Sunday, March 25, 2012

25/3/2012: QNA Q4 2011 - Part 3

In part 1 of the QNA analysis we covered annual results for annual GDP and GNP in constant prices terms. Part 2 analysis focused on GDP/GNP gap and losses in national income compared to pre-crisis trend. Here, we cover some quarterly trends for GDP and GNP based on constant prices data.

Let's consider changes by sector:

  • Agriculture, forestry and fishing sector output fell 5.1% yoy in Q4 2011 following a 9.34% rise yoy in Q3 2011. In Q4 2011 the sector accounted for just 1.26% of the total quarterly GDP. Compared to Q4 2007 the sector output is now down 6.0%.
  • Industry output rose 2.3% yoy in Q4 2011 after rising 6.25% in Q3 2011. The sector is now accounting for 28.34% of the quarterly domestic output. Sector output is now down 3.3% when compared against Q4 2007.
  • Building & Construction sub-sector of Industry sector posted yoy decline of 6.7% inQ4 2011 that follows on 39.32% drop in Q3 2011. The sub-sector is now accounting for just 2.62% of total output and is down 55.0% on Q4 2007.
  • Distribution transport and communications sector shrunk 0.6% yoy in Q4 2011 which follows 4.99% drop in Q3 2011. The sector accounts for 13.23% of total output and is down 17.3% on Q4 2007.
  • Public administration and defence sector shrunk 3.8% yoy in Q4 2011 which follows on a 6.53% contraction in Q3 2011. The sector now accounts for 3.58% of the domestic output and is down 6.5% on Q4 2007.
  • Other services including rents output contracted 3.1% yoy in Q4 2011 following on a 5.14% contraction in Q3 2011. The sector accounts for 42.37% of the economy and is down 12.5% on Q4 2007.
  • As the result of this, GDPat constant factor cost expanded in Q4 2011 by 1.1% yoy and this follows on a rise of 0.88% in Q3 2011. This metric of domestic output is now dow 10.6% on Q4 2007.
  • Taxes net of subsidies are down 2.3% yoy in Q4 2011 and this follows a 2.76% drop in Q3 2011. This accounts for 9.70% of GDP and the category is now down 30.0% compared to Q4 2007.
  • Headline GDP at constant market prices rose 0.7% yoy after expanding 0.52% in Q3 2011. The GDP at constant prices in Q4 2011 was 12.8 below that in Q4 2007.
  • Net factor income from the rest of the world (aka largely transfer pricing net of receipts by Irish corporates and individuals on their foreign investments) grew 59.9% yoy in Q4 2011 which follows on 7.41% growth in Q3 2007. These transfers now account for 18.51% of our GDP and were running 10.0% ahead of the levels recorded in Q4 2007.
  • Headline GNP in constant prices in Q4 2011 fell 7.1% yoy following a 1.18% contraction in Q3 2011. National income in constant prices is now 16.6% below that attained in Q4 2007.
  • GDP/GNP gap stood at 18.51% in Q4 2011 slightly down on 20.18% in Q3 2011.
Charts:



More sectoral analysis to follow in the next post.

Saturday, March 24, 2012

24/3/2012: QNA 2011 - Part 2

In the previous post (here) we considered 2011 results for NationalAccounts in relation to sectoral composition of GDP and GNP in constant prices terms.

Recall that the headline results are:

  • Annual growth in GDP of +0.71% yoy in 2011, with GDP still 9.51% below its pre-crisis peak in constant prices (controlling for inflation)
  • Annual contraction in GNP of -2.53% with GNP now down 14.33% on its pre-crisis peak.
  • Net factor income outflows to the rest of the world have hit historical peak at €31,801mln outflowing to foreign investors and MNCs net of whatever might have been paid in dividends and other revenues to Irish investors. This figure is now up 16.39% on 2010 and 18.62% on the pre-crisis levels.
As the result of the above, Irish GDP/GNP gap - the measure by which our Government and international agencies overestimate the true size of our real economy - has gone up from 20.61% in 2010 to 24.61% in 2011, marking absolute historical record.


The above chart shows an interesting dynamic. Remember that there are claims being floated about that  there are many so-called uber-rich walking the streets of Ireland. Alas, here's a sticky point. People who are rich in Ireland today clearly do not hold Irish property in any significant proportion of their protfolia, since the can't remain rich with property values down by more than 50% in the country. They are also not holding Irish equities - because these are still substantially down on their pre-peak valuations and because absent banks, there is really not much you could have invested in in terms of Irish shares before the crisis to begin with. This, in turn, implies that to be filthy rich, these individuals must own assets outside Ireland. Assets outside of Ireland pay dividends and some realised capital gains. Which, were they remitted to Ireland, would count as inflows into Ireland and compensate for MNCs and foreign investors expatriations out of Ireland. In other words, either there is no glut of the Irish rich or their assets and profits from these assets are not being on-shored into Ireland. Take your pick, but either way, good luck imposing a wealth tax on the so-called super rich.

