Sunday, May 24, 2020

Where stands the crisis of 2020? Some insights from a century of leading and lagging indicators

The Irish economy is no stranger to crisis.  Since the 1950s, the most severe of these have occurred in roughly 25-year intervals.  The current crisis has brought about the sharpest downturn, at least in employment terms, that the economy has ever experienced.  As the duration remains uncertain it is cannot be definitively classed as severe so it may be that comparisons to previous crises aren’t wholly appropriate but it may be instructive to look at what preceded and coincided with previous episodes.

Regardless of whether  COVID19 has ended the sequence of 25-year intervals between severe economic crises hopefully we have not returned to the rhythm of the early years of the State when no decade passed without a severe crisis, or more, of some form or another.

The chart below shows a time series for the real growth of the Irish economy since just after Independence. The series is smoothed by taking a three-year, centred average.

Real Growth 1924-2019

The shaded periods are when this three-year average growth rate was negative, and this will also be used in the charts that follow.  Five such negative growth episodes can be identified:

  • 1930s: Great Depression and Economic War
  • 1940s: The Emergency (WWII)
  • 1950s: Balance of Payments Crises
  • 1980s: Procyclical Fiscal Policy
  • 2000s: Bursting of the Credit Bubble

The Gerlach and Stuart (2015) estimates are based on GDP and provide the most plausible annual estimates up to the late 1940s.  A series based on GNI* from Fitzgerald and Kenny (2017) is shown from then but it differs little from the Gerlach and Stuart series right through to the end of the 20th century. 

The Fitzgerald and Kenny series is chosen because it better fits with the constant price GNI* for 2013 on as published by the CSO.  A chart showing unsmoothed versions of both historical series, and illustrating the strong overlap between the two, is here.

The negative growth episodes of the nineteen thirties, forties, fifties, eighties and a decade ago could be joined by a similar outturn for the start of the twenty twenties.  Given that we have gone through periodic economic crises it may be instructive to look for some “then and now” comparisons for some key indicators.

The most severe of Ireland’s economic crises have typically being preceded by a deterioration in the current account of the balance of payments.  From Fitzgerald and Kenny (2017) we have annual estimates of the current account balance as a share of gross national income beginning in 1938 which here is combined with the modified current account of a share of GNI* from 1995 on.

BoP Current Account 1938-2019

As stated, a deterioration in the current account has been a leading indicator for major negative growth episodes, with the deteriorations in the late-1970s and mid-2000s in particular due to economic mismanagement and pro-cyclical fiscal policy.  The presence of a large balance of payments deficit before these crises hit severely restricted the policy options available to respond to the downturn with “restoring order” taking precedence of over supporting incomes and economic activity. 

But in a case of “this time it’s different” we can see that in the past few years there has been a balance of payments surplus that is unmatched since the years of The Emergency (World War II to the rest of the world).  Indeed the 6.3 per cent of GNI* figure for the 2019 current account surplus taken from the Stability Programme Update may be an underestimate.  This strongly suggests we do not have structural imbalances that need to be corrected first before responding to the crisis.

When the slowdown took hold in 2008 one of the first fiscal responses was to announce a package of spending cuts in July 2008.  This time around one of the response was to announce a multi-billion package of increased spending.  A year ago, we said that the economy had savings that could have been spent but suggested it maybe should be a sector other than the government sector that did so. 

We can look at how the sectoral balances contribute to that six per cent of national income surplus we have been running on the current account (with all adjustments to make the sectoral balances consistent with the modified current account applied to the non-financial corporate sector which is where the MNC distortions occur).

Sectoral Balances and the Modified Current Account 2001-2019

A chart showing the domestic sectors for recent years stripping out the impact of foreign-owned companies is here.  Previously, we thought it might be the household sector that could cut loose a bit, but needs must, and it is the government sector that is doing the spending.  Indeed, it could be that the household sector, which has been deleveraging for a decade actually increases its savings during the crisis which is something we will come back to. These savings can be used to fund the government’s spending.

Of course, flows are only part of the story. Stocks matter too.  From Fitzgerald and Kenny (2017) we also have a long-run series of government debt as a share of national income.  The path of the ratio of public debt to national income before each crisis has not been the same.

General Government Debt to GNI 1924-2019

The debt ratio was already rising in advance of the crises of the 1950s and the 1980s.  The ratio was declining in advance of the 2008 crash but that still saw the largest run-up of public debt of any crisis (to date).  In recent years the debt ratio was on a declining path, however the level is still elevated and at around 100 per cent of national income is the highest it has been as the country potentially enters a severe crisis.

For private debt we can get a measure of personal, i.e. household, debt from Stuart (2017) and this shows that increasing household debt was really only a factor in advance of the crash of 2008.

