Tuesday, November 30, 2010

Central Bank Data

The Central Bank have released the Credit, Money and Banking Statistics to the end of October. (Release here, data here).  A couple of trends have remained consistent.

We’ll start with total private sector credit.

Private Sector Credit

The total amount of credit extended to Irish residents has been falling since the middle of 2008.  The small ‘jump’ seen for January 2009 was when the loans offered by credit unions were included in the Central Bank’s measure of private sector credit.  Private sector credit peaked at €375 billion in October 2008.  In September it had fallen to €285 billion and this fall continued in October when it was €280 billion, a level not seen since June 2006.

Here we break the above total into lending to households, non-financial corporations (business) and financial corporations.

Private Sector Credit by Category

The biggest drops have been in the business sector which has seen the total amount of credit extended fall from €170 billion at the peak  in mid-2008 to €103 billion now.  The quantity of loans extended to business since the start of 2009 paints a telling picture.

Loans to Business

Some of this decline may be due to the transfer of developer loans from the banks to NAMA but a significant portion of it is due to a contraction in the amount of credit available to businesses.  Here we look at the category of loans extended to business.

Loans to Business by Category

Although the totals in all categories of loans extended to businesses have been falling, the fall in 2010 for loans issued for up to 1 year has been very dramatic.  This has fallen by 42% in the first ten months of the year, from €49 billion in January to €28 billion now.  NAMA is not good for all of that.  Working capital for firms is getting scarcer and scarcer.  If only they had the ECB to act as an ‘lender of last resort’ to tide them over.

In the household sector some 80% of loans are mortgages, and for the past two years or so repayments on existing mortgages have been greater than the amount of new loans issued. 

Household Loans by Purpose

Although we do have a huge arrears problem we do have a lot of household meeting their mortgage obligations and more.  The amount of outstanding mortgages peaked at €128 billion in May 2008.  These balances are now down to €108 billion.  It must be noted that most of this fall occurred up to the end of 2009 when mortgage balances stood at €110 billion.  This was the primary destination of our €11 billion of household savings in 2009. 

In the first 10 months of 2010 mortgage balances have fallen by €2 billion.  Unless household deposits are rising rapidly this suggests we can expect a dramatic drop in the household savings rate in 2010 from its 12% level in 2009.

So on that let’s look at deposits.  Not good.

Household Deposits

Since the start of 2010, household deposits have fallen by about €3 billion.  With total loans to households down by one €1 billion over the year (from €139 billion to €138 billion) this indicates that Irish households are dissaving in 2010.  This is not because they are borrowing to fund consumption, but that they are drawing down savings to fund consumption.

If  we look at the ratio of household deposits to household debts we see a ratio that improved through 2008 and 2009 but has deteriorated this year.  The credit boom during the middle part of the decade is clearly visible as household debt soared.

Ratio of Deposits to Loans

Of course, there are number of caveats to the above ratio.  Firstly, this is an aggregate measure.  It is