The destruction of our national income as opposed to gross domestic product has been spectacular in recent years. As charts below illustrate, we are now well beyond much of hope of ever regaining the pre-crisis trend income levels.

Between 2008 and 2011, Ireland has lost €93.95bn in cumulative GDP (€20,514 per capita) and €75.49bn in terms of GNP (€16,482 per capita) once inflation is factored in. 

The losses accumulated in GNP compared to GDP have been more severe and this means that in 2011 overall, the burden of taxation has risen, not fallen, in the Irish economy when measured against GNP:


Keep in mind that the above chart shows taxes net of subsidies as a share of overall economy, which, of course, is an underestimate of real dynamics as subsidies have risen during the bust. 

In the following post we will deal with some quarterly comparatives and results.

24/3/2012: QNA 2011 - Part 1

With some delay, the next few posts will deal with the latest release of QNA data - Q4 2011 and annual data for national accounts 2011.

This first post in the series will deal with annual aggregates in constant prices terms.

There are overall two headlines to consider in the constant prices (real) data. The first one is that annual data shows continuation of the trend underlying weakness in the GDP in 2010-2011 and the second on is the precipitous contraction in GNP in 2011.

Let us start with Sector of Origin data (Table 1 in CSO release):

  • Agriculture, Forestry and Fishing sector output rose from €3,081mln in 2010 to €3,092mln in 2011 a rise of 1.98%. This follows sector expansion of 0.7% in 2010. The sector is now 21.78% below its peak output attained in 2005. There was contraction in the sector real output of 2.84% back in 2009, so overall growth has accelerated in 2011, compared to both 2010 and to every year since 2007. Alas, in absolute terms, the sector is comparatively small and levels of activity increases have been underwhelming. Sector output remains well below 2007 and even below 2008 levels.
  • Industry, including construction, activity rose to €45,639mln from €44,420 in 2010 - a gain of 2.74%. Back in 2010, the sector grew by 5.17% yoy, an that growth marked a reversal from a contraction of 4.03% in 2009. The sector activity in real terms remains 2.68% below its peak attained in 2004 when Industry (including Construction) yielded output of €46,895mln.
  • Building &Construction component of Industry output continued uninterrupted contraction for the fourth year in a row. 2011 output in the sub-sector stood at €3,753mln, down 13.51% on €4,339mln in 2010, which follows contraction of 30.08% in 2010 and 27.49% fall in 2009. Relative to peak attained in 2004, Building and Construction activity is now down 72.46%. Assuming 8% amortization & depreciation in the stock of capital, current rate of Building and Construction activity barely covers 60% of the O&M expenditure required to maintain the stock of capital accumulated in 2003-2010.
  • Distribution Transport and Communications sector activity fell in 2011 to €20,932mln - a decline of 1.58% yoy, that follows on a 2.04% drop in 2010 and 9.81% contraction in 2009. Relative to peak in 2007, the sector is now turning out 16.63% less output on an annual basis.
  • Public Administration and Defence sector posted a decline of 3.30% yoy in 2011 to €5,602mln, marking the third year of declines. Relative to peak, attained in 2008 at €6,199mln, the sector ctivity is now down 5.67%.
  • Other services (including rents) sector posted a sizable 2.15% contraction in 2011 to €67,578mln marking the 4th year of uninterrupted declines, with 2010 yoy decline of 2.29% and 2009 decline of  2.34%. The sector activity in 2011 was 7.89% below its peak attained in 2007.
Few charts:



Overall, not a single sector has managed so far to regain pre-crisis peaks after 4 years of the crisis. Only two sectors - Agriculture and Industry - posted growth in 2011, and the combined rate of expansion for these two sectors was shallower in 2011 (+2.7%) than in 2010 (+4.9%). In other words, if 2011 was a 'recovery' year as the Government is claiming, the rate of recovery in sectoral activity was shallower, implying that by the same Government 'metric' we had a boom in 2010.

