24/2/19: Europe of Divergence: Euro and the Crisis Aftermath

A promise of economic convergence was one of the core reasons behind the creation of the Euro. At no time in the Euro area history has this promise been more important than in the years following the series of the 2008-2013 crises, primarily because the crisis has significantly adversely impacted not only the 'new member states' (who may or may not have been on the 'convergence path' prior to the crisis onset), but also the 'old member states' (who were supposed to have been on the convergence path prior to the crisis). The latter group of states is the so-called Euro periphery: Greece, Italy, Spain and Portugal.

So have the Euro delivered convergence for these states since the end of the Euro area crises, starting with 2014? The answer is firmly 'No'.

 The chart above clearly shows that since the onset of the 'recovery', Euro area 8 states (EA12 ex-periphery) averaged a growth rate of just under 2.075 percent per annum. The 'peripheral' states growth rate averaged just 1.623 percent per annum. In simple terms, recovery in the Euro area between 2014 and 2018 has been associated with continued divergence in the EA4 states.

This is hardly surprising, as shown in the chart above. Even during the so-called 'boom' period, peripheral states average growth rates were statistically indistinguishable from those of the EA8. Which implies no meaningful evidence of convergence during the 'good times'. The picture dramatically changed starting with 2009, starting the period of severe divergence between the EA8 and EA4.

In simple terms, the idea that the common currency has been delivering on its core promise of facilitating economic convergence between the rich Euro area states and the less prosperous ones holds no water.

5/2/19: The Myth of the Euro: Economic Convergence

The last eight years of Euro's 20 years in existence have been a disaster for the thesis of economic convergence - the idea that the common currency is a necessary condition for delivering economic growth to the 'peripheral' euro area economies in the need of 'convergence' with the more advanced economies levels of economic development.

The chart below plots annual rates of GDP growth for the original Eurozone 12 economies, broken into two groups: the more advanced EA8 economies and the so-called Club Med or the 'peripheral' economies.

It is clear from the chart that in  growth terms, using annual rates or the averages over each decade, the Euro creation did not sustain significant enough convergence of the 'peripheral' economies of Greece, Italy, Portugal and Spain with the EA8 more advanced economies of the original euro 12 states. Worse, since the Global Financial Crisis onset, we are witnessing a massive divergence in economic activity.

To highlight the compounding effects of these annual growth rates dynamics, consider an index of real GDP levels set at 100 for 1990 levels for both the EA8 and the 'peripheral' states:

Not only the divergence is dramatic, but the euro area 'peripheral' economies have not fully recovered from the 2008-2013 crisis, with their total real GDP sitting still 3.2 percentage points below the pre-crisis peak (attained in 2007), marking 2018 as the eleventh year of the crisis for these economies.  With Italy now in a technical recession - posting two consecutive quarters of negative growth in 3Q and 4Q 2018 based on preliminary data, and that recession accelerating (from -0.1% contraction in 3Q to -0.2% drop in 4Q) we are unlikely to see any fabled 'Euro-induced convergence' between the lower income states of the so-called Euro 'periphery' and the Euro area 8 states.

28/9/17: Schauble: A Requiem For Austerity Finance

My comment for yesterday’s NY Times on Wolfgang Schäuble’s departure from the Finance Ministry post: https://nyti.ms/2k5N2Er 

17/2/16: Another Germanic policy straightjacket

My comment on the Germany's "Sages" proposal for sovereign bonds bail-ins rule for Portugal's Expresso: http://expresso.sapo.pt/economia/2016-02-16-Risco-de-um-ataque-especulativo-as-dividas-dos-perifericos.

In English unedited:

The proposed 'sovereign bail-in' mechanism represents another dysfunctional response to the sovereign debt crisis in the Euro area. The mechanism de facto exposes sovereigns locked in a currency union to the full extent of monetary and fiscal risks that reside outside their control, while reinforcing the risks arising from their inability to control their own monetary policies.

Under the current system, a run on the sovereign debt in the markets for any individual state can be backstopped via ESM as a lender of last resort. In a normally functioning currency union, such a run can be backstopped also via monetary policy and fiscal mechanisms.

