on a day-to-day or operating basis Irish banks are hugely profitable.   The huge hole is in their balance sheets and this money is not going to fill that hole.

Also, this money is just replacing debt that was already on the banks books.  Previously the banks had received the money from the inter-bank market and large corporate deposits.  They had to pay interest on this money.  Now the inter-bank funds and withdrawn deposits have been replaced by funds from the ECB and ICB on which the banks again have to pay interest.  These liabilities have been on the bank’s books the whole time.  Why is Brian Lucey getting so excited about this money now just because they owe it to the ECB and not the inter-bank market and corporate deposit holders as was previously the case?

Finally, while we do own the banks, we also own Bord Gais, the ESB, the DAA and a raft of other state companies.  Why didn’t our hero include the substantial debts of all these companies in his measure of state debt?  Not enough time?  He had guessed on lots of other things why not guess on this.

We are in a very serious position, but this ridiculous scaremongering helps no one.  The numbers are immense but makey-uppy sums to get to €343 billion are offside, €200 billion is scary enough.

Tweet

Bond yields heading back to 9%

A “bail-out” is good, right?  The reaction of bond markets to Ireland’s IMF/EU “rescue” has not been stellar.  Yields on Monday were largely unchanged as markets digested the fallout from Sunday’s announcements.  Yesterday yields on 10-year Irish Government bonds rose from 8.1% to 8.4%.  Already today they have risen by the same amount.  From Bloomberg.

Heading for 8.7%, fast. 

Tweet

More on closing the gap

Update on this.

With the IMF in town and the EU’s 3% GGB target by 2014 now seemingly the drivers of our economic policy it is probably worth a moment to take stock and look into the numbers behind our fiscal crisis.  This may be moot at the banks threaten to pull the country into the abyss regardless of what Budget is or is not agreed in the next few weeks.

The public finances have a €19 billion hole to be filled.  In 2009 the government had €53 billion in receipts and spent €72 billion running the country.  We will look at both of these in turn.

First, let’s take the revenue side. 

Looking at the euro amounts shows the drop in tax revenue that has occurred since 2007.  See here.  However, it is more intuitive to look at how much of our income (i.e. Gross National Product) the government is collecting in revenue.

This is not showing much movement for an an economy that has shown a dramatic swing from boom to bust.  In 2009, government revenue as a percentage of GNP was 40.4%.  This is a slight drop from the 41.6% recorded in 2006.  Although this measure hasn’t show much variability over the past decade, it my view it is (and has been) too low.  We should be aiming for a tax/GNP of around 46%.  In terms of 2009, this would require an increase in government receipts of close to €7.5 billion.

Now we’ll turn to expenditure.

Again it is not the euro amounts which are most intuitive but they are revealing.  See here.  Again we will look at the expenditure figures as a percentage of GNP.

Wow! And this is just “normal” government expenditure as it excludes the monies used to start our ill-fated bank bailout in 2009.  As a proportion on our income, government expenditure has risen from 38.5% in 2006 to 55.3%.  Many of the most socialist regimes in Europe would not a level of government expenditure this high.  

With a stated revenue target of 46% of GNP, this would ‘allow’ a expenditure level of just under 50% of GNP to meet the 3% GGB target.   Again in 2009 terms, this would require an expenditure cut of about €7.5 billion.  Equal pain between tax and expenditure.

Here are the total revenue and total expenditure graphs combined.

The expenditure graph above also shows that the driver of the increase in total expenditure has been current expenditure.  Lets looks at the components of current expenditure.

All of these have been increasing, but the rise has been greatest for social transfers (up from 15,4% of GNP in 2006 to 22.8% in 2009)  and the public sector pay bill (up from11.2% of GNP in 2006 to 15.1% in 2009).  Debt service costs have started to edge up (from 1.2% of GNP in 2006 to 2.4% in 2009) and we can expect this to increase substantially further over the next few years as our borrowing escalates.

The last issue we will consider in this post is the breakdown of the increase in transfer payments.

The increase in unemployment benefits is readily observable but these transfers remain the fourth biggest category of social protection transfer payments.  The largest area of expenditure here is on old-age benefits which have increased from 3.4% of GNP in 2006 to 5.5% in 2009.

Here are the details of some of these payments in €millions.

The table excludes old-age health-related benefits provided (medical cards, drug purchases).

Highlighting these payments is not to suggest that they should be cut, but with the ‘Croke Park Deal’ supposedly ruling out pay cuts in the public sector and politicians from all sides voicing opposition to pension cuts it is hard to see where the announced expenditure cuts can be found without affecting these areas.

A related point is that if we want to maintain public services and social protection payments at existing levels we have to be willing to pay the taxes to finance them.  We cannot be a “low-tax economy” and cry out for high-cost public services. 

The current strategy of a €15 billion adjustment with a €10 billion expenditure cut and €5 billion tax increase split is being undertaken as a mere accountancy exercise.  Our target should be where we want to the country to be in five years , not aiming for some artificial goalpost. 

Let’s get government revenue up to about 46% of GNP in the next two to three years and have a four to five year plan for getting government expenditure down to a similar level.