Headline numbers for GDP & GNP are exceptionally weak:
  • GDPat constant factor costs - the metric that reflects real value added in the economy - rose from €144.51bn in 2010 to €145.95bn in 2011 - an increase of 1.0% yoy that followed on the contraction of 0.07% in 2010 and a fall of 5.41% in 2009. This marked the first year of expanding factor cost-based activity since 2008. However, overall activity is down 6.21% on its peak attained in 2007.
  • Taxes net of subsidies fell to €15,082mln down 2.05% yoy compared to 2010. In 2010 these declined 3.71% and in 2009 they were down 19.80% on 2008. Overall, taxes net of subsidies are now down 33.26% on the peak attained in 2007 (see chart above).
  • Headline GDP in constant prices is now at €161,034mln or 0.71% ahead of 2010 levels. This follows on a contraction of 0.43% in 2010 and 6.99% decline in 2009. Relative to the peak of €177,963mln attained in 2007, our GDP in constant market prices terms is down 9.51%, standing just over €1bn ahead of 2004 levels. In effect, in real GDP terms, assuming long-term growth rate potential of 2% pa, Ireland has lost 16% of its output by the end of 2011. If Irish economy continued to grow at 2% pa in real terms through 2011, our GDP would have stood at €192.6bn instead of €161bn today.
  • Net factor income from the rest of the world (effectively payments received from abroad less payments paid out to foreigners) have reached -€31,801mln in 2011 - up a massive 16.39% yoy, following a contraction of 3.67% in 2010 and an expansion of 10.38% in 2009. These, of course, reflect massive transfer activity ramp-up in exports sectors (to be discussed in subsequent post). Transfers abroad are now at a record high, running 18.62% ahead of pre-crisis levels in 2007. The boom town has arrived for MNCs.
  • As the result of accelerated transfers of profits out of Ireland, our GNP in constant market prices terms has shrunk 2.53% to €129,232mln. This is the real income of the Irish economy and the contraction of 2.53% is the real masure of our 'recovery'. 2011 yoy fall-off follows on growth of 0.27% attained in 2010.The Government claim that in 2011 Irish economy has finally posted a recovery is wholly bogus. In fact, according to real metric of Irish economic activity, our economy grew in 2010 and contracted in 2011. Irish GNP is now 14.33% below its pre-crisis peak of €150.86bn attained in 2007.


To conclude, let's plot the relative importance of each sector in overall economic activity:


 Chart above clearly shows that
  • Agriculture retained relatively modest increase in its output share, rising from 2.3% of total economic output in 2010 to 2.4% in 2011. Agriculture contribution to overall economic activity is still below its pre-crisis 2003-2005 levels.
  • Industry, including Construction share of total output rose to 35.3% in 2011 from 33.5% in 2010 and is now more important to the economy than in any other year since 2003.
  • Building and Construction used to account for 9.9% of overall economic activity in the country back in 2004 and now accounts for just 2.9%
  • Distribution Transport and Communications sector share of overall activity remained within 16.5-15.5 percent range of 2003-2011 period at 16.2% in 2011.
  • Public Administration and Defence, despite all the austerity is still running slightly ahead of 2003-2007 average. In 2003-2007 the sector accounted, on average for 4% of economic activity in the country. In 2011 this share was 4.3%. In 2007 - last year before crisis - the share was 3.9%. So austerity years to-date average is 4.4% while pre-crisis is 3.996%. Drastic cut-backs?
  • Other services are running at 52.3% of economic activity in 2011, compared to 52.1% in 2010 and 53.5% in 2009. Back in 2003-2007 these averaged 47%
In the following post we will look at evolution of GDP/GNP gap and the overall share of the economy shipped out in form of profits by the MNCs.


Wednesday, March 21, 2012

21/3/2012: Wholesale Price Indices for February 2012

A quick note on wholesale prices for January-February 2012.

Per CSO:

  • Monthly factory gate prices declined by 0.6% in February 2012 mom against a decrease of 0.2% recorded for February 2011. Annual prices rose 2.3% in February 2012, compared with an increase of 2.7% in the year to January 2012.
  • Price index for export sales decreased by 0.9% mom while the index for domestic (CSO calls it 'home') sales rose 0.3%. 
  • Yoy there was an increase of 1.9% in the price index for export sales (CSO notes, correctly, that this index can be influenced by currency fluctuations) and an increase of 3.7% in respect of the price index for home sales.
  • So domestic factory gate inflation is outstripping exports sales. The summary below explains.
Mom the most significant changes were increases in

  • Other food products including bread and confectionary (+2.1%), 
  • Electrical equipment (+1.5%) and
  • Other non-metallic mineral products (+0.4%), 
Most significant mom prices decreases were recorded in



  • Computer, electronic and optical products (-2.0%), 
  • Basic pharmaceutical products and pharmaceutical preparations (-1.4%) and 
  • Chemicals and chemical products (-1.1%). 