In contrast, within the proposed bail-in system, both the ESM and the monetary policy become unavailable when it comes to securing a backstop against a market shock. The full extent of a run on Government bond for a member state will befall the fiscal authorities of the member state - aka the taxpayers who will end up paying for bonds bail-ins through higher yields of Government debt and fiscal squeeze on expenditure and taxation.

In theory, a bail-in mechanism for sovereign debt can be implemented in the presence of three key conditions:

• firstly, the implementing country must have control over its own monetary policy; 
• secondly, the implementing country must have benign debt levels and low reliance on concentrated holdings of its debt, especially in the systemically important institutions (for example by a handful of larger banks); and 
• thirdly, the implementing country must have strong fiscal balancesheet to absorb shocks of risk-repricing during the period of bail-in rule introduction. 

None of these conditions are satisfied by the Euro 'periphery' states today, nor are likely to be satisfied by them in the foreseeable future. At least two of the three necessary conditions are not satisfied by the vast majority of the Euro area states at the moment and are also unlikely to be satisfied by them in the foreseeable future.

In a sense, we are witnessing another attempt to put Euro area into a Germanic policy straightjacket in a hope that this time around, the outcome will be different and that bail-ins rules will fix the unresolvable dilemmas inherent in the Euro design. It is a vain hope and a futile exercise that is creating more risks in exchange for no tangible gain.

18/10/15: Is Ireland a Euro Periphery Outlier? Some Historical Data

How unique is Ireland within the club of euro peripheral countries? Well, historically, rather unique. Alas, sometimes for the reasons not entirely in our favour.

The following are excerpts from the recent ECB paper titled “Fiscal policy adjustments in the
euro area stressed countries: new evidence from non-linear models with state-varying thresholds”.

Quote: “Fiscal policy authorities of Greece, Ireland, Portugal and Spain are shown to have, on average, historically followed a "spend-and-tax" model of fiscal adjustment, where government spending is decided by the political process, and the burden of correcting fiscal disequilibria is entirely left to the tax instrument.”

Of course, ‘historically’ here means over the period 1960-2013 for all countries, with exception of Spain (1970-2013).

But before then, what were the pre-conditions (thresholds) for taking action? “During the 1960-2013 period for Greece, Ireland and Portugal and during the 1970-2013 period for Spain, we find that the threshold estimate for the budget deficit-to-GDP ratio, which led to different fiscal correction regimes, was on average 4.90% for Greece, 5.10% for Ireland, 3.22% for Portugal and 3.12% for Spain.”

In other words, Ireland had the greatest tolerance - over the entire period - for deficits, opting to wait until average deficit as % of GDP would hit above 5.1%, well above Greece (4.9%) and the rest of the peripheral states.

So now, let’s tackle the more recent period, from the start of the Euro: “When considering the period after 1999, this overall picture worsens for Greece and Portugal and improves for Ireland. Moreover, the results for Ireland and Spain are driven by the financial crisis period. In particular for Ireland, the decoupling dynamics of the government spending reflects the support to the financial sector. In fact, when considering the pre-crisis EMU period between 1999 and 2007, the threshold for fiscal adjustment in Ireland and Spain are estimated to be positive; namely, the regime change took place when the budget balance was in surplus. Conversely, the fiscal deficit-to-GDP thresholds estimated at 5.32% for Greece and 4.08% for Portugal remained rather high.”

The above basically boils down to the following: since 1999, growing economies of Ireland and Spain allowed two countries to substantially reverse pro-cyclicality of deficits and significantly reduce thresholds for budgetary actions. This did not happen in Greece and Portugal. While Ireland gets a pat on the back for pre 2007 period, it is hardly unique in this achievement.

But despite the gains of the 1999-2007, things did not change all that much within the structure of deficits and adjustments. So per ECB paper “Looking at the effects of the economic cycle, we find that fiscal deficit-to-GDP ratio was not reduced in Greece, Ireland and Portugal with the improvement in economic activity. Consequently, during the contractionary times, fiscal corrections became more costly, as tax adjustments became a priority in an attempt to restore fiscal discipline.”

In other words, we were not unique in the way we handled the underlying structure of public spending imbalances, despite having substantially reduced the fiscal action thresholds.

