Wednesday, November 10, 2010

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.

Dof GDP Projections

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.

Dec 09 and Nov 10 Projected GDP

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. 

Dof Nominal GDP 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?

Projected GDP with CSO Revision

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.

Projected GDP with CSO Revision Compared to Nov 10 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.

Revised GDP Projections Dec 09 and Nov 10

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.

Revised GDP Projections Dec 09 and Nov 10 with larger multiplier

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.

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