Yoy, the most significant contributions to prices changes were in

  • Meat and meat products (+7.8%), 
  • Other food products including bread and confectionary (+4.9%) and
  • Computer, electronic and optical products (+3.3%),
  • Electrical equipment (-3.2%), 
  • Furniture (-2.3%) and 
  • Basic pharmaceutical products and pharmaceutical preparations (-1.7%). 

Yoy, Building and Construction All materials prices increased by 1.7% in the year since February 2011. The most notable yearly changes were increases in Insulating materials (+10.1%), Other timber excluding windows and doors (+9.7%) and Concrete blocks and bricks (+7.8%) while there were decreases in Sand and gravel (-9.4%), PVC pipes and fittings (-7.8%) and Other steel products excluding structural steel and
reinforcing metal (-2.3%). Building and Construction All material prices increased by 0.1% in the month. This suggests that there is no significant signs of uptick in building & construction sector, but there is some ongoing inflation feed-through in heavily subsidized insulation and refitting activity.

Year on year, the price of Capital Goods increased by 0.7%, while the monthly price index increased by 0.1%. Again, spare capacity in the sector relating to investment continues to run against the lack of demand.

The core driver of all price hikes, is most likely energy cost, feeding through a lag. Price of Energy products rose 3.9% in the year since February 2011, and Petroleum fuels increased by 10.3%. In February 2012, the monthly price indices for both energy-related categories decreased by 0.1%.

21/3/2012: Anglo's Promo Notes - perfect target for debt restructuring

This is an unedited version of my Sunday Times article from March 18, 2012.



At last, courtesy of the years of economic and financial mess, Ireland is waking up to the problem of our debt overhang. For those of us who have consistently argued about the unsustainability of our fiscal and real economic debts predicament, this moment has been long coming. The restructuring of some of the debts carried by the Government directly or indirectly, on- or off-balancesheet is a matter of when, not if. Enter the debate concerning the Promissory Notes.

Per international research, State debt in excess of 90-95% of the real economic output is unsustainable. In real economics, as opposed to fiscal projections, debt becomes unsustainable when it exerts a long-term drag on future growth.

At the end of 2011, official Government debt in Ireland has reached 107% of our GDP or 130% of GNP, according to NTMA. The Irish economy is now operating in an environment of records-busting exports, current account surpluses, and healthy FDI inflows, and yet there is no real growth and unemployment remains sky-high. By comparatives, Irish economy is a well-tuned, functional car stuck in the quicksand – engine revving, power train working, wheels engaging, with no movement forward. This is a classic scenario of a debt overhang crisis – the very same crisis that Belgium has been struggling with since 1982, Italy – sicne 1988, Hungary – since 1991, and Japan – since 1995.

Something has to be done to deal with this problem in Ireland no matter what our Government and the EU say in public.

Uniquely for a euro area country, Ireland’s debt overhang did not arise solely from fiscal or structural economic shocks, but was strongly driven by the country response to the financial crisis rooted in a number of forces, including policy and regulatory errors by the EU and ECB. Also, Ireland has undergone the most severe adjustments in its fiscal position to-date compared to all other ‘peripheral’ economies, proving both our capability and commitment to reforms.

Lastly, in contrast with all other countries, Ireland’s economy is capable of getting back to sustainable levels of economic activity. Irish economy needs a supporting push out of the quicksand of banks-linked debt overhang to deliver on its sovereign debt commitments, and become once again a net contributor to the sustainable fiscal system within the euro area.

The IBRC Promissory Notes are a perfect focal point for such a push for a number of reasons.

First, the magnitude of the Promissory Notes allows for significant room to reduce Irish Government’s future liabilities, combining €28.1 billion of debt, plus 17 billion in interest repayments. These represent 29% of our GDP. Eliminating this liability will restore Ireland back onto sustainable fiscal and growth paths. Restructuring the Notes will not constitute a sovereign default. Although their value is counted in Irish Government debt, they are not traded in the markets. The Notes are, de facto, Irish Government IOUs to the Central Bank of Ireland with IBRC acting as an agent.

