Fiscal Assessment Report April 2013 Report 13/01 © Irish Fiscal Advisory Council 2013 ISBN 978-0-9570535-4-0 This report can be downloaded at www.fiscalcouncil.ie 2 CONTENTS FOREWORD ........................................................................................................ I SUMMARY ASSESSMENT ......................................................................................... II 1. ASSESSMENT OF MACROECONOMIC FORECASTS ........................................................ 1 SUMMARY.................................................................................................................... 1 1.1 INTRODUCTION ....................................................................................................... 1 1.2 T HE O UTTURN FOR 2012 COMPARED TO E ARLIER FORECASTS ................................................ 1 1.3 RECENT M ACROECONOMIC D EVELOPMENTS ...................................................................... 2 1.4 A N A SSESSMENT OF FORECASTS CONTAINED IN BUDGET 2013 ............................................... 7 1.5 FORECASTING M ETHODS .......................................................................................... 13 2. ASSESSMENT OF BUDGETARY FORECASTS ...............................................................25 SUMMARY.................................................................................................................. 25 2.1 INTRODUCTION ..................................................................................................... 26 2.2 HOW C LOSE WAS THE 2012 B UDGETARY O UTTURN TO D EPARTMENT OF FINANCE FORECASTS? ....... 26 2.3 A N A SSESSMENT OF THE B UDGET FORECASTS FOR 2013 TO 2015 ......................................... 32 2.4 SENSITIVITY A NALYSIS ............................................................................................. 47 3. A SSESSMENT OF C OMPLIANCE WITH F ISCAL R ULES ..............................................52 SUMMARY.................................................................................................................. 52 3.1 INTRODUCTION ..................................................................................................... 52 3.2 COMPLIANCE WITH THE FISCAL R ULES .......................................................................... 52 3.3 T HE STRUCTURAL BALANCE ....................................................................................... 57 4. ASSESSMENT OF THE FISCAL STANCE ....................................................................69 SUMMARY.................................................................................................................. 69 4.1 INTRODUCTION ..................................................................................................... 70 4.2 A SSESSING THE FISCAL STANCE: A N U PDATE .................................................................. 70 4.3 T HE FISCAL M ULTIPLIER D EBATE ................................................................................ 80 4.4 COMPLEMENTARY A CTIONS TO S UPPORT CREDITWORTHINESS ............................................... 88 GLOSSARY ........................................................................................................97 BIBLIOGRAPHY...................................................................................................99 BOXES BOX A: A D ECOMPOSITION OF FORECAST E RRORS ...................................................................... 11 BOX B: D EPARTMENT OF FINANCE ONE-Y EAR-A HEAD T AX FORECASTS .............................................. 30 BOX C: IMPACT OF THE PROMISSORY NOTE A NNOUNCEMENT ON THE GOVERNMENT A CCOUNTS................ 34 BOX D: CURRENT E XPENDITURE CEILINGS ................................................................................ 42 BOX E: T HE IRISH FISCAL A DVISORY C OUNCIL .......................................................................... 53 BOX F: IDENTIFYING THE A PPROPRIATE M EDIUM T ERM FISCAL STANCE: SOME CONSIDERATIONS ........................................................................................... 78 BOX G: BATTLE OF THE M ULTIPLIER B OXES .............................................................................. 85 APPENDICES A PPENDIX A: M ACROECONOMIC FORECASTS T ABLES ...................................................................... 20 A PPENDIX B: CONSOLIDATION M EASURES T ABLES ......................................................................... 51 A PPENDIX C: T HE FISCAL RESPONSIBILITY A CT AND THE EU D EBT RULE ............................................... 65 A PPENDIX D: E UROPEAN COMMISSION M ETHODOLOGY FOR E STIMATING POTENTIAL O UTPUT ..................... 66 A PPENDIX E: RECENT LITERATURE ON FISCAL M ULTIPLIERS .............................................................. 