Household Debt to GDI 1949-2019

And in the decade since, the Irish household sector has undertaken a remarkable level of deleveraging – reducing debt was what a large share of the household sector surplus shown with the breakdown of the current account was used for.  Household loan liabilities have fallen from €205 billion at their peak to around €130 billion now.  As the chart shows, the household debt to income ratio peaked at around 215 per cent in 2009; at the end of 2019 it was 115 per cent and is approaching ‘normal’ levels faster than anyone could have imagined.

As stated earlier, it could be that the household sector actually increases its savings in response to the crisis – this may show through an increase in deposits.  This would not be unusual.  The household savings rate is something that tends to react to a crisis rather than something that foretells it. 

Household Savings Rate to GDI 1945-2019

Using Stuart (2017) we have estimates going back to 1945 and it can be seen that the savings ratio does increase at the start of each negative growth event meaning the reduction in household consumption is greater than the reduction in household income.  Remarkably, the Stability Programme Update estimates that the household savings rate will jump from 10 per cent in 2019 to close to 20 per cent this year, which would be the highest for the series by some distance.  In nominal terms this would be an increase of around €10 billion.

The savings rate only reflects the difference between income and consumption; one would need to add the impact of investment spending to get the final non-financial position of the household sector. Such a sectoral breakdown of investment is only available back to 1995 and is what is shown in the chart of sectoral composition of the current account.  The large borrowing position of the households sector in the decade before 2008 is clearly evident, as is the net lending the sector has done in the decade since.

Another response variable or lagging indicator can be the real growth in household disposable income.  Using Stuart (2015) we can see that this followed the same pattern as each of the last three major negative growth crises took hold: it too turned negative.

Household Disposable Income Real Growth 1945-2018

We do not yet know what will happen to aggregate household income in this crisis.  Yes, earnings will fall very significantly for a period but there will be an offsetting effect from government transfers.  As already pointed to, additional social welfare spending of almost €7 billion has been allowed for (thus far).  This is countercyclical policy and is maybe another reason why comparisons to previous crises are not be appropriate.  We still don’t have enough information but if there is a shaded area for the early-2020s added to future versions of these charts it could be the first time the real growth of household disposable income does not also turn negative (on a three-year average basis).

Fiscal policy was a contributory factor to the reduction in household income seen in the 1950s, 1980s and a decade ago.  Some automatic stabilisers would have played a role in mitigating income losses but steps taken to address imbalances, perceived or otherwise, which included tax increases and real expenditures cuts, meant that the impact of the downturns on incomes was exacerbated by fiscal contractions.  Fiscal policy was procyclical.

From Fitzgerald and Kenny we have a long-run series of the balance of the government sector right back to the earliest years of the State.  It can be seen that there was a wide range of levels and trends in the government balance prior to the previous three negative growth events.  There was a deficit that was reducing in the mid-1950s; the late-1970s saw a large government deficit that was increasing and during the mid-2000s budget surpluses were recorded. 

General Government Balance to GNI 1924-2019

But what is as significant is what happened to the government balance not long after economic growth turned negative in the 1980s and 2000s: it improved.  And this was a forced improvement brought about through tax increases and real expenditure cuts which started almost as soon as those crises hit which is the opposite of what is required to support incomes and economic activity in a downturn.

The past few years have seen the headline government balance improve and move to a (small) surplus.  If the government had stuck to its own spending plans maybe the surplus would have been a bit bigger and fiscal policy was probably acyclical, at best.  But there is capacity now for policy to be countercyclical and in large part it is down to what is shown below.

General Government Interest to GNI 1924-2019

At the end of 2019, government debt was equivalent to almost 100 per cent of national income.  In the 96 years since 1924, according to the estimates from Fitzgerald and Kenny there have been only been 13 years when the debt ratio was higher.  But if we look at the interest chart we see that the interest to national income ratio does not reflect this.  In fact, since 1924 there have only only be 35 years when the interest ratio was lower than the 2.2 per cent recorded in 2019. 

As some of this interest is paid to the central bank it is recycled back to the government.  And as long as the ECB keeps the taps opened the massive additional borrowing that will happen will not significantly increase the interest ratio – in the short term at least.

And to conclude, here another lagging indicator that illustrates why this crises will be different to previous ones: the escape valve of emigration is unlikely to be available to alleviate unemployment.

Net Migration per Thousand 1926-2019

This is yet another series where the response to the 25-year crises is clearly evident.  In fact, it has been pointed out that the crisis of 2020 may be the first since that linked to The Great Depression in the early 1930s when net outward migration does not increase.  Emigration did increase in the mid-1930s but by then the international economy was pulling out of The Great Depression. 

Taking the unemployment series from Gerlach, Lydon and Stuart (2016) it is probably safe to predict that the record unemployment from 1935 of 18 per cent will be exceeded in 2020 (at least for part of it).