But may be during the peak of the crisis we widened up? Indeed, ECB offers some positive evidence in this direction, but it also argues that the same took place in Spain and Portugal. “The results also suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed in Ireland and Spain, while it was reduced in Portugal. By relaxing the fiscal deficit-to-GDP threshold (in an attempt to stave off deep recessionary pressures) Ireland and Spain relied on business cycle improvements to raise tax revenues. Given the tendency by Portuguese authorities to improve the fiscal imbalances during a financial crisis, these figures make sustainability concerns for Ireland, Portugal and Spain less of an issue compared to Greece, in an historical perspective.”

Which, once more, does not really identify Ireland as a ‘unique’ case amidst the imprudent (but learning) peripherals.

“The results …suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed from 5.10% to 6.99% in Ireland and from 3.12% to 4.00% in Spain, while it was reduced from 3.22% to 1.92% in Portugal.” In other words, Irish Government thresholds actually worsened in the financial crisis, albeit most of that worsening is attributable to the Government decision to rescue Irish banks.

Overall, as table below illustrates, Ireland has managed to perform best during 1999-2007 period in fiscal adjustment thresholds terms, while Spain was the overall best performer in 1999-2013 period and over the entire sample.

My handy addition to the chart are red boxes (highlighting worst performers) and green boxes (best performers) when it comes to budgetary adjustment thresholds.

This completes the arguments about Ireland’s alleged uniqueness as an outlier to the group of peripheral states: with exception of the period during which our property and financial sectors bubbles were inflating to unprecedented proportions, Ireland was pretty much a ‘normal’ peripheral state when it comes to fiscal management. Celtic Tiger et al…

So let's hope the latest Budget 2016 does not return us back to the historical record track...

28/6/15: Grexit with Help: Hans Werner Sinn

My favourite Bad Dude of German Economics, Hans Werner Sinn on Greek crisis:

Orderly Grexit is, in my view, still more disruptive and costly to all sides than a facilitated debt writedown and restructuring, while allowing Greece more time and fiscal room for implementing real reforms (as opposed to the currently proposed reforms, which are aimed solely on addressing short term fiscal imbalances).

Truth is - Europe has the means to meaningfully help Greece, as well as other 'peripheral' states, to get back onto growth path consistent with long term sustainability (in Greek case, we are talking about 3.5-4 percent annual growth averaging over a good decade). What Europe lacks is the will.

1/4/15: H-W Sinn "Europe’s Easy-Money Endgame"

A very interesting op-ed by Professor Hans-Werner Sinn of German Ifo Institute for Project Syndicate: http://www.project-syndicate.org/commentary/euro-demise-quantitative-easing-by-hans-werner-sinn-2015-03

The problem outlined by Professor Sinn is non-trivial.

"...for countries like Greece, Portugal, or Spain, regaining competitiveness would require them to lower the prices of their own products relative to the rest of the eurozone by about 30%, compared to the beginning of the crisis. Italy probably needs to reduce its relative prices by 10-15%. But Portugal and Italy have so far failed to deliver any such “real depreciation,” while relative prices in Greece and Spain have fallen by only 8% and 6%, respectively".

As Professor Sinn notes, there are four possible solutions:

1. "Europe could become a transfer union, with the north giving more and more credit to the south and later waiving it." 
2. "The south can deflate." 
3. "The north can inflate." 
4. "Countries that are no longer competitive can exit Europe’s monetary union and depreciate their new currency."

So here's the problem, correctly identified by Professor Sinn: "Each path is associated with serious complications. The first creates a permanent dependence on transfers, which, by sustaining relative prices, prevents the economy from regaining competitiveness. The second path drives many debtors in crisis countries into bankruptcy. The third expropriates the creditor countries of the north. And the fourth may cause contagion effects via capital markets, possibly forcing policymakers to introduce capital controls".

Now, note: Ireland has opted for the second path. Any surprise we are driving people into bankruptcy in tens of thousands (once current legal queue is taken into account), along with multiple businesses?

But back to Prof Sinn's analysis. Remember the ECB QE? Ok, says Prof Sinn, suppose it delivers on target inflation of just under 2%. What does it mean for internal devaluations in the 'peripheral' Europe?

"If, say, southern Europe kept its inflation rate at 0% and France inflated at a rate of 1%, Germany would have to inflate by a good 4%, and the rest of the eurozone at 2% annually, to reach a eurozone average of slightly less than 2%. This pattern would have to continue for about ten years to bring the eurozone back into balance. At that point, Germany’s price level would be about 50% higher than it is today."