Second, Promissory Notes underwrite €28 billion of €42 billion IBRC debts to the ELA programme run by the Central Bank of Ireland. ELA funds are not borrowed by the Central Bank from the Eurosystem or the ECB, but are created by the Central Bank under its mandate. There is no offsetting physical liability the Central Bank needs to cancel by receipt of payments from the Government. The Notes also do not constitute Central Bank funding for the Government as they finance stabilization of the Irish (and thus European) banking system. Lastly, the ELA funding extended to the IBRC is already in the financial system. Removing requirement on the Irish state to monetize the Promissory Notes will not constitute an inflationary quantitative easing.

The Government is correct in focusing much of its firepower on the IBRC’s Promissory Notes. Alas, efforts to-date suggest that it is not setting its sights on the real solutions needed. This week, Minister Noonan has identified the direction in which the talks are progressing: restructuring the Promissory Notes repayment time schedule, plus possibly reducing the interest rate attached to the notes via converting the notes into ESM debt.

The problem with this approach is that a transfer of liabilities to ESM will convert Promissory Notes into a super-senior Government debt. This is likely to have a negative effect on Ireland’s ability to borrow funds from the markets in the future and make such borrowing more expensive.

In addition, lowering interest rate on the Promissory Notes carries two associated problems with it. The move can only have an appreciable effect on Exchequer finances after 2014, when interest on the notes ramps up to €1.8 billion from zero in 2012 and €500 million in 2013.

Delaying repayment of notes instead of reducing the principal amount owed on them will not provide significant relief to the Exchequer in the future and will make the period over which the debt overhang occurs even longer than 20 years envisioned under the current Notes structure. This will pose serious risks. History of business cycles suggests that between now and 2025 when Notes repayments will fall significantly, we are likely to face at least two ‘normal’ or cyclical recessions. During these recessions, Notes repayments will coincide with rising deficit pressures and national income contractions that will exacerbate the Promissory Notes already adverse impact on Irish economy. Extending the period of notes repayments risks compounding more recessionary cycles in the future.

Furthermore, delaying notes repayments can risk increasing the overall future demand for debt issuance by the state. Currently, Ireland is facing two debt-refinancing cliffs during the life of the Promissory Notes: €45.6 billion refinancing over 2013-2016 and €62.4 billion over 2017-2020. If Notes repayments are delayed, their financing will stretch further into post-2020 period, just when the subsequent roll-overs of Government bonds will be coming due.

In more simple terms, current proposals for Promissory Notes restructuring are equivalent to making quicksand pit shallower, but much wider.

Ireland needs and deserves a direct restructuring of the ELA. The most optimal outcome of such a restructuring would be de facto cancellation of ELA requirement for repayment of IBRC-borrowed €42 billion. Once again, such a move would have zero inflationary impact on the economy as on the net no new money will be created in the euro system over and above the amounts already present.

There remains, however, one sticky point. Allowing Ireland to restructure its ELA can, in theory, lead to other Central Banks following the suit. This problem of moral hazard can be easily mitigated by ECB by ring-fencing Irish ELA restructuring solely for the purpose of winding down IBRC. Making ELA writedown conditional on shutting down Anglo and INBS, plus potentially Permanent tsb will disincentives other countries from using their own ELAs to rescue solvent banks. Irish restructuring can be further isolated by tying ELA writedown to progress already achieved by Ireland in tackling fiscal deficits and restructuring its banking sector. Put simply, with such a proviso in place, no other Euro area country would want to dip into its National Central Bank vaults if the associated cost of doing this will amount to over 50% of its GDP.

Ireland’s crisis is unique in its nature and its resolution provided a buffer to cushion the credit crisis blow to the entire euro area banking sector. Ireland both deserves and needs a breakthrough on the debts assumed by taxpayers in relation to the insolvent IBRC. Even more importantly from Europe’s point of view, the ECB needs a positive example of a country emerging from the deep crisis within the euro system. Ireland is the only candidate for success it has.

Source: NTMA and author own calculations.
Note: In computing second round of rollovers, only Government bonds are included and taken at 95% of the principal amount. All other debts are excluded.

