Friday, November 5, 2010

Getting back to reality?

The 10-page Information Note on the Economic and Budgetary Outlook 2011-2014 has caught the media attention.  The key issues have been the commitment to a budgetary of adjustment of €6 billion in the December Budget (with €3 of spending cuts for every €1 of tax increases) and the postponed of interest payments on the Promissory Notes issued as part of the bank recapitalisation programme. 

Although the note lacks specifics on budgetary actions it does give an insight into the assumptions and predictions the DoF is using for it’s budgetary analysis.  The most recent set of forecasts came from last December’s Stability Programme Update and we considered these in a recent post.

One of our main beefs was with the “positive macroeconomic forecasts” used.

Dof GDP Projections

The DoF has now brought their growth forecasts back a little closer to reality and we have the following updated projections.

DoF Updated Projections

Laying these on our previous graph gives us the new growth path.

Dof GDP Projections Nov 10

The downward drop in the 2009 figure to the end of the solid lines is attributed to “revisions by the CSO to the level of GDP in 2009 and to previous years (a methodological change)”.  The dashed lines form the DoF projections and they are now clearly lower.  So the DoF must have a closer grasp of reality and on which to base their analysis.  Or maybe not.

For 2010 the DoF is now projecting nominal GDP of €157.3 billion and a growth of ‘just’ 0.25%.  However, half year figures for 2010 have already been released.  These tell ue that nominal GDP for the first six months of the year was €78.1 billion.  To get the annual forecast of the DoF, nominal GDP in the last six months of the year has to be €79.2 billion.  While an annual growth forecast of 0.25% might seem modest this actually needs a growth of 1.4% in the last six months of the year relative to the first six months.  This might happen (driven mainly by chemical exports) but is an accelerated growth rate for the latter half of this year nonetheless.

Moving to 2011 we see that the DoF has ‘slashed’ its real growth forecast from 3.3% to 1.75%.  Again it might appear that this more modest growth forecast is appropriate.  However, the December 2009 forecast was based on a 2011 budget ‘adjustment’ of €2 billion.  We are now told that this will be €6 billion.  The extra €4 billion adjustment, if fully implemented, will act as a considerable drag on the growth rate.  Determining the exact growth effects of this austerity is not an exact science, but assume the effect of it could possibly be of the order of a 2% reduction in the growth rate.  [This would happen if the €4 billion fiscal adjustment resulted in a drop in GDP of about €3 billion, which in itself may be optimistic depending on how the additional adjustment is achieved – tax or spend].

Anyway let’s assume the €6 billion package cuts a further 2% off the growth rate.  This means that the updated growth forecast could be 3.3% minus 2.0% equal to 1.3%.  This would be with no revision whatsoever of the underlying growth prospects.  The actual updated growth forecast for 2011 is 1.75%.  The DoF hasn’t forecast a fall in the growth rate for 2011 – it has just forecast an increase!! But the increase is camouflaged by the impact of the additional €4 billion adjustment just announced.

Back to reality? Not quite.


  1. Excellent point, Seamus. From my own, admittedly, back-of-the-envelope calcuation, it appears that the DoF is using as an underlying growth rate the December 2009 numbers which, in turn, were just a turn over of the April 2009 nominal numbers slightly deflated. The debate would certaily be assisted if pre and post consolidation numbers were produced so that we could see the fiscally netural growth rates and the DoF's impact assessment of fiscal measures. As it is, we just have to take a lot of this on trust or turn to reasonable, but always contestable, extrapoloation.

  2. Hi Michael,

    It does seem that the DoF has made little adjustment to the underlying growth rate. The Decemeber 2009 SPU contained this gem of a paragraph.

    The forecasts covering the period 2011 – 2014 are based on an assessment of the economy’s potential growth rate. Taking into account the underlying growth in labour supply and productivity, it is tentatively estimated that the Irish economy can expand at an average rate of 3 per cent per annum (there is, of course, considerable uncertainty surrounding this estimate given the openness of the Irish economy). Given significant under-utilised capital and labour at present (i.e. a negative output gap), the economy can grow above trend as these under-utilised resources are brought back into productive use (i.e. as the output gap closes). In these circumstances, an annual average growth rate of 4 per cent over the period 2011 – 2014 is assumed."

    The current Information Note condenses this to one line.

    "Medium term projections are based on an assessment of the economy’s trend growth rate and the amount of slack in the economy."

    It is not clear whether this document is nothing more than nonsense. The reason given for the reduced growth rates in this outlook is

    "The rate of nominal growth has been revised downwards as legacy effects of the bursting of the property bubble are weighing on economy-wide prices and activity to a greater degree than initially assumed."

    There are plenty of reasons why they needed to revise down their growth forecasts for 2011 - 2014 but the trail of the now-departed property bubble would not feature high on my list. It would be incredible if they produced a document announcing a €6 billion 'adjustment' while the new growth figures in that same document ignored the impact of this 'adjustment'. But this may just what we are expected to believe.

  3. Update:

    It seem as though the forecasts in the Information Note take account of the negative impact of the increased 'adjustment'. From page 3:

    "real GDP is projected to increase by 1¾% next year (GNP by 1%). This takes account of budgetary adjustments amounting to €6 billion, which are estimated to reduce the rate of growth by somewhere in the region of 1½ - 2 percentage points."

    Thus it does appear that they have increased their underlying growth rate (primarily through accelerated export expectations).

    The 2011 growth rate being updated is the 3.3% forecast from the Stability Programme Update. Just using DoF figures for the effect of the announced fiscal adjustment this would be in the range 1.3% to 1.8%. At 1.75% it suggests that they have not taken account of much else.

  4. Then, there are two aspects to consider, in addition to their variations in the underlying growth rate. First, are they under-estimating the impact of their adjustments? From the passage you cite, the DoF is estimating the impact to be between 41% and 56% of the €6 billion adjustment. However, the ESRI (in their Working Paper 287) estimates that a €1 billion adjustment (0.6%) in public sector employee numbers deflates GDP by 0.8% - above unity.

    Second, are they taking into account the persistence of the adjustments' impact after the first year. Again, the ESRI shows the adjustment in public sector employee numbers deflates GDP by 0.8% in Year 4. Adjustments in income tax deflate the GDP by 0.2% in Year 1 rising to 0.4% in Year 4 - doubling its negative impact.

    How do you see this, Seamus?