The problem, thus, is an unresolvable dilemma, since with that sort of arithmetic, we are in a tough bind:

• Either Germany runs mild inflation, while the 'periphery' runs outright deflation, allowing - over a painfully long period of time (decade or more) to devalue the imbalances, or
• Eurozone pursues Mr Draghi's objective of 'just under' 2% inflation across the entire Euro area at the expense of Germany (and the rest of the already shrunken 'core').

Do note, I have argued before that deflation in the 'periphery' is not a bad thing, as it allows for the interest rates to remain low (servicing cost of household and corporate debts is lower) and deleveraging of the households and companies to be less painful, while sustaining some domestic demand through increased purchasing power of incomes. So I agree with Professor Sinn's criticism of the ECB QE programme. 

The problem is that this means, as Professor Sinn rightly suggests, continued suppression of demand (the 'austerity' bit).

The choice faced by Europe are ugly. All of them. And there are no guarantees for any of them to actually work. And the cause of this problem is singular: creation of a political currency union. For anyone who says that Greece, Italy, Portugal, Cyprus, Ireland and Spain have caused their own problems, the replies are both simple and complex: 

• The simple one: absent the euro, their problems would have been by now solved by a combination of the old-fashioned defaults and devaluations. 
• The complex one: absent monetary transfers (lower interest rates and ample bank liquidity flowing cross-borders) with the EMU from the late 1990s through 2007, the imbalances generated in the 'peripheral' economies would never have been this large. Which means that the simple reply above would have been even more easy to apply.

3/10/2014: East Asian Crisis, European Disaster: Tale of Two Recoveries

My post for Learning Signal blog on IMF report covering East Asian Crisis of the 1990s comparatives to the Euro area crisis 2007-present is available here: http://blog.learnsignal.com/?p=55 

1/10/2014: That Exports-Led Recovery... in Germany

And a Scary Chart of the Day prize goes to @IanTalley who produced this gem:

That's right, Germany is now officially producing more stuff that its people can't afford than China...

But its a good thing, for it means that people in countries like Italy, Spain, Greece, Portugal, Cyprus etc who owe Germany money can buy more stuff from Germany they can't quite afford either, except for the credit supplied from Germany funded by the credit they take from Germany... Confused? Try confused.edu for some academic analysis... or just look at KfW bank latest foray into Ireland (apparently it took months of planning to get us to this absurdity http://www.independent.ie/business/irish/kfw-deal-to-fund-irish-firms-was-months-in-the-planning-29896868.html).

26/9/2014: Those Fabled Euro Area Structural Reforms: Greece, Spain, Portugal & Italy

EU Commission has published some interesting research on structural reforms in Italy, Spain, Portugal and Greece (strangely, no Ireland or Cyprus).

The full paper is available here: http://ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee5_en.pdf

But here is an interesting set of charts, showing the effect of the said 'reforms' on the economies of these 'peripheral' states.

First chart shows employment growth against productivity growth in 2001-2008 and 2008-2013:

Above clearly shows that in two 'peripheral' countries covered, namely Portugal and Spain, productivity (as measured by value added per hour worked) rose during the crisis period, while the same fell in Greece and Italy. Productivity growth accelerated over the crisis period in Portugal and Spain and de-accelerated in Italy and literally fell off the cliff in Greece. And in all four economies, hours worked collapsed.

This all means two things:

• Firstly, jobs destruction failed to sustain growth in productivity in Italy and Greece (in other words, the two economies suffered jobs losses dispersed across all sectors of activity), while jobs destruction did sustain improved productivity for the remaining active workforce in Spain and Portugal (where jobs destruction was more concentrated in several domestic sectors, such as retail and construction). 
• Secondly, given that all four economies developed broadly similar 'structural reforms' packages, albeit with varying degree of implementation, the above suggests that the said reforms had zero-to-negative effect on economic performance in Italy and Greece, and potentially positive effect in Spain and Portugal. This is basically equivalent to saying that reforms overall effectiveness is not anchored in the structure of reforms, but is rather being driven by something else, something more idiosyncratic. Or, alternatively, that the reforms had no discernible effect whatsoever and instead nature of jobs destruction is driving differences in productivity growth.