Box-out:
In the wake of last week’s Quarterly National Household Survey release, the Government was quick to point to the improvement in the number of employed on a seasonally adjusted basis as the evidence the employment policies success. Overall numbers in employment rose in Q4 2011 by 10,000 or 0.56% compared to Q3 2011, once seasonal adjustments were made. Furthermore, per seasonally adjusted data, full-time employment was up 8,700 – accounting for 87% of this jobs creation. Alas, this is not the entire picture of the job market health. Year on year, seasonally adjusted employment was down 17,800 or 0.97%. More ominously, unadjusted employment was up just 2,300 in Q4 2011 compared to Q3 2011 – an addition of statistically insignificant 0.1%. Interestingly, full-time unadjusted employment figure fell by 700 jobs (-0.1%), while part-time employment rose 3,000 (+0.7%). At the same time, number of part-time workers who are underemployed has jumped 5,800 in a quarter and 28,100 year on year. Two reasons can help explain the above disparities. First, Government training programmes have been aggressively taking people out of unemployment counts, increasing employment numbers. In the case of Job Bridge, for example, these are unpaid ‘internships’ with questionable rate of post-internship transition to work so far. Second, since Q1 2011, CSO has used a new model for seasonal adjustments, which may or may not have an effect on seasonally adjusted headline numbers. Lastly, seasonal adjustments can increase, not reduce quarterly data volatility at the times when trends change. Particularly, with flattening out of the employment figures after years of steep declines, seasonal adjustments can introduce a temporary bias into subsequent data. In short, making conclusions about the actual changes requires more careful reading of the numbers than a simplistic headline figure referencing. With all annual indicators pointing to a shallow decrease in employment, the Government would be best served to have some patience and see how subsequent quarters numbers play out before jumping to conclusions on the success of its policies.

Tuesday, March 20, 2012

20/3/2012: There is nothing new about Europe's growth crisis

EU's latest catch phrase is 'growth'. The Commission is banging on about subsidies along with an old tune of EU2020 'plan' for subsidies, picking of winners and rewarding the whiners. The IMF is whinging about 'structural reforms' which is all about extracting some sort of a surplus from something other than domestic consumers demand and investment. National authorities are singing the diverse songs - calling for subsidies and more borrowing from the North in the Periphery, calling for less transfers to the Periphery in the North. Belgium, as ever stuck in-between, has all of the above to the detriment of national dis-unity, which by now is a second-stage show, given all the dis-unity in the European Union.

And the reality is - EU and especially the Euro area are falling out of the world's economic orbit, with speeds that are accelerating - from the modest declines of the 1980s to faster rates in the 1990s and to acceleration in 2000s followed by speedier 2010s.

Note, all data below is sourced from the IMFWEO database with my calculations based on the same.

Here's how the mighty have fallen:




And no, the above charts do not show us performing any better than the US or G7. They show us performing as badly as Italy and worse than Japan:

  • Between 1980 and 2010, Italy's share of world GDP fell 46.7%, Euro area's share declined 47.1%, Japan's dropped only 32.8%.
  • Between 2010 and 2016, based on IMF projections, Euro area's share of world GDP will decline 15.2%, US' share will drop 9.7%, Germany's 15.0%, France's 13.6%, Italy's 19%, Japan's 15.7%
  • In the Decade of the Euro, Euro area's share of world GDP declined 20.7%, while during the decade of the 1990s it fell 15.0% and in the decade of the 1980s it declined just 7.5%
No matter how you spin it - Euro area is going down in world rankings of growth areas and it is moving at the speed worse than the one attained by Japan. 

The last chart above clearly shows that the rate of Euro area's might decline has accelerated dramatically since 2001 and that this rate is invariant to the current crisis.

More subsidies, Brussels, please! More 5-year plans for 'Knowledge, Green, Social, Whatnotwellhaveit Economy', Commission, please! They all have been working so well so far.

Monday, March 19, 2012

19/3/2012: Debt and Unfunded Obligations

Chart of the day (updated):


Sources: http://www.ncpa.org/pdfs/st319.pdf and author own calculations. Update covers latest IMF estimates for GDP change 2009-2011 and rebasing of all liabilities to 2011.

Sunday, March 18, 2012

18/3/2012: Fiscal Stimulus Multipliers - US data and some Irish considerations


In a recent paper, “Fiscal Stimulus and Distortionary Taxation”, Thorsten Drautzburg and Harald Uhlig (published Becker Friedman Institute for Research in Economics Working Paper No. 2011-005 ) estimate the fiscal policy multipliers from the federal spending programmes under the American Recovery and Reinvestment Act (ARRA) of 2009.

Fiscal multiplier is the ratio of output changes to the total stimulus policy-driven change in Government spending and transfers. So positive large multiplier means greater response in economic output per unit of spending, negative multiplier means a fall in the economic output for a unit of spending.

