Michael Burke: The Central Bank’s latest Quarterly Bulletin contains a sharp reduction in its growth forecasts.
It is now forecasting 1.0% GDP in 2011 and -0.3% GNP. Previous forecasts were 2.4% GDP and 1.7% GNP. The media coverage of the downward revision almost completely neglected the reason for the increased pessimism, and over at the Irish Economy blog there has also been a discussion of the Bulletin without ever referring to the cause of the lower forecasts.
So, here is the Central Bank’s own rationale for lowering its forecasts:
"These projections represent a significant downward revision to those published in the last Quarterly Bulletin, which were compiled on the basis of a much smaller €3bn fiscal consolidation in 2011 than the one currently budgeted, and on the basis of continued market access to funding on reasonable terms.”
The point on reasonable funding terms seems misplaced. The average interest rate on the EU/IMF debt to bail out Europe’s banks is no greater than market rates that obtained when he prior Bulletin was published. On 1 October 2010 Irish 10yr yields were 6.6% and 4yr yields were 5.25%.
Therefore, the real change in circumstances is the much larger ‘fiscal consolidation’ in 2011; €6bn in spending cuts and tax increases rather than the anticipated €3bn. This is a rare explicit official admission that the cuts’ policy has a depressing effect on activity, with obvious implications for the entire logic of the policy. If an extra €3bn in fiscal measures can depress GDP by 1.4% and GNP by 2%, what will be the impact of a €15.8bn ‘fiscal consolidation’? In reality, as the central bank points out €700mn of the 2011 measures are non-recurring asset sales and similar (p.29) - which will not affect growth.
Therefore the additional measures affecting growth amount to €2.3bn. And the impact on the economy? GNP will be €2.6bn lower than previously forecast (Table 1).
Now, of course this doesn’t mean that the central bank has joined the investment, not cuts camp. The intellectual contortions required to accept that cuts are necessary even while identifying the damage arising from them is not confined to the central bank.
But what is the fiscal impact?It is commonplace to assert that lower growth will lower taxes by 30%, as that is the proportion of tax revenues relative to GDP. This nonsense is recycled by many who should know better. First, total government revenues (including social security and other items not in the Exchequer Statements) are overwhelmingly derived from GNP and in 2010 were 43.8% of it. Secondly, the sensitivity of taxation revenues is greater still. Sensitivity is not taxation/output but the change in taxation revenues/change in output.
Some leading commentators – advocates of ‘fiscal consolidation’ – seem wholly unaware of this sensitivity of taxation, which the DoF puts at 0.6. Thirdly, the sensitivity of government finances also includes outlays, ie of output falls and unemployment rises social welfare outlays will rise even if welfare entitlements are cut. Usually, these are neglected in the debate but they are about half the size of the tax impact.
So, we reach a situation where, according to Central Bank analysis, a €2.3bn fiscal tightening leads to a fall of €2.6bn in output. According to DoF analysis this will lead to a €1.56bn in fall in tax revenues. Standard assessments of the impact on government outlays would suggest a rise of €780mn, for a total deterioration in government finances (combining falling taxes and rising outlays) of €2.34mn. That’s €4mn more than the ‘fiscal consolidation’.
So, the deficit is being entrenched and consolidated, along with Depression and unemployment. That’s how we got here. Getting somewhere else still requires a different path.