The second chart shows annual trajectory in hours worked against productivity growth from 2008 through 2013.

Again, the above chart shows that in all four economies, relationship between productivity growth and employment is broadly negative. The diagonal line shows two segments of the chart: above the line, jobs destruction / creation effects are dominated by productivity growth effects. Below the line, the opposite takes place. So in a summary, the chart shows that the dominant driver in every economy as jobs destruction, not productivity growth. If structural reforms are of any significant help in driving productivity of workers, one would expect at least one of the economies to perform above the diagonal line. None do.

Quite surprisingly (or may be not) EU Commission offers an entirely opposite arguments on reforms efficacy. Even in the case of Greece - a country where both employment and productivity collapsed, the Commission paper argues that "Greece made a substantial adjustment in terms of employment while productivity stopped falling down". The folks in Commission believe that once the economy is completely exhausted on the downside, the lack of further declines is a sign of 'reforms-driven improvements'. This is about as crazy as cheering the fact that a lifeless body at the bottom of the empty pool is no longer falling.

Here is the Commission own guide to the above charts:

Do tell me which of the four countries locates in 'jobless growth' (early stage of reforms and structural changes working) area? Do note that other area of "Repositioning (growth less restructuring)" - which sounds exactly what it is: mindless demolition of jobs in hope that such a move can improve the remaining average. This is the best the 'periphery' has been able to achieve so far under the watchful eye of the EU Commission boffins.

16/8/2014: Three Charts of Euro Area's Abysmal Growth Performance

Few charts to summarise the continued problems with growth in euro area and the 'peripheral' states:

First, consider changes in real GDP on pre-crisis peak:

Next, the weakest link in the euro area: Italy. This is really woeful - since hitting absolute lows, Italian economy continued to decline, steadily and with little sign of improvement.

The above also shows the miserable state of the euro area as a whole.

Another chart, to show changes on crisis-period absolute lows:

Note: the first 2 charts reference index to 2005=100, the last one references index to Q4 2006=100.

14/8/2014: Euro Area Industrial Production H2 2014

With stagnant GDP and falling inflation, Euro area is set back into the rot of economic crisis, not that you'd notice as much from the Eurostat headline lauding 'stable' GDP print.

Here is the chart showing the miserable performance of the euro area's industrial production from end-June 2011 through 2014:

A message to Brussels: keep digging, folks...

And here's the same story in terms of average year-on-year growth rates for the last 3 years:

And the last 12 months:

19/7/2014: Global Innovation Index 2014: Ireland vs 'Periphery'

In the previous post I gave detailed breakdown of Ireland's performance in Global Innovation Index 2014. I used small open economies and Switzerland (the world's highest ranked economy) as a reference group.

Here, primarily for the reason of convention, are the comparatives of Ireland's performance relative to the Euro area 'peripheral' states:

Clearly, Ireland is a much stronger performer in Innovation than all other 'peripheral' states. This is neither surprising nor unexpected. Crucially, the gap is wider today than in 2007-2008 and the gap is rather persistent over time. Average ex-Ireland 'peripheral' state rank was 34st in 2014 against Ireland's 11th, this is a very significant gap. This gap increased from 16-19 points on average for 2007-2010 period to 32 points in 2012 and 23 points in 2014.

Furthermore, it appears that even if we are to abstract away from the metrics very heavily influenced by the tax optimising MNCs, Ireland (under such a metric closer to 20th-23rd position in the World rankings) would still post a stronger performance than any other 'peripheral' state (best - Spain at 27th).

29/6/2014: What a Difference a Year of ECB Activism Makes...

Mapping decline in CDS and implied probabilities of default for Euro area 'peripherals' over the last 12 months:

Largest declines: Greece, followed by Portugal, Spain, Italy and lastly Ireland. Timing of declines and divergent macrofundamentals of these countries suggest that drop in CDS has little to do with internal policies and performance of individual states - the 'periphery' is still being priced jointly. The decline in risk assessments of the 'peripherals' is primarily down to common policy, aka: the ECB.

On the other hand, if we are to distinguish within the 'peripherals', we can identify 3 sub-groups of countries:

• Weakest and stand-alone: Greece
• Mid-range weakness, also stand-alone: Portugal
• Stronger 'peripherals': Ireland, Spain and Italy

28/6/2014: Is S&P Behind the Curve on Portugal and Spain?