Tweet

Let’s all meet up in the year 2000

HT: Stephen Kinsella

UPDATE: Here’s another from 1998

Tweet

The interest cost of household debt

We have been considering the household sector in recent weeks.  We look at the aggregates from the household sector accounts, the use of the €11 billion saved in 2009 and the components of the €84 billion of private consumption expenditure.

One further issue to consider is the role of debt and interest in the household account.  Interest form parts of “property income” which was part of the table produced with the first post linked above.  Household debt is a feature of the capital account which we have not yet considered.

Interest expenditure does not form part of private consumption expenditure.  The graph below shows household interest outgoings since 2002 while a comparison of this to interest earned can be seen here. 

After rising to a peak of €8.1 billion in 2008, the household interest bill fell to €4.0 billion in 2009.  This is likely because of the fall in the ECB base rate which was raised to 4.25% in July 2008 but had plunged to 1.00% by May 2009.

There  was also a decrease in the amount of debt on which this interest was accruing.  According the Central Bank data outstanding household loans in December 2007 was €153.0 billion.  By December 2008 this had fallen to €144.6 billion with a further fall to €140.1 billion by December 2009.  This €140 billion in debt was made up of €110 billion of loans for house purchase, €24 billion of consumer credit and €6 billion of other loans.

The household sector capital account for the period 2006-09 is shown below the fold

Tweet

Components of Consumption

The release of the Non-Financial Institutional Sector Accounts prompted us to the consider the Household Sector.  In a subsequent post we looked at what we had done with the close to €12 billion we had saved in 2009.  It is clear that this money was used to pay down debt rather than build up deposits.

We now turn to an examination of the money used for personal consumption expenditure.  In 2009 personal consumption was €84.3 billion down from a peak of €94.8 billion in 2008.  In nominal terms these are increases from the €29.7 billion in personal consumption expenditure in 1995.  Here is the pattern of the nine components of consumption expenditure in current prices as reported by the CSO since 1995.

The graph shows dramatic increases across a number of sectors, particularly food, housing, transport, recreation and education.  The largest increase over the 15 year period is seen in the category labelled miscellaneous goods and services.   The effect of the recession is most visible in the miscellaneous, housing and transport and communications categories, all of which recorded drops of more than 10% in 2009.

Using current prices it is clear that some of these changes in nominal consumption could be due to price effects.  Here is the same graph using constant prices.

Looking at the aggregate figures is reasonably information but it is probably more intuitive to look at the relative proportions of the components of personal consumption expenditure, i.e. the proportion of consumption was devoted to each category.

The stand-out feature of this graph is the drop in the proportion of expenditure that goes on food, beverages and tobacco.  The category comprised 29.6% of expenditure in 1995.  This had dropped to 18.8% by 2008, though increased slightly to 20.2% in 2009.   The breakdown of this category can be seen here.   The sub-category food (excluding meals out) has fallen from 14.0% of consumption in 1995 to 8.9% in 2009.  The other sub-categories have also shown declines in the proportion they comprise of consumption: non-alcoholic beverages (-0.2%), alcohol (-2.8%) and tobacco (-1.3%).  This reduction in the amount of our income we have to devote to food expenditure was the subject of a previous post.

With less of our expenditure devoted to the food, beverages and tobacco category we used a greater proportion of consumption on housing (as a proportion up 4.6% from 11.9% in 1995 to 16.5% of consumption in 2009), miscellaneous goods and services (up 4.4% to 22.3%) and expenditure outside the state (up 2.4% to 6.8%).  There are no sub-divisions provided for the housing and expenditure outside the state categories, and the rather inconclusive sub-categories of the miscellaneous category can be seen here, though there does appear to be an increase in the proportion of consumption on health services.  It is also worth noting that the housing category does not include mortgages as these are treated as investment expenditure.

The only other category for which notable sub-categories are provided is the transport and communication category which up 13.2% of consumption expenditure in both 1995 and 2009 though it had risen to 15.7% in 2006.  The breakdown of this category can be seen here which shows a sharp decline in expenditure on personal transport equipment (down from 6.1% in 2000 to 2.4% in 2009) in the last two years with expenditure on communication showing a steady increase (up from 2.0% in 1995 to 3.3% in 2009).

Tweet

Exports show some real improvement

The CSO have released the latest External Trade Statistics giving details of our merchandise trade up to the end of August (with some preliminary figures for September).  The performance of our exports and imports up to the end of September is shown below.

Compared to August exports rose 2.0% in seasonally adjusted terms while imports rose 1.2%.  This resulted in an increase in the trade balance for September.

In our analysis of previous external trade releases from the CSO we have attributed this improvement in out balance of trade to the Chemical and Pharmaceutical sectors which make up 60% of our total exports.  That may not be the case with the trade balance up to the end of August (the categorical breakdown of exports for September are not part of the preliminary estimates).  Here are our monthly Medical and Pharmaceuticals exports for the past four years.