In addition to the traditional literature, the authors include a number of coincident effects:
  • Fiscal expansion takes place in the environment of recession, which is also coincident with the Federal Reserve carrying out a monetary easing – referenced as the zero lower bound interest rates policy (ZLB). When the fiscal policy stimulus creates positive impact, this translates into incentives for the Fed to exit ZLB earlier, which in turn reduces economic activity rate of growth. The effect is compounded in the case when wages are sticky (for example, if negotiated via collective bargaining) and/or prices are sticky (for example, if set by regulatory authorities).
  • In addition, the authors recognize that implementing / deploying fiscal stimulus in practice takes time in practice.
  • Third, government expenditures on stimulus are financed, eventually, with distortionary taxes, creating costly disincentive effects in the future.
  • Fourth, welfare transfers matter “to the degree to which they are given to credit-constrained households”.
  • Fifth, the authors use Bayesian estimation techniques as well as sensitivity analysis to quantify the uncertain nature of the estimated coefficients in the New Keynesian model.


The study distinguishes between short-run and long-run multipliers in a benchmark model, finding:
  • “Modestly positive short-run multipliers” that average 0.51, and
  • “Modestly negative long-run multipliers” averaging around -0.42.
  • The multiplier is particularly sensitive to the fraction of transfers given to [credit constrained] consumers, is sensitive to the anticipated length of the zero lower bound [the expected period of monetary policy easing], is sensitive to the capital share [in overall stimulus – i.e. the share of stimulus spending directed to capital formation as opposed to consumption] and is nonlinear in the degree of price and wage stickiness.
  • Crucially, “reasonable specifications are consistent with substantially negative short-run multipliers within a short time frame” meaning that under reasonably realistic assumptions on price/wage stickiness and model parameterization fiscal stimulus can result in a negative effect on economic growth even in a short-run.
  • In the US, the stimulus results in negative welfare effects for agents not constrained by debt. The debt-constrained agents gain, if they discount the future substantially.

Now, the above results are quite interesting in the context of the US economy, but they are even more interesting in the context of Ireland, as a small open economy with fixed interest rates. This is so for a number of reasons:
  1. Ireland’s domestic demand is closely linked to imports, which means that unlike in the US, Ireland’s short-run multipliers can be expected to be smaller in magnitude due to losses of economic activity to imports. Note – imports enter GDP and GNP determination as a negative component, so any stimulus funds expended on imported consumption (public and private) will have a dual effect on overall economic activity: in the short run, they will reduce economic activity via imports increases (effects not present in the US economy), and they will reduce, in the longer term economic activity via same pathways as those revealed in the paper.
  2. Ireland’s public expenditure is heavily leaned in the direction of consumption supports / income transfers. These provide support for both credit ‘unconstrained’ (non-indebted) poor households (who do not have mortgages and are not subject to the adverse effects of debt overhang) and for households of the unemployed who are constrained by debt overhang (hence significant rise in mortgage supplements payments). Those households, constrained by debt (such as mortgage holders still in employment) and the ones unconstrained by debt and not in welfare net (for example older households with no debt overhang) are therefore direct losers in the short run and in the long run. This, per findings above means that increasing social welfare transfers during the current crisis can lead to reduced economic activity even in the short run, while increasing negative effects of the stimulus in the long run.
  3. Our monetary policies are determined outside Ireland and hence we can add higher uncertainty and shorter periods of ZLB duration to the Ireland-specific assumptions (remember, the ECB did hike interest rates into the Irish recession and then repeated the same again). This means that any fiscal stimulus in Ireland will be subject to stronger monetary policy headwinds, further reducing the multipliers in the short run and amplifying long-term costs of such a stimulus.
  4. Ireland’s tax system became even more distortionary during the crisis and this process is ongoing. Once again, this amplifies the adverse finding from the US data and interacts negatively with point (2) above.

The study also incorporates consideration of the time-varying differentials between the central bank-set interest rates, government borrowing costs (bond rates) and returns to private capital (cost of private sector credit). The paper shows that “these wedges are indeed the key to understanding the recession of 2007 to 2009.” Although the study does not explicitly quantify these drivers effects, one can suspect that in the case of Ireland, dramatic increases in the cost of Government borrowing, alongside the rise in retail-level interest rates due to banks bust would have much more adverse impact on fiscal stimulus effectiveness. Whether or not these effects are enough to swing the stimulus short-run multiplier to the negative territory we do not know. But it is pretty safe to assume that they will make long-term costs of the stimulus more severe.

The use of New Keynesian model specification allows authors to conclude that “the model here is heavily tilted towards a model in which fiscal stimulus is often thought to work well: we therefore believe that the negative long-run effects of fiscal stimulus should give pause to arguments in its favor. Even at the short horizon, the benchmark multiplier is just around 0.5.”