Euromoney Country Risk report is profiling S&P ratings on Portugal and Spain, with a comment from myself: here.

If you can't access the article, here is the article (click on each image to enlarge):

23/4/2014: Some scary reading from the Eurostat...

Eurostat published full comparatives on key fiscal performance indicators across the EU and euro area for 2013. Here are three summary tables comparing euro 'periphery' states against each other and the EU18. You can click on images to enlarge:

First data summary:

Second: Ireland's share of the mess:

Third: Ireland's position within the 'periphery':

And key takeaways are:

1. In 2013, after years of austerity and pain, Irish Government deficit (7.2% of GDP) was the second worst in the euro 'periphery' group.
2. By relative comparative to EA18 (33% and 50% over EA18 levels), Ireland ranks worse than Italy, Cyprus and Portugal, and Spain (we have more 'red'/'green' cells).
3. In cumulative terms, 2010-2013 years were brutal to Ireland: we posted worst cumulated Government Deficits over this period and 2nd worst increases in Government debt.

Note: data is taken from http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-23042014-AP/EN/2-23042014-AP-EN.PDF

3/4/3014: Latest Country Risk Updates: April 2014

Latest updates to ECR Euromoney Country Risk scores (higher score implies lower risk):

Two notable sets of changes:

1. Russia and Ukraine scores continue to fall, with Ukraine still leading Russia
2. Euro area 'periphery' scores continue to rise, with Portugal and Ireland showing biggest improvements.

22/1/2014: 2013 - A Kinder Year for Peripheral CDS...

2013 was a kind year for Irish CDS... but it was an even kinder one for CDS of the countries from which, allegedly, Ireland decoupled, e.g. Italy and Spain...

Oddly enough (for those claiming Ireland's 'uniqueness' in terms of positive performance) the year was even kinder for Slovenia - a country that is only starting to move into a crisis mode:

And even lots-of-pain-for-little-gain Greece and Cyprus managed to pick up some positive momentum:

So the entire thesis for the 2013 CDS markets in euro area 'periphery' is really about global chase for yield squeezing more and more funds into 'peripheral' bonds and bidding down risk valuations of the said paper. This re-assessment of risks has little to do with underlying reforms or fundamentals on the ground in the countries and more to do with the exuberance of investors pushing cheaper funds into every corner of financial universe.

The good news is - this has a positive effect of lowering longer-term borrowing costs. The bad news is - this presents a threat of reforms fatigue. But we know this much already. After all, the sovereigns are not immune from the effects of QE...

13/11/2013: That Feta Feeling... a quick reminder...

Remember that Michael Noonan's gaffe about him missing feta cheese in the supermarket should Greece exit the euro back in 2012? Reminder:

Speaking at a Bloomberg event in Dublin, the Minister said: “Apart from holidaying in the Greek islands, I think most Irish people don’t have a lot (of connections with Greece),” he said. “If you go into the shops here, apart from feta cheese, how many Greek items do you put in your basket?”

Now, here's 2011 distribution of Greek exports via http://www.atlas.cid.harvard.edu/explore/tree_map/export/grc/all/show/2011/

All cheese exports accounted for 1% of total Greek exports. Just thought I'd share while rummaging through the data piles...

Oh, and while on the topic... latest Leading Economic Indicators for the euro area:

Spot numbers 1, 2 and 3... Let's not stay too arrogant...

17/10/2013: Budget 2014 Missing the Targets: Sunday Times, October 13

This is an unedited version of my Sunday Times column from October 13, 2013.


Recent events have led to a significant reframing of the Budget 2014. With these, the Government is now actively signaling a more accommodative stance on next year's cuts. Alas, the good news end there and the bad news begin. Any easing on austerity in 2014 will be unlikely to produce a material improvement in household budgets. In return, the Government will be placing huge hopes on robust growth returning in 2014. If this fails to materialise, lower austerity today will spell more pain in 2015. Like a dysfunctional alcoholic, unable to stop binging at closing time, we ignore tomorrow’s hangover.


A combination of the latest IMF report on the Irish economy and the outcome of the Seanad abolition referendum have settled the debate on the scale of adjustment to be taken on October 15th. Embarrassing defeat in the referendum has meant that the continuation of Taoiseach's leadership required some symbolic gesture toward the electorate. Lowering the 2014 cuts targets on October 15th can serve the purpose for a few crucial months until the New Year.

