29/12/2014: Historical Evidence on the Size of Fiscal Adjustments

A recent IMF paper looked at the historical precedents of large scale fiscal adjustments across advanced and emerging economies in the aftermath of the major fiscal crises. Escolano, Julio and Mulas-Granados, Carlos and Terrier, G. and Jaramillo, Laura paper titled "How Much is a Lot? Historical Evidence on the Size of Fiscal Adjustments" (IMF Working Paper No. 14/179. http://ssrn.com/abstract=2519005) argue that "the sizeable fiscal consolidation required to stabilize the debt-to-GDP ratios in several countries in the aftermath of the global crisis raises a crucial question on its feasibility."

To answer this question, the authors look at historical evidence "from a sample of 91 adjustment episodes of countries during 1945-2012 that needed and wanted to adjust in order to stabilize debt to GDP."

"We find that in most cases fiscal adjustment is sizeable and the debt-to-GDP ratio stabilizes by the end of the episode, albeit at higher levels. In at least half of the episodes, countries managed to improve their primary balance by 5.4 percent of GDP (4.8 percent of GDP in cyclically adjusted terms). The sample distributions of the levels and changes in the primary balance (actual and cyclically adjusted) show that, while there are significant differences across advanced and developing countries in terms of the levels of primary balances achieved, the changes in primary balances are comparable across the two groups."

"The fiscal adjustment implemented was enough to close the primary gap in two-thirds of the episodes. This implies that debt stabilized, and in most cases was put on a downward trend." Given the hope-inspiring dynamics above, however, the follow-up is less impressive: "This does not however imply that debt returned to initial levels. While countries kept primary balances well above those observed before the adjustment episode, they did not sustain primary balances at the highest levels for prolonged periods of time. This suggests that countries make substantial efforts to stabilize debt but, once this is achieved, they see room to ease primary balances and do not necessarily seek to get back to the lower initial debt-toGDP ratio."

 "We find that consolidations tended to be larger when the initial deficit was high and adjustment efforts were sustained over time." In addition, "Several factors are found to be significantly associated with the size of fiscal adjustments. …The results also show that fiscal adjustment tended to be higher when accompanied by an easing of monetary conditions (as measured through a reduction in short-term interest rates) and, to a lesser extent, an improvement of credit conditions (measured as the change in credit to the private sector as a percent of GDP), especially in advanced economies."

Couple of figures. In the below,
CAPB: cyclically adjusted primary balance as a percent of potential GDP;
CAB: cyclically adjusted balance as a percent of potential GDP

Note the following interesting facts:

• Ireland's fiscal adjustment post-2009 has been shallower than its adjustment post-1986. 
• The cause of this shallower adjustment was the collapse of the credit markets in Ireland plus the on-going deleveraging of the real economy, not present in 1986 crisis. Also, the factors not accounted for in the list presented in the chart. In 1986 episode such factors were positively contributing to fiscal adjustment. In 2009 episode - they had negative impact. We can only speculate what these factors might have been, but clearly they are not related to external trade, or FDI. Which suggests they were domestic.
• Ireland's adjustment was longer in the 1986 episode than in 2009 episode, but that is because the paper does not go beyond 2012. And the adjustment post-2009 episode is not completed still, even in 2014.
• CAPB is the main driver of adjustment in 2009 episode, and is much larger than in 1986 episode. 
• Ireland's fiscal adjustment since 2009 has been shallower than that of Greece since 2008, Portugal since 2010 and Spain since 2009, although it has been longer running that in Portugal and as long running as in Spain. In fact, the UK - a country that lent funds to Ireland for adjustment - is running similar magnitude fiscal adjustment as Ireland since 2009. A bit rich for us to be claiming to have taken most of fiscal pain in this crisis.

So what does the above tell us about Euro area peripherals' adjustments? IMF paper says that things tend to go well when:

1. adjustment efforts were sustained over time, which suggests we are in for a much longer run than the Government's 'free from IMF' meme suggests;
2. there is an an accompanying easing of monetary conditions, which we do have, courtesy of the ECB, except it is unclear how does this relate to the cases similar to the current crisis where monetary accommodation is simply fuelling asset bubbles and temporarily relieving mortgages pain, while doing nothing for growth; and
3. to a lesser extent, by an improvement in credit conditions, which is yet to materialise, 5 years since 2009.

Not that any of the above will pause the IMF public statements about sustainability of adjustments everywhere and anywhere.