93 Foreword FOREWORD The Irish Fiscal Advisory Council was established as part of a wider agenda of reform of Ireland’s budgetary architecture as envisaged in the Programme for Government 2011. The Council was initially set up on an administrative basis in July 2011, and was formally established as a statutory body in December 2012 under the Fiscal Responsibility Act (FRA). The Council is a public body funded from the Central Fund. The terms of its funding are set out in the FRA. The mandate of the Irish Fiscal Advisory Council is: • To assess the official forecasts produced by the Department of Finance; • To assess whether the fiscal stance of the Government in each Budget and Stability Programme Update is conducive to prudent economic and budgetary management, including with reference to the provisions of the Stability and Growth Pact; • To assess Government compliance with the budgetary rule as set out in the FRA. The Council submits its Fiscal Assessment Reports to the Minister for Finance and within 10 days releases them publicly. The Council is chaired by Professor John McHale, National University of Ireland, Galway. Other Council members are Mr Sebastian Barnes, Organisation for Economic Co-operation & Development; Professor Alan Barrett, Economic & Social Research Institute; Dr Donal Donovan, University of Limerick (formerly International Monetary Fund staff) and Dr Róisín O’Sullivan, Associate Professor, Smith College, Massachusetts. The Council would like to acknowledge the help of Dwayne Price and Loretta O’Sullivan (Central Bank of Ireland) and Rossa White and Eddie Casey (NTMA). Finally, the Council would like to thank the Council Secretariat—Diarmaid Smyth (Chief Economist and Head of Secretariat), Eimear Leahy and Rachel Joyce—for their extensive contributions to the report. This report was finalised on 05 April 2013. More information on the Irish Fiscal Advisory Council can be found at www.fiscalcouncil.ie i Fiscal Assessment Report, April 2013 SUMMARY ASSESSMENT In the September 2012 Fiscal Assessment Report, the Council suggested €1.9 billion in additional adjustments compared to Government plans over the period 2014-2015. While assessing the overall fiscal stance as “conducive to prudent economic and budgetary management”, recognising the uncertainties surrounding economic growth, the report argued for the additional measures to provide a margin of safety to bring the General Government deficit below 3 percent of GDP by 2015 and to ensure the stabilisation of the debt to GDP ratio. Post-Budget 2013 developments have improved the budgetary outlook. Based on the better than expected Exchequer outturn and higher than forecast level of nominal GDP in 2012, it now appears likely that the 2012 General Government deficit will be significantly below 8 percent of GDP, which compares with a Budget-day estimate of 8.2 percent of GDP. This should have some beneficial carryover effects for future years. In addition, the promissory note transaction has reduced the projected 2015 deficit by 0.6 percent of GDP. Based on technical adjustments made by the Council to Budget 2013 projections to reflect the recent developments, the General Government deficit to GDP ratio in 2015 now appears likely to be closer to 2 percent of GDP (compared to the official forecast of 2.9 percent). This also assumes the full implementation of the Government’s planned €5.1 billion in consolidation measures in 2014-2015. The impact of the developments is estimated to be equivalent to €1.6 billion of additional adjustments over the period 2014-2015. The suggested margin of safety has therefore been broadly achieved under the Government’s current plans and so a case for the €1.9 billion in additional adjustments is not being made in this assessment. Overall, the fiscal stance remains conducive to prudent economic and budgetary management. However, the Council’s assessment is that the planned adjustments of €3.1 billion in 2014 and €2.0 billion in 2015 should not be reduced. Budget 2013 projections imply compliance with the national Budgetary Rule in 2013, 2014 and 2015. The structural budget balance plays a key part in the domestic and EU fiscal rules. However, this poses serious measurement challenges. These need to be addressed both at EU level and by the development of a more comprehensive domestic analysis. ii Summary Assessment There are significant uncertainties surrounding these budgetary projections. While there are tentative signs of a stabilisation in domestic demand, the weakening of growth in major trading partners is curbing growth in net exports. Expenditure pressures in Health and Social Protection in 2012, in part driven by service demand, have also raised concerns