Meanwhile, ambiguity-embracing IMF lent a helping had. The IMF repeated its insistence on EUR5.1 billion combined 2014-2015 cuts in the latest assessment of the Irish economy. Yet, the IMF avoided specifying the breakdown of these adjustments between 2014 and 2015. This has given the Government confidence to argue the case in favour of partially delaying 2014 adjustment in front of the EU overseers of our budgets.

Immediately after the IMF report publication, Irish media was promptly fed the rumors that the Minister for Finance was seeking a reduction in the level of budgetary cuts. This week Minister Noonan said that the 2014 adjustment will be EUR600 million lower than EUR3.1 billion originally agreed with the Troika. The savings will amount to 0.37 percent of our GDP: a small boost for the Irish economy, but a massive splash in the PR spin terms for the Government.

With some cuts delayed to 2015, Ireland’s debt sustainability and deficit targets now hinge on the Government’s forecasts for growth materializing over the next twelve months. The risks to these are non-negligible. Last week IMF lowered Irish GDP growth forecasts for every year from 2013 through 2018. Compared to the forecasts released in June this year, October forecasts for inflation are also down. This implies that nominal growth – the source of budget deficits and debt dynamics – is expected to be even slower. If back in June this year IMF expected Irish economy to be at EUR205.8 billion by 2018, now the fund is projecting it to hit EUR201.7 billion. Cumulated forecast nominal GDP for 2013-2018 is EUR15.6 billion lower in October report than in June assessment.  Even before Minister Noonan’s latest reductions in fiscal adjustment for Budget 2014, IMF projected worsening of Irish deficits in 2014-2018.

Department of Finance forecasts, released this week and underpinning the Budget 2014 calculations are more optimistic on nominal growth, expecting higher inflation and anticipating more domestic consumption and investment than the IMF. If the Department gets its forecasts wrong, we will pay 2015 for the delays in cuts planned for the next year.



Flying on hopium of rosy growth expectations is a risky proposition for the Exchequer especially ahead of our drawing down the final tranche of the Troika funding. For this risk, the savings to be delivered in the Budget 2014 are likely to be insignificant from economy’s point of view.

Given the precarious position of the Government in public opinion polls, it is a safe bet to assume that the coalition will be putting the money to ‘work’ as an investment stimulus and a cushion against cuts to social welfare and health.

New building programmes in the more sensitive constituencies hold some serious political capital. But planning allocation of large sums to new investment is a lengthy process before construction jobs actually materialise. Growth impact of these measures in 2014 is unlikely to be significant.

But the thrust of 'savings' is likely to go to the second option. Doing as little as possible for yet another year in structurally altering the way we spend on social supports and healthcare will mean that the budgetary changes to health spending in 2014 will likely be identical to those undertaken in the past. Expect more cost shifting to private insurance, more sabre-rattling over cost overruns and more imaginary gains in productivity. Social welfare ‘cost containment’ measures will continue to rely on 'demand attrition' - the declines in demand due to unemployment benefits expiration and emigration. This means zero impact on growth in 2014.

Meanwhile, revenue side of the budgetary equation will keep pressuring the economy.

Fine Gael's side of the Coalition is promising us that the Budget will contain no new taxes. Alas, in Ireland we have a very narrow definition of both terms: 'new' and 'taxes'. In 2014 we will be facing a full annual Property Tax bill, which is expected to take out additional EUR250 from the average household income. The Budget will also likely raise charges on families to fund education and healthcare. The Irish Government is saying these are not new taxes. Anyone expected to pay them would disagree.

Last year, PRSI changes and reduction in child benefits were not identified as 'new taxes' either. These cost an average working family with two children some EUR494 per annum – an involuntary reduction in family income.

Per research note published by Grant Thornton two weeks ago, a family on EUR80,000 with two earners with two children saw their tax bill rise by 54 per cent since 2008. Their disposable income is now down a massive EUR6,132 per annum. Only a small fraction of these were officially recognised as new tax measures.