20/12/2012: Pensions, health costs & education fees for 2014-2015

Staying with the IMF report on Ireland, and with the theme of 2014-2015 adjustments, here's again what the IMF had to say on what we should expect from the Government:

"The authorities should outline the remaining consolidation measures for 2014–15 around the time of Budget 2013 (MEFP ¶8). The program envisages additional consolidation of 3 percent of GDP over 2014–15. Taking into account the measures already specified for these years (such as on capital spending), and carryover savings from earlier measures, new measures of about 1½ to 2 percent of GDP remain to be identified for 2014-15."

I wrote about the above here. But there's more:

"To maximize the credibility of fiscal consolidation, and to reduce household and business uncertainties, the authorities should set out directions for some of the deeper reforms that will deliver this effort. These could include, for instance, on the revenue side, reforming tax reliefs on private pension contributions; and on the expenditure side, greater use of generic drugs and primary and community healthcare, and an affordable loan scheme for tertiary education to enable rising demand to be met at reasonable cost."

Further, per box-out on Health costs overrun: "there is scope for increased cost recovery in respect of private patients‘ use of public hospitals"

Hence, per IMF, the Government should hit even harder privately provided pensions (on top of the wealth tax already imposed), thus undermining even more private pensions pools and increasing dependency on state pensions. For those of us with kids, IMF - concerned with already unsustainably high personal debt levels - has in store more debt. This time to pay for our kids education. And for those of us with health insurance, there is more to pay too.

The above combination of measures is idiocy of the highest order. Per IMF, Irish economy is suffering from private debt overhang which leads to more deleveraging, less consumption and less investment. And these lead to lower growth. I agree. But what IMF is proposing is going to:

• Increase private debts and reduce the speed of deleveraging, and
• Raise the demand for already stretched public services.

This is the Willie Sutton moment for Ireland: the state (with the IMF blessing) is simply plundering through any source of money left in the country is a hope of finding a quick fix for Government insolvency. Now, with low hanging fruit already bagged, this process is starting to directly impact our ability to sustain private debts. But no one gives a damn! As Sutton, allegedly claimed, it makes sense to rob banks, because that is where the money are. Alas, with banks out of money, the Government, prompted by the IMF 'advice' is going to continue robbing us.

So a message to our Pensions industry, which hoped that going along with expropriation of customers' funds via pensions levy would allow the industry to avoid changes to tax incentives on pensions (the blood of the sector demand). Prepare for tax reliefs savaging. Once you fail to stand up to the bullies and protect the interests of your customers, you deserve what you are going to get. Every bit of it.

19/12/2012: Fiscal Issues, flagged by the IMF

Keep on reading the IMF report, folks. Nice little bots on offer regarding the fiscal programme performance.

Platitudes abound, well-deserved, but...

"A combination of slower growth, higher unemployment, and the over-run in health spending, have dimmed prospects for any significant fiscal over performance in 2012. Indeed, given the weak economic conditions, only about half of the 6 percent of GDP consolidation effort over 2011-12 has translated into headline primary balance improvement. [Meaning that we've been running into a massive headwind, with pants caught on rose bushes behind us...] Nonetheless, the authorities‘ consistent achievement of the original program fiscal targets despite adverse macroeconomic conditions gives confidence in their institutional capacity and commitment to consolidation."

Question is, when will rose bushes thorns get our fiscal pants shredded? We don't know, but here's the road ahead:

Of course, we knew this before, but it is a nice reminder that Enda Kenny's claim that Budget 2013 is going to be the hardest of all budgets is simply bull - the above figures have to be delivered on top of Enda's 'hardest' Budget 2013. Per IMF, however:
"The program envisages additional consolidation of 3 percent of GDP over 2014–15. Taking into account the measures already specified for these years (such as on capital spending), and carryover savings from earlier measures, new measures of about 1½ to 2 percent of GDP remain to be identified for 2014-15.

"To maximize the credibility of fiscal consolidation, and to reduce household and business uncertainties, the authorities should set out directions for some of the deeper reforms that will deliver this effort. These could include, for instance, on the revenue side, reforming tax reliefs on private pension contributions; and on the expenditure side, greater use of generic drugs and primary and community healthcare, and an affordable loan scheme for tertiary education to enable rising demand to be met at reasonable cost."

In other words, the Government will have to find somewhere around €3-3.2bn more cuts/tax hikes in 2014-2015 on top of those already factored in for 2013.

Now, in spirit with IMF paper, let me reproduce for you a box-out from IMF report on public sector wages in Ireland:

Enjoy the above - you can enlarge the text by clicking on the images.