After the record monthly exports in this category of €2.34 billion in July, exports medical and pharmaceutical exports dropped 28% to €1.68 billion in August.  With our exports falling by ‘only’ 3.5% in August this suggests that the performance of exports excluding medical and pharmaceutical exports was strong.  Here we see that this was indeed the case.

The poor performance of our exports excluding medical and pharmaceutical exports that was seen up the end of 2009 has been replaced by a strong performance for the first eight months of 2010.

With all the negativity concerning the Irish economy this week here is a table that is virtually entirely positive.

Exports have risen in nine of the ten categories reported by the CSO.  The only category to show a decline is in the Machinery and Transport Equipment category which is down 25% on the same period last year.  This is largely of a result of a drop in computer exports from €4.2 billion in 2009 to €2.8 billion in 2010.  That aside, virtually all other merchandise export categories are on the way up.

Our exports are still dominated by the chemical and pharmaceutical sector but there are signs that exports are “turning the corner”.  Now we need to know if these increases are leading to an increase in employment

Tweet

Eurogroup statement

The statement from the Eurogroup of EU Finance Ministers on the Irish situation can be read here.  An extract.

“We nevertheless invite the Irish authorities to include an annual review in their strategy that will allow them to cope with the implications of less favourable macro-economic developments were they to arise.”

Could they be concerned about our growth projections?  Over the past fortnight we have looked at the forecasts for nominal GDP, real GDP and the components of GDP.  You bet they’re concerned.

Tweet

Crisis? What crisis?

Minute by minute updates here. 

10.20am: Brian Lenihan is late, again, for this morning's EU finance minister's meeting in Brussels, Elena Moya tells us. The meeting was due to start at 9.30am GMT.

Tweet

Under pressure with deadlines?

Consider what one ‘student’ can achieve.

“On any day of the academic year, I am working on upward of 20 assignments.”

There are so many economic concepts in this piece that a whole course could be built around it.  The key – people respond to incentives. Always. Even Charles Dickens.

Tweet

Budget deficits and all that

Here is the unedited version of an article printed in tonight’s Evening Echo.

In 2009 total expenditure by the all the sectors of Irish government was €72 billion. At the same time total receipts of the Irish government were €53 billion. This represents a gap or fiscal deficit of €19 billion. Unlike the costs of our banking collapse, which we hope are once-off, the huge gap in our public finances will continue year after year unless something is done to address it.

The most pessimistic estimates of the total cost of the bank bailout are for a debt of approximately €70 billion to be assumed by the State. However, if left unchecked, the annual deficit in the State’s own finances would match this amount in less than four years and would quickly run ahead of it. To fund this deficit each we year we have to borrow money from international bond markets, and it is clear that such investors now have growing doubts about our ability to repay this money.

There are two ways which the deficit can be closed: increase revenue or reduce expenditure. Although much of the focus has been on expenditure cuts, the deficit has emerged largely because of a collapse in tax revenue. In 2007, tax receipts for the Exchequer were over €47 billion. This year they will struggle to raise €31 billion. We can attribute the main portion of the deficit to the €16 billion drop in tax revenue, which is largely the result of the evaporation of taxes associated with the now departed construction and property bubble.

So how will we close the gap? It is clear that up to a few weeks ago, the Department of Finance had pinned most of our hopes on increased tax revenue which would be generated by a growing economy that had “turned the corner”. We have a €19 billion budget deficit but the plan to address this presented last December suggested that €7.5 billion in budget ‘adjustments’ would be sufficient to close the gap. The remaining €11.5 billion of the deficit would be covered by the buoyant tax revenue provided when our economy returned to the stellar performance of a few years ago. Well that was the plan anyway.

A few weeks ago the finance spokespeople of main opposition parties trooped into the Department of Finance building on Merrion Street. As the day progressed Joan Burton, Arthur Morgan and Michael Noonan emerged ashen-faced and they were the ones to inform us that the ‘head-in-the-sand’ approach did not have much chance of success. It was Michael Noonan who said that “the adjustment required in the Government's four year budgetary plan will be 'significantly higher' than the €7.5 billion figure previously mentioned”.

Why it took so long for this reality to be grasped by all sides of Leinster House is hard to fathom. The European Commission reviewed our original budgetary plan and concluded that “the budgetary outcomes could be worse mainly due to the programme's favourable macroeconomic outlook after 2010”. This was published by the Commission back in March. Yet, it took until the end of October for this nettle to be finally grasped over here. We cannot expect to fill a €19 billion gap with €7.5 billion worth of changes.

And so, last week the Department of Finance produced outline information on some of elements of the new four-year plan it hopes to publish before the end of the month. These sketchy details informed us that the proposed adjustment between now and 2014 could be of the order of €16 billion. At first glance this appears to be much closer to reality.

Last December, when introducing his 2010 Budget, with €4 billion of adjustments, to the Dail, Minister for Finance, Brian Lenihan said that:

“A Cheann Comhairle, the worst is over. The international economy has exited recession. Recent indicators suggest that economic activity in this country is turning the corner, and my Department is now expecting a return to positive growth within the next six to nine months.