Unemployment Rate 1923-2019

So where stands the crisis of 2020? The short-term shock is likely to be the most severe the economy has ever experienced.  But relative to what has gone before we have identified a number of key differences. 

The most significant of these is probably the large balance of payments surplus.  The government might not have a rainy-day fund but the household sector has been saving for a decade.  And as the government cuts back on its emergency measures there will be capacity, and hopefully the confidence necessary, for households to increase their spending. 

A second difference arises from the fact that this is a global crisis. If a country using a common currency experiences an asymmetric shock there is a risk of interest rates exacerbating the problem.  Ireland has a high level of government debt but the medium-term risk of adverse interest rate moves is low so we can expect the interest burden of public debt will remain low.

We enter the crisis from a position of structural strength.  And the response so far, at a macro level at least, can be considered to have been appropriate.  Duration remains the key unknown.  But if the phased re-opening of the economy is successful, and microeconomic policy can keep viable businesses alive, it may that this shock, sharp and all as it will be, does not break the 25-year cycle between severe, multi-year negative growth events of the Irish economy.  Here’s hoping.

Friday, May 15, 2020

International travel restrictions and the location of consumption spending

With COVID19 all countries are going through the same crisis but not all countries will experience the crisis in the same way.  International travel is likely to be curtailed for a significant period of time.  Some countries are more dependent on tourism than others.

One way to look at this is to compare consumption expenditure by residents of a country outside of that country to spending by non-residents in that country.  Here are 2018 figures for the then EU28.  These figures exclude expenditure linked to business or commercial activity.

HFCE by Location

For Household Final Consumption Expenditure (HFCE), the “national concept” is that amount undertaken by residents of the country (both at home and abroad) while the “domestic concept” is that amount undertaken within the jurisdiction (both by residents and non-residents).  For measures like GDP it is the “national concept” of HFCE that is included. 

This means that consumption spending abroad by Irish residents is counted in Irish GDP (though it does not increase GDP as there is obviously an offsetting import included for the goods and services consumed, which of course then results in an export for the country where the spending happened).  The purpose is to make the Consumption figure in GDP better reflect the actual use of goods and services by a country’s residents.  In the circular flow framework, this is a leakage from the country where the people live and an injection to the country where the spending occurs.

Anyway, for Ireland, we can see that residents spent about €6 billion abroad while non-residents spent about €4.5 billion here, such that non-residents spending here was 76% of Irish residents spending abroad.  As shown by the second column from the left by which the countries are ranked, this ratio is one of the lowest in the EU – only the UK, Belgium, Germany and Romania are lower.

This means that a lot of the spending that non-residents would typically do in Ireland could be replaced by the spending that Irish residents would typically spend abroad – if and when businesses premises are opened and people have the confidence to go and visit them.

At the top end of the table we can see countries where the spending by non-residents is multiple times greater than the spending their residents do abroad, notably Greece, Croatia, Portugal, Malta and Spain.  The final column gives the spending of non-residents as a share of Gross National Income.  And again, the countries that are most dependent on spending by non-residents are those at the top.

It can be seen there is what could be considered a north-south or even a core-periphery split to the table.  The countries at the top (most dependent on spending by non-residents) include Portugal, Italy, Greece and Spain while towards the bottom are The Netherlands, Sweden, Finland, Germany and Belgium.

Of the bottom five countries, the spending by non-residents in Ireland is the largest as a share of Gross National Income (with modified GNI, or GNI* used in the case of Ireland).  While we are in a position to replace much of the spending by non-residents by the spending we would typically do abroad this is only in an aggregate sense. 

But just like the restrictions on international travel will have unequal impacts on countries, the location and composition of any additional spending in Ireland that might typically happen abroad will be significantly different than that which it might replace which will result in winners and losers.

Thursday, May 14, 2020

The strong position of the household sector (and the poor case for helicopters)

A couple of weeks ago the CSO published the Q4 2019 update of the Institutional Sector Accounts.  This is one of the most useful from the suite of macroeconomic datasets produced by the CSO but also one of the least used.  Here we will look at what it tells us about the household sector. 


We will start with the current account which shows the generation of income

Household Sector Current Account 2015-2019


The end point of the current account is that the household sector had a gross savings rate of 11 per cent.  This arises from the finding that of a gross disposable income of €117 billion, €106 billion was used for household final consumption expenditure (HFCE).  While the changes for 2019 are far removed from where the economy is now they can be helpful in telling us where we were before the crisis hit.

Household gross disposable income increased by €7.5 billion in 2019.  The largest contribution to this came from employee compensation which grew by €7 billion (though some of this would have been paid to the government sector through income taxes and social contributions).  As pointed out before the boom was in labour income rather than non-labour income.

