7/5/2014: Eurostat backs out of Greek data mess

Here's Ifo Institute press release on Eurostat and data manipulation for Greece:

I have covered the issue here: http://trueeconomics.blogspot.ie/2014/04/2542014-stretch-of-numbers-here-bond.html

29/5/2012: Quick note on Structural Deficits and Growth

Per someone request: can growth result in larger structural deficit?

Answer is yes, it can. Here's how.

Equation 1:
Structural Deficit = Total Government Deficit -- Cyclical Deficit -- One-off Measures

(One-off Measures are emergency spending, one-off banks recaps etc)

So Structural Deficit = Government Deficit that would have prevailed if economy operated at 'full employment' (full capacity)

What is Cyclical Deficit in the above?
Equation 2:
Cyclical Deficit = Output Gap * Elasticity of Fiscal Balance
where
Output Gap = Potential (Full-Employment) Output of Economy -- Actual (realised) Output of Economy
Output Gap is expressed in % terms difference.
Elasticity of Fiscal Balance = 0.38-0.4 for Ireland and captures the percentage change in (Government expenditure net of Government revenue) per 1% change in output gap. DofF estimates this to be 0.4 and EU Commission estimates it to be 0.38 for Ireland.

Thus, from Equation 2 above:
Equation 3:
Cyclical Deficit  = [Potential GDP -- Actual GDP]*0.38     
for EU Commission, or replacing 0.38 with 0.4 above gets you approximation for DofF model.

Now, economic growth can happen at the point above 'Full Employment', in which case Output Gap will be negative, as potential GDP will exceed actual GDP, giving positive output gap - consistent with economy overheating.

Alternatively it can happen at 'Below Full Employment', so that output gap is negative (economy growing without overheating).

If growth happens when economy is overheating, in the equations above, cyclical deficit becomes positive, in other words, there is actual deficit. If it is happening in the economy that is not overheating, then cyclical deficit is negative, so there is cyclical surplus.

Now's for an interesting bit: both the EU Commission and the DofF estimate that in 2014, despite the fact that we are expected to run double-digit unemployment, Irish economy will be technically in 'overheating' or 'above full-employment' mode. This explains why even with shallow growth, in 2015 Ireland is still forecast to run 3.5% structural deficit (DofF forecast, which is ahead of 2.5% structural deficit forecast for the same year by the IMF).

In other words, if we hike growth even more, in 2015 over and above currently assumed by the DofF, so that our output gap will rise by 1% in 2015, this will result in an increase in Cyclical Deficit of 0.4%. This will result in subtracting a larger negative number in computation of Structural Deficit in the first equation above, thus increasing Structural Deficit.

In other words, if growth happens when economy is considered 'overheating' and that growth does not increase potential output of the economy, but only transient output, then such growth will increase, not decrease Structural Deficit, unless the state somehow taxes entire growth*0.4 out of the economy and does not spend the collected amounts. This can be done if we were to run a cash-based sovereign wealth fund that will not invest any of its proceeds back into the economy.

Logic? Who said economics supposed to have real world logic? Not me...

23/11/2011: A longer term view of Ireland's structural deficits

Someone recently requested the analysis of structural deficits for Ireland. So here's a quick note. All data is taken from IMF WEO database for September 2011. IMF estimates 2011 deficit and forecasts deficits for 2012-2016. All frequencies and cumulative data calculations are my own.

Let's start with graphing our structural deficits. Remember, these are measured as % of total potential GDP, omitting the effects of business cycles on volatility in GDP. This makes structural deficits to be less precise than actual deficits, but useful in so far as they tell us the story of the long-term sustainability of the Exchequer spending.

Chart 1 below shows the overall structural deficits expressed as the percentage of potential GDP and in absolute national currency terms.

In the nutshell, the above chart shows that Ireland remained structurally insolvent for the entire history of the series since 1980 through 2010 and is expected to remain insolvent through 2016. It also shows that:

• Ireland was least insolvent in 1997-200 when the average structural annual deficit was just -0.65% of potential GDP
• The closest we came to structural balance was in 1997 when structural deficit hit -0.394% and in 2000 when it was at -0.209%
• Our peaks of insolvency were 1981 (-14.034%) and 2008 (-13.323%)
• Our worst periods of insolvency were the early 1980s, when 1981-1986 average annual deficit stood at -12.125% and 2007-2010 when structural deficits averaged -10.555% annually (omitting 2007 raises this to -11.266%)
• In 2011 we are expected to run structural deficit of 6.761% and in 2012-2015 we are expected to run average structural deficits of -3.753%.

All of these deficits add up to a nifty number. Chart below shows cumulative structural deficits. Per this, by the end of this year, our structural deficits since 1980 on will be adding up to €162.3billion. By 2016 these numbers are forecast to rise to €193.6 billion.

In terms of the frequencies of various solvency performance conditions, Irish structural deficits historically exceeded 3% per annum in 26 out of 32 years, implying a 84% chance of excessive unsustainable structural deficits. In contrast, relatively safe deficits (<2%) occurred in only 4 years in 36 years of history plotted above: 1997-2000. Thus, Ireland was close to sustainability only 13% of the time.