The effort demanded of every citizen in this Budget is substantial, but it is the last big push of this crisis. Further corrections will be needed in the coming years, but none as big as today’s.”

As we now know, the script of the Minister did not reflect the subsequent reality of the Irish economy. The 2011 Budget to be announced in a few weeks will feature €6 billion of adjustments. This will continue with further adjustments of €3-€4 billion in 2012, €3-3½ billion in 2013 and €2-2½ billion in 2014. The upper limit of this total is €16 billion.

The use of the word “adjustment” is akin to the ploy of misdirection used by an illusionist. We think we know what he’s doing, but out of sight the full effect of the trick is being prepared. Adjustment is just a word to hide the reality. Adjustment means expenditure cuts or tax increases, but using the word adjustment avoids specifics so we have no idea how this €16 billion of hardship will be distributed. At the moment it is just a number on a page.

Another key issue is the speed of this process. The €19 billion gap is evident to everyone but what is not so evident is why it has to be closed by 2014. This is an artificial target and one that has been largely self-imposed. When we produced the ‘pie-in-the-sky’ plan last December we said we would have the deficit down by 2014. The EU has taken this as our commitment and has tied us to it. Commissioner Ollie Rehn was here during the week and it is likely he was given further promises that we would cut the deficit by 2014.

The target we have to reach is a government deficit of less than 3% of Gross Domestic Product by 2014. Whatever the size of the economy is, as measured by GDP, the government have committed to having a deficit of less than 3% of this by 2014. This year we are likely to run a general government deficit of over 12% of GDP which we must reduce to 3% by 2014.

Our target is based on two elements: the size of the deficit and the size of the economy. The four-year plan is aiming for moving goalposts depending how big the deficit is and what happens to the GDP figures. Up to now the hope was that an economy returning to the growth rates of five years ago would help us reach the target by increasing our total GDP.

Last December we were told that the changes required for the 2011 budget would be €3 billion in adjustments. Now that figure is €6 billion and special-interest groups the length and breadth of the country are getting their message out that their funding and services are vital.

Why have we gone from €3 billion to €6 billion and what are we getting for this extra pain? There are three reasons that explain the jump to the €6 billion adjustment: a fall in GDP, a continued widening of the budget deficit, and a more ambitious deficit target for 2011.

The forecasted GDP number for 2011 has fallen because of a downward revision by the Central Statistics Office of prevision GDP figures. Also, projected GDP for 2011 has fallen because the government has announced they are going to cut more. Direct government expenditure on goods and services (on health and education services etc.) and government funded household expenditure (through social welfare benefits and pensions) are a major component of the economy. If these are cut, the size of the economy is reduced and the allowable budget deficit is reduced. We are cutting more because we have announced we are cutting more. This could be a vicious circle. These changes to the GDP numbers have added €1 billion to the adjustment.

Even with the €4 billion adjustment announced in last December‘s Budget the deficit for this year looks like being even larger than last year. This is because compared to last year, tax revenue is lower, social welfare expenditure is higher and the interest costs on our growing national debt are increasing. We’re trying to close the gap at the same time as the gap is getting wider. This has added a further €1 billion to the adjustment. It is like pouring water into a bucket with a hole in it.

The final reason we have moved to a €6 billion adjustment is the apparent wish to have ourselves viewed as gluttons for punishment. Last year, when we announced the plan to get to a 3% budget deficit by 2014 we said that we would get it down to 10% for 2011, from the 12% this year as an intermediate step on the road to reaching the 3% target. With the economy contracting and the public finances continuing to deteriorate, the Department of Finance has said that we should heap more pain onto the economy by reducing the original target. €1 billion has been added to the adjustment just for the hell of it.

All in all, we will see very little benefit from increasing the budgetary pain from €3 billion to €6 billion. In terms of the EU target we will move from a projected deficit of 10% of GDP for 2011 to a deficit of 9.3% of GDP. We’re going nowhere and it’s like pushing a car with all your might while someone has left the handbrake on.

The government is focusing much of its budgetary efforts on the expenditure cuts and tax increases that it is hoped will meet the 3% target by 2014. We will not meet this target and nor should we be too concerned about this. Yes, the budget deficit has to be addressed, but dancing to a tune called by someone else is not what is required. It is clear that changes have to be made to our public services and our tax system, but they should be done to satisfy the needs of Irish people and not to satisfy an accounting ratio.

We have to decide what is best for Ireland. We have the chance to completely overhaul our public services and tax system but because we are so focussed on an artificial goal we are failing to see the wood from the trees. Making changes at the margin can only offer a temporary solution.

We must decide the kind of public sector and social welfare system we want to have in this country. Do we want a public sector that provides as many services and supports to as many people as possible? If so, we will have to design a tax system that will raise the funds to finance these services. Or do we want to maintain the view of Ireland as a ‘low-tax economy’? If so, we must realise that we will not have the money to provide everything we may wish from our public services. At present we have chosen the impossible. We want the high-cost public services but we cannot pay for them with our current tax base.