Meanwhile, the same families have also seen the costs of basic services provided by the state agencies and enterprises, or controlled by the state regulators and heavily taxed, rise dramatically over the course of the crisis. On average Irish consumer prices fell 1.6 percent between August 2008 and August 2013. Health insurance costs more than doubled over the same period, education costs inflated by 29 percent, bus fares have gone up over 46 percent, and motor tax went up 27 percent. Increases in core public services costs have taken out close to EUR3,500 annually out of the pockets of an average Irish family. These came on top of the Grant Thornton tax cost estimates cited above.

What is the opportunity cost for the families of the losses brought about by the fiscal crisis? For an average family with expected working life of 25 years, the above costs of austerity are equivalent to around EUR111,000 in foregone pensions savings. This excludes costs of the same measures continuing beyond December 31, 2013 and the new measures yet to come in 2014-2015.

The devastation of the above financial arithmetic is even more apparent when we realise that we are far from completing the full set of fiscal adjustments needed to restore our public finances to health. Medium-term Government fiscal consolidation forecasts confirmed by the IMF last week, envision total fiscal consolidation for 2014-2015 to be EUR5.1 billion. Of this, new revenue measures for 2014-2015 are to be set at EUR1.5 billion against carry forward measures of EUR0.3 billion. Current spending cuts are set at EUR3.2 billion. These adjustments translate into additional fiscal burden of EUR3,300-3,500 per annum for an ordinary family.

The hope is that the general economic recovery will mop up the household finances blood spilled by the fiscal crisis.  This rosy expectation is in turn driven by Minister Noonan’s worldview in which Irish trade partners are expected to also grow faster in years ahead. Alas, this Tuesday, IMF cut its global growth forecasts for both 2013 and 2014.


Forecasts aside, today, Ireland has run out of the road on tax hikes and revenue raising measures.

Instead of hiking tax rates, the Government is expected to widen the tax base in Budget 2014. The most efficient way for doing so would be to close loopholes on income exemptions. Less efficient, will be to lower income threshold at which upper marginal tax rate kicks in. Middle and upper-middle class families will pay in either scenario, but the costs to them will be higher in the latter.

In addition, the Government has been briefed on the potential for hiking PRSI for self-employed, while opening up access for this category of workers to social security net. Conditions for accessing cover will be so onerous, few self-employed will ever be able to qualify, but the hike will be politically acceptable. Currently, a self-employed person earning the equivalent of minimum wage pays almost six times as much tax and PRSI as an employee. Few interest groups so far have taken up a challenge of pointing this fact out.

Reality is, Ministers Noonan and Howlin have hit the brick wall. All the low-hanging fruit of marginal tax hikes and revenues extraction schemes has been picked. What's left now are two possible options. Option one: cut social welfare and health. Option two: delay adjustments and hope that comes Budget 2015 day, growth will pick up, unemployment assistance costs will fall, and Brussels will be happy enough reveling in the euro recovery to let things slip a bit on targets in Dublin. No prizes for guessing which option the Coalition will pursue comes next Tuesday.

Source: Department of Finance

BOX-OUT:

This week, the IMF published an assessment of the impact of the monetary policies deployed since 2008 by the ECB, the US Fed and the Bank of England. These unorthodox measures ranged from outright quantitative easing to lowering of the key interest rates to direct lending to the banks against riskier collateral. These monetary interventions, it has been argued in the media and by the majority of analysts, helped to ameliorate euro area sovereign crises. Per conventional wisdom, as the result of the central banks interventions, and particularly those carried out by the ECB, government bond yields and borrowing costs declined post-2011 across the euro area periphery. In addition, supporters of these policies have suggested that unconventional MPs were responsible for increasing equity funding in the real economies, thus supporting the recovery.

Rejecting the mainstream claims, the IMF researchers found that over 2008-2012 various monetary policies had zero statistical impact on the sovereign bond yields in Ireland, Portugal, and Greece. The policies have let to a moderate reduction in Italian Government bond yields, and a weak reduction in Spanish yields. In the case of Ireland, the IMF found no benefits to sovereign bond flows or prices that can be associated directly with the ECB interventions. Furthermore, ECB interventions were associated with outflows of liquidity from Irish equity funds. In contrast, Fed and Bank of England interventions resulted in net inflows of funds into Irish equities.

The paper clearly suggests that the ECB has not done enough to support recovery in sovereign debt and equity markets in the euro periphery.