Another interesting result is that consumption taxes, rather than income taxes are a better way to offset the costs of stimulus in the longer term. This is intuitive and consistent with other evidence. However, the paper finds that “adjusting [raising] consumption taxes only yields a slightly higher multiplier than adjusting labor tax rates.”

Please keep in mind that the Irish stimulus theory supporters have ardently argued that fiscal stimulus must be financed via income tax increases, not consumption tax hikes and have opposed even a modest Budget 2012 shift of tax burden on VAT.

Saturday, March 17, 2012

17/3/2012: Long-term impact of unemployment - US study, Irish implications

An interesting study by Steven Davis and Til Wachter titled "Recessions and the cost of job loss"published by Becker Friedman Institute for Research in Economics Working Paper No. 2011-009 aims to quantify some of the effects of jobs displacement in the recession on cumulative losses in earnings. The study uses microdata from Social Security records for US workers from 1974 to 2008. 


Some findings:

  • In present value terms, men lose an average of 1.4 years of re-displacement earnings if displaced in mass layoff events that occur when the US unemployment rate is below 6 percent. 
  • Men lose double that - 2.8 years - of pre-displacement earnings if they lose their job when the unemployment rate exceeds 8 percent. 
  • To add to authors conclusions: if you think of it in terms of the life-time losses, this is equivalent to roughly 14% loss in life-time earnings. Now, if you put this into a retirement perspective - this amounts to roughly 1/3 of an average funded retirement stream of earnings.
  • Some more granularity on the study results: "For men with 3 or more years of prior tenure who lose jobs in mass-layoff events at larger firms, job displacement reduces the present value of future earnings by 12 percent in an average year. The present value losses are high in all years, but they rise steeply with the unemployment rate in the year of displacement. Present value losses for displacements that occur in recessions are nearly twice as large as for displacements in [economic] expansions. The entire future path of earnings losses is much higher for displacements that occur in recessions. In short, the present value earnings losses associated with job displacement are very large, and they are highly sensitive to labor market conditions at the time of displacement."
  • The study also finds "large cyclical movements in the incidence of job loss and job displacement and present evidence on how worker anxieties about job loss, wage cuts and job opportunities respond to contemporaneous economic conditions". 
  • More specifically on the above point: "Drawing on data from the General Social Survey and Gallup polling, we examine the relationship of anxieties about job loss, wage cuts, ease of job finding and other labor market prospects to actual labor market conditions. The available evidence indicates that cyclical fluctuations in worker perceptions and anxieties track actual labor market conditions rather closely, and that they respond quickly to deteriorations in the economic outlook. Gallup data, in particular, show a tremendous increase in worker anxieties about labor market prospects after the peak of the financial crisis in 2008 and 2009. They also show a recent return to the same high levels of anxiety. These data suggest that fears about job loss and other negative labor market outcomes are themselves a significant and costly aspect of economic downturns for a broad segment of the population. These findings also imply that workers are well aware of and concerned about the costly nature of job loss, especially in recessions."
While re-parameterizing the US labour market experience as revealed in the study into that in Ireland is not possible, the above results very clearly point to the extremely significant implications of the current unemployment in Ireland on expected future life-time earnings of a large proportion of our population. In Ireland, we have not even began assessing the impact that current unemployment crisis will have on:

  • future economic growth (via earnings-savings-investment and earnings-consumption links which imply that previous unemployment-related reduction in life-time earnings will have significant, potentially double-digit-sized adverse drag on savings, investment and consumption levels, let alone growth rates, into the future) 
  • fiscal revenues in the future (via earnings-tax revenues links which imply reduced tax revenues levels from consumption, investment and income taxes into the future) 
  • retirement funding and demand for public health and pensions (via earnings-savings-investment links which imply reduced funding for retirement and private health)
  • education funding for children (via reduced earnings of parent impact on children education) and
  • the links between current debt levels, property markets, future investment and economic activity.
Neither do the above results cover the Irish-specific case of household wealth destruction and debt overhang accompanying the stratospheric rise of unemployment.

Friday, March 16, 2012

16/3/2012: ECB policy - Death Star Can't Do Growth

Two charts from the ECB's monthly bulletin that really do describe the anti-inflationary madness of Europe manifested in "Kill Economy, Keep germans Safe from Inflation" mantra:



 And in case you need a summary in numbers:


Look at differentials in growth on M1,M2 and M3 and look at credit to the private sector - also see next chart.
Yep, go into economic slowdown and tighten credit supply growth. Nice.