Our long-term plan for closing the budget deficit should be based on the type of Ireland we want to see in ten years time. Now is the time to be making these decisions and not fighting over percentage points.

Tweet

Eggs, Cheese and “Angles”?

RTE reports on the egg and cheese reception the people of Nenagh laid on for Mary Harney when she was there today.

The eggs and cheese I have some understanding of, but this?

UPDATE  23/11

Who are the  “TRATIORS”?

Tweet

Core deflation stubbornly remains

The CSO have published the October CPI release.  The headline is that annual inflation is up.  In October, the overall rate of inflation increased to +0.7% from +0.5% in September.  But what are the measure of core inflation we have been tracking.

This measure excludes the effect of mortgage interest and energy products and represents 85% of the overall index.   Mortgage interest represents a single product and you can see the components of the energy products sub-group here.

Deflation in this measure is proving much more stubborn.  Core deflation was –1.41% in September and was largely unchanged at –1.42% in October.  Excluding mortgage interest and energy products, consumer prices fell slightly in the month to October.

It is probably too much to expect that there will be no commentary relating the CPI figures to inefficiencies in the “state-controlled” sectors but if there is note this.

Tweet

Mortgage Debt Forgiveness

The Irish Times carries an article today signed by 11 economists (including two affiliated to UCC) on the topic of debt forgiveness for mortgage holders.  I was asked to sign my name to the article but did not.

Here is my reply to a post by one of the signatories earlier in the week.  It is below the fold.

Tweet

The real story

Our previous post looked at changes to DoF nominal GDP projections.  There are none.  What about our GDP in real terms?  In nominal terms it appears that the DoF expect the GDP figure to be no different than it was before, but what about the price effects that will determine the real changes behind these nominal figures?

We can compare the Department’s HICP predictions to the end of 2014 made in December 2009 to those produced last week.

The Department is predicting less inflation (or more deflation) for every year up to 2014.  This is particularly true for 2010 to 2012 with lower inflation of between 0.25% to 0.70% forecast.  For 2013 and 2014 the Department’s forecasts are largely unchanged and are probably influenced by the units the Department chooses to present their forecasts in.

If the Department expects prices to fall faster in 2010 and rise slower in 2011 and 2012, the only way they can meet their nominal GDP projections if they are expecting real GDP to rise by a greater amount than they thought last year.  There must be a greater increase in activity to offset the effect of lower increase in prices.

To see this in practice we will work through the numbers for 2011.  Last December’s SPU has a real growth rate prediction of 3.3% for 2011.  Last week’s EBO gives a predicted real growth rate of 1.75% for 2011.  Surely this is a reduction and is in line with all observer expectations.

The EBO gives 2010 nominal GDP at €157.3 billion.  The real GDP growth rate of 1.75% for 2011 would give a real GDP in 2011 of €160.05 billion at 2010 prices.  The EBO gives a nominal GDP figure for 2011 of €161.2 billion.  This increase in nominal GDP over real GDP is line with the 0.75% inflation expectation.

But we are not comparing like for like.  The 3.3% predicted real growth rate from last December was based on a €3 billion adjustment.  The 1.75% predicted real growth from last week is based on a €6 billion adjustment.  If we again use a fiscal multiplier of 1.0 for the first year and zero thereafter to allow us to simply add back this extra €3 billion that the government is going to cut from the economy, we get a revised real GDP figure of €160.05 billion plus €3 billion equal to €163.05 billion.

Without the extra adjustment the increase in real GDP is predicted to be from €157.3 billion in 2010 to €163.05 billion in 2011.  This is equivalent to a growth rate of 3.66%.

Last December there was a predicted real growth rate for 2011 of 3.3%.  Excluding the effect of the additional adjustment the current predicted real growth rate for 2011 is 3.66%.  We’re not reducing our GDP growth prediction for 2011– we’re increasing it!

If we carry through the same analysis for the years 2012 to 2014 we get the following results.

We are pinning our hopes to higher growth rates in 2010 and 2011, a largely unchanged growth rate for 2012 and 2013, with the only notable decrease in 2014.  So much for moving away from a “favourable macroeconomic outlook”. 

And this is only achieved with very benign assumptions about the impact of the additional fiscal adjustment on the growth rate.  A more thorough consideration of this effect would probably reveal that the predicted real growth rates for all years have increased.

Did Ollie Rehn really buy into this?

Tweet

The progression of projections

Here is the nominal GDP forecast that the Department of Finance produced as part of last year’s Stability Programme Update.  This was the path to the promised land of the 3% GGB.

This was an absurd projection then and appears even more so now.   Last week’s Economic and Budgetary Outlook presented revised nominal GDP projections for the same period.

Ah, surely that’s more like it.  It seems the GDP projections have been scaled back per the European Commission wishes and this is the reason we need a €15 billion plus ‘adjustment’ over the next four years rather than the €7.5 billion announced back in December.  The gap between the predicted nominal GDP for 2014 is a massive €21.3 billion (€204.8 billion versus €183.5 billion).  Here are the “revised” nominal growth forecasts. 