Gross Operating Surplus/Mixed Income

The gross operating surplus/mixed income of the household sector rose €2.5 billion in 2019.  Preliminary figures provided by the CSO to Eurostat show that the mixed income component of this (essentially the earnings of the self-employed) rose by €1 billion to €13.5 billion.

The gross operating surplus component rose €1.5 billion to €17.5 billion.  The gross operating surplus of the household sector is derived from the provision of housing services, i.e. rental income less costs for maintenance, repairs, utilities and property taxes. 

Around 80 per cent of this arises through imputed rents – estimated rents of owner-occupiers for the housing services that they provide to themselves (and this income exits the above table as part of final consumption expenditure so has no impact on the bottom line). 

The remaining 20 per cent is actual rentals for housing which landlords receive for providing housing services to others.  When the NIE and annual sector accounts are published later in the year it is probable that these will show an increase of €1.2 billion in imputed rents and €0.3 billion in actual rents.

Summary of Income Changes

So a summary of the change in resources for the household sector in 2019 would be:

  • Employee compensation +€7.2 billion
  • Self-employed earnings +€1.0 billion
  • Imputed rentals for housing +€1.2 billion
  • Actuals rentals for housing +€0.3 billion
  • Property income –€0.1 billion
  • Social benefits in cash +€0.7 billion

All-in-all, gross disposable income for the household sector rose seven per cent in 2019, which in the absence of widespread inflation will have translated into significant real income gains.  Households used most of this increase for additional consumption.  As noted above imputed rentals of owner-occupiers will have risen by more than €1 billion and households will have used other parts of the increase in resources for purchases of goods and services.

Increased Savings

But household final consumption expenditure ‘only’ rose by five per cent. This means there was an increase in the gross savings of the household sector of €1.5 billion t0 €13 billion, giving a gross savings rate of 11 per cent.  The only time the household savings rate was higher than this in the past 25 years was in 2009 and 2010 and, of course, that was after a crisis had hit not before it.


We can turn to the capital account to see what the household sector does with these savings.

Household Sector Capital Accounts 2015-2019

In summary, the household sector undertook €9 billion of gross capital formation in 2019(mainly purchases and upgrades of housing assets).  In recent years, household investment spending has been growing rapidly albeit from a low base.  It doubled from 2015 to 2019.

Net Lending of the Household Sector

The bottom line is that the household sector was a net lender to the tune of €4 billion in 2019, with this going on the financial balance sheet – either through an increase in deposits or a reduction in loans.  This is actually a reduction on the net lending levels seen in recent years as a result of the increase in investment by the household sector but is far removed from the huge net borrowing (and fundamentally weak position) of the household sector in the run up to the crisis of a decade ago.

Household Sector Net Lending-Borrowing 2001-2019

This persistent net lending has seen the financial position of the household sector improve considerably in recent years.  In 2009, household loan liabilities stood at nearly 220 per cent of gross disposable income.  The latest figures indicate that this was down to 115 per cent in 2019 which is a remarkable reduction in a decade and brings it back pretty much to where it was before the credit-fueled excesses of the mid-2000s (it was 115 per cent at the start of 2003).

Additions to deposits also means that the household sector has more currency and deposits which again is something that brings things back to a position last seen in 2003.

Household Sector Loans and Deposits 2002-2019 CB Data


What impact will COVID19 have on all this?  We know it is having a huge negative impact on the economy but when looking in aggregate terms at the sector accounts, the impact on the household sector will not be as large.  There will be significant income losses as self-employed and employee earnings will fall but these will be offset to some extent by transfers from the government sector. 

At this stage it looks like that between the government and household sector it will be the balance sheet of the government sector which carries most of the burden.  It may seem paradoxical but we could actually see the balance sheet of the household sector improve while we are the teeth of the crisis.  This is because household income will have held up reasonably well (again we are talking in an aggregate sense) but the opportunities to spend money have evaporated. 

Separate figures from the CSO show that, even for retailers that are open, 26 per cent of the population aged over 15 are “afraid to go shopping” (see Table 4(b)). That is one million people.

Looking at Table 11.1 of the Money and Banking Statistics published by the Central Bank shows that the deposits of Irish households in banks regulated by the Central Bank rose by almost €1 billion in March.  This was by no means an exceptional increase but the average monthly increase in household deposits in the banks since January 2018 has been €0.5 billion.

Ireland doesn’t need “helicopter money”. The reason people aren’t spending is because business premises are closed or because they are fearful; not because they don’t have money.  Helicopter money is only really appropriate, if ever, for countries that don’t have efficient social welfare systems. 

The fact that hundreds of thousands of applications, and crucially payments, for the Pandemic Unemployment Payment were processed in a very short period of time shows that Ireland does have an efficient system for delivering supports rapidly and effectively.  The money is been delivered and it’s going to people who need it.  We can stand down the helicopters.  Now if businesses could be reopened and fear reduced…