However, although both of these are nominal GDP projections they are not comparable as they are not based on the same underlying assumptions.  The gap between them may be more virtual than real.  We will see that this is an incongruous comparison.

We will begin with the December 2009 projections and work through the changes that have been made to this projection and try to get a meaningful comparison to the November 2010 DoF projections.

The first issue we have to consider is the revision carried out by the CSO on the GDP figures.  The DoF in last week’s Economic and Budgetary Outlook referred to this and claimed that “the overall size of the economy is now smaller, reflecting revisions by the CSO to the level of GDP in 2009 and to previous years (a methodological change)". 

I cannot find any evidence of the CSO undertaking “a methodological change”, but they did revise the GDP numbers.  This is a regular occurrence.  When first released by CSO the 2009 nominal GDP was stated as €163.543 billion.  (See Table 2 in 2009 Q4 National Accounts Quarterly here).

When June came around the CSO issued the revised GDP numbers and nominal GDP for 2009 was stated as €159.647 billion (see the equivalent table here).  This represents a drop of €3.896 billion or 2.4%.  With budget deficits and borrowings measured relative to nominal GDP this is a substantial change.

Anyway last December’s DoF GDP projections were based on a nominal GDP of €164.6 billion in 2009.  Their growth figures are projected from this number.  The true nominal GDP figure is now almost €5 billion below this.  If we keep the same growth rates as produced by the DoF what effect does this revision have on the projected GDP numbers?

Even using the same growth rate the revision by the CSO sees the projected 2014 nominal GDP decrease by about €6.2 million.  Here is the most recent GDP projections compared to this revision of the 2009 projection.

The gap between the original GDP prediction and the new prediction for 2014 has narrowed from €21.3 billion to €15.1 billion.

Again, however, this is a false comparison as the Dec 2009 figures was based on a total ‘adjustment’ of €7.5 billion in the period to 2014, where as the Nov 2010 projections are based on an up-scaled adjustment of €15 billion plus. 

We will rescale the Nov 2010 projections as if adjustment had remained at €7.5 billion as announced last year.  We will do this very crudely.  We will assume that the fiscal multiplier is 1.0 for the year the adjustment is introduced and 0.0 thereafter.  With this assumption we can just add the amount of the cumulative extra adjustment to each year to get the nominal GDP figure as if the extra adjustment did not occur. 

This is crude but suffices in this instance, though it probably understates the true growth effect of the additional adjustment.  The extra adjustment is €3 billion for 2011, with an upper limit of an extra €2 billion for 2012, €2 billion in 2013 and €1.5 billion in 2014.

Hey, where did the gap go?  I thought we’d revised down our 2014 nominal GDP prediction by a massive €21.3 billion.  But a couple of logical revisions later and the gap is down to €6.6 billion.  And this is with the possibly benign assumption that the multiplier on the extra adjustment is 1.0 in the first year 0.0 in subsequent years.  If this was above unity in the first year or anything greater than zero the year after it could be that the relevant comparison is actually much closer to something like this.

And, just like that the gap is gone!

We haven’t revised our figures to account for “the programme's favourable macroeconomic outlook after 2010” as said by the European Commission back in March.  We have altered our GDP figures because the CSO revised the number down and the Minister has revised the adjustment up.  In nominal terms, if we factor out these two effects, everything is as it was before.

Tweet

Oh dear.

Yields on 10-year Irish government bonds today.

And for the last three months

No commentary required.

Tweet

From €3 billion to €6 billion

Here are the slides I used for a short presentation in the Department of Economics on the release of last week's Economic and Budgetary Outlook.

From €3 billion to €6 billion

View more presentations from s.coffey.

Tweet

They don’t believe us now!

We wondered back in March why it was that ‘others believe in us’.  Well now it seems things have gone from one extreme to the other.  On Bloomberg today a chap by the name of Mark Grant got some airtime and didn’t really hold back.

Ireland `Going Bankrupt,' 60 Days left; EU Rescue a `Sham'

Tweet

Why €6 billion?

How did it transpire that the planned ‘adjustment’ in the upcoming budget jumped from the €3 billion announced last year to the €6 billion announced last week? 

I think we can attribute the increase to three factors.

1. Reduction in the level of nominal GDP (partly as a result of the increased fiscal contraction).
2. Continued deterioration of the public finances.
3. Reduction of the planned General Government Balance as a percentage of GDP from 10% to 9.3%.

We can look at these in more detail to see the size of these effects.

1. Reduced nominal GDP (€1 billion)

Last December the DoF forecast the nominal GDP in 2011 would be €169.9 billion.  Ten months later this forecast is down to €161.2.  With the original forecast this would have allowed a GGB of €17 billion to meet the then published target of 10%.  Sticking with this target and the revised GDP figures would allow a GGB of €16.1 billion.  This means a reduction in the planned deficit of close to €1 billion.

Some of this reduction is due to revisions of GDP figures by the CSO.   For example when first published the 2009 GDP figures were €163.5 billion.  Following the methodological revision the revised figure for 2009 GDP is €159.6 billion.  (See the 2009 figure given in Table 2 of the National Accounts releases linked above.)  The CSO revisions have increased the adjustment by about €0.4 billion!

The remainder of the €1 billion adjustment here is due to reduced inflation expectations (depressing nominal GDP) and the growth effects of the increased budgetary adjustment.  The greater the adjustment, the greater the drag on GDP, the greater the adjustment must be to meet a stated target.  Quite the vicious circle.

The sum of these effects is an additional €1 billion adjustment to meet the 10% target.

2. Continued deterioration of the public finances (€1 billion)

Back in December with the €3 billion adjustment the DoF forecast a current budget deficit of €13.8 billion for 2011 and a capital budget deficit of €4.2 billion.  The latest forecasts are that the €3 billion adjustment would give rise to an current budget deficit of €14.25 and a capital budget deficit (excluding the interest on the so-called promissory notes) of €4.9 billion.  Combined this give an Exchequer deficit of just over €1 billion more.

The deterioration in the current budget deficit is because of a forecast drop in current revenue (€33.9 billion to €33.5 billion).  In the capital budget there is an increase in non-voted expenditure (€0.8 billion to €1.1 billion) likely due to increased interest payments on our growing national debt.

3. Reduction in planned GGB to 9.3% of GDP (€1 billion)

The “four-year plan” to reach the 3% GGB target by 2014 outlined back in December, stated that the target for 2011 was to get the GGB down to 10% of GDP. 

It we stuck to the 10% target it would allow a GGB of €16.1 billion.  Changing the target to 9.3% means the allowable (in the sense of the target) GGB can be of the order of €15 billion.  Moving the goalposts sees another €1 billion added to the planned adjustment.

So there it is.  Each of these three factors contribute €1 billion to the adjustment.  €1 billion because the nominal GDP forecast has been revised downwards.  €1 billion because the ailing public finances are showing further deterioration. €1 billion because we decided the above wasn’t enough pain, and we want to show the EU/bond markets/IMF/Greeks  how tough we really are by cutting another billion just for the hell of it.

And all this to reduce the GGB from 10% to 9.3%.  Seems like an awful lot of effort just to move a number by 0.7 percentage points.  And of course this is only because we have “delayed” the interest to paid on the promissory notes used as part of the bank bailouts.

Tweet

Shortfalls – on a lighter note

The admission by the Dept of Education that spending on new school construction projects was behind target for 2010 generated a heated response.  One report begins:

MARY Coughlan's Department of Education has yet to spend almost half of its 2010 budget for building new schools and classrooms.

Only €381m of a total annual allocation of €712m has so far been spent on capital projects by the department this year.

With less than two months left in 2010, much of the remaining amount is expected to be returned to the Department of Finance.

Some 10pc of the surplus can be carried over to 2011 but any remaining funds will be returned.

Education chiefs have attributed the shortfall to massively reduced building costs.

How are we to view such ‘shortfalls’?  More reaction from the media here and here.  Reproduced here are two views from across the Irish Sea.

Alan Clark:  The following is an extract from Diaries by Alan Clark.

“We had one of the PES [Public Expenditure Survey] preliminaries today. … Was finally goaded by Fred Bayliss, the Under Secretary, who appears to be our Chief Accountant. He mumbled along, ‘… looks as if there is going to be a shortfall as our overall provision is £408 million and at present we are going to be pushed to get expenditure over £335 – 360 million’.

That’s not a f**king ‘shortfall’ I thought, or at least not my idea of one. It slowly sank in that he was rambling round for suggested ways of getting last-minute expenditure authorised so as to ‘approach more closely our provision’. ‘Look, Fred, Ministers in this Department are members of a government which is dedicated to – whose raison d’etre, you could say, is – the reduction of public expenditure. Surely it’s a matter for congratulations?’

Ah no, don’t you see – ‘It’s important to get as close as possible to last year’s provision in order to have a firm base from which to argue increases this year …’ This was crazy. Nightmare. Kafka. … Icily I asked in what other Departments of State ‘is this kind of budgetary practice prevalent’? ‘All of them,’ they shouted triumphantly. General Laughter, of the tee-hee kind.” (Alan Clark, 1994, Diaries, London: Orion Books, pp. 39-40)

Yes Minister: The following is an extract from the episode ‘The Economy Drive’.

Humphrey: He told you £32 million?

Bernard: Yes, Sir Humphrey.

Humphrey: I’m aghast.

Bernard: So am I. I mean, its incredible we didn’t know.

Humphrey: Oh, I knew about it.

Bernard: Then why are you aghast?

Humphrey: I’m aghast it got out. It means we get less money from the Treasury next year. Oh, good Lord, it’s after half past five. Sherry?

Bernard: Yes, thank you.

Humphrey: You still look worried Bernard?

Bernard: Well, yes. Surely, we want to save money?

Humphrey: Bernard, you know perfectly well there has to be some way to measure success in the Civil Service. British Leyland measure their success by the size of their profits. Or, to be more accurate, they measure the size of their failure by the size of their losses. But, we don’t have profits and losses. We have to measure our success by the size of our staff and our budget. By definition a big department is more successful than a small one.

Bernard: Are you saying that the North-West Regional Controller boobed by saving so much money?

Humphrey: Well of course. Nobody asked him to. Suppose everyone did it. Suppose everyone went around saving money irresponsibly all over the place.

HT: JC

Tweet

Forecasting the components of GDP

The new growth projections from the DoF are worth a little more study.  It is clear they have revised down their overall growth forecasts.  Here we make a comparison to the forecasts made in the December 2009 Stability Programme Update (Table 4) and the November 2010 Economic and Budgetary Outlook (Table 2).

The listed figures for 2009 are taken from the CSO.   The two DoF documents provide forecast growth rates of the “components of real GDP”.   The forecast levels for 2010 and 2011 are based on the actual outturns from the CSO and the forecast real growth rates from the DoF.   We can use this to compare the changes in the DoF forecasts from December 2009 to those made this week.

Back in December 2009, the DoF forecast that over the two years 2010 and 2011 the domestic economy would shrink by 3.8% in real terms.  The November 2010 forecasts predict a total deterioration in the domestic economy in these two years of 6.9%.  This is substantially worse.

For the annual forecasts made for consumption, investment and government expenditures for the years 2010 and 2011 we can see that the Department has downgraded five of the six growth forecasts.  The only predicted improvement is in household consumption expenditure in 2010 which previously was expected to fall by 3.0% but this has been tempered to a fall of ‘only’ 1.7%.  All other forecasts have been downgraded.

This is particularly through of investment expenditure in 2011.  The previous forecast increase of 4.5% has been completely reversed to a continued decrease of 6.0%.  This change alone counts for more than half of the increased deterioration forecast for the domestic economy.  The overall picture painted of the domestic economy is extremely bleak.

What changes have been made to the trade components of GDP?

And, suddenly the future looks so much brighter.  The forecasts for exports, in particular, and imports all show increases.  The forecast export growth in 2010 jumps from a stagnant 0.4% to a rampant 6.3%.  For 2011 the forecast improves from 3.4% to 5.0% export growth.  The forecast increase in imports for 2010 is from a decrease of –2.8% to an increase of 2.8%.  Very little change is seen in 2011 imports.

The net effect of these changes is that the contribution of trade to GDP is forecast to increase from €24.4 billion in 2009 to €34.4 billion in 2011.  This would have a huge positive effect on the GDP growth rate, virtually cancelling out the drag the domestic economy places in the growth rate.

[Aside: I’m not sure whether it is coincidence or not but the forecast further deterioration of the contribution of the domestic economy to GDP of €4.2 billion is almost perfectly offset by the forecast further improvement in the contribution of trade the GDP of €4.2 billion.  I sure hope this is a coincidence.]

For the period 2010-2011 the DoF now forecast that exports will increase by €16.7 billion with an accompanying increase in imports of €6.7 billion.  This raises a number of concerns. 

First as we have pointed out our exports are dominated by a few sectors.  Nearly 60% of our merchandise exports come from chemicals with half of this coming from the pharmaceutical exports alone.  Of our service exports, nearly 40% is derived from the export of computer services.  These high-value sectors have the capability of skewing our exports figures but large increases in the value of exports may not be accompanied by significant increases in employment.

Second, it is hard to imagine how we can increase exports by €16.7 billion and only have an accompanying increase in imports of €6.7 billion.  The Information Note states that “imports are projected to increase in line with final demand”.  Only a portion of Irish imports are based on domestic demand.  This is apparent when we note that imports in 2009 were €120 billion and while consumption was €84 billion. 

A lot of our imports aren’t used for consumption, but for rather production and a great proportion of those are used in the export sector.  A fairly crude regression of the first differences of imports on the first differences of consumption and exports on quarterly data from 1997Q1 to 2010Q2 using seasonally adjusted constant price data can be seen here.

For example, much of our exports are in the pharmaceutical sector that are based on the processing of compounds and ingredients that are imported.  Also, because of a historical lack of R&D in Ireland the patents and copyrights for many of the products which form the bulk of our exports (chemicals and computer services/software) are held abroad.  Any increase in exports in these sectors requires a proportionate increase in imports through royalty payments. 

It is likely that the €16 billion would require somewhere in the region of an extra €12 billion in imports.  This growth in imports would wipe out the tentative positive growth forecast by the DoF and see GDP continue to fall over the next two years.

Increases in exports (and less than proportionate increases in imports),  is the factor that is holding the positive DoF forecasts together.  The forecast increases in exports may come about, but because of the distribution of our exports they are unlikely to have much of an impact on our unemployment.  It does appear that the DoF is aware of this as, although they have forecast positive GDP growth for 2010 (+0.25%) and 2011 (+1.75%), they have forecast a further contraction in employment in 2010 (-4.00%) and 2011 (-0.25%).

Placing all our eggs in the export basket may appear to help us reach the 3% GGD target by 2014 but this will primarily be achieved through an increase in denominator in the debt/GDP ratio.  The prospects for the domestic economy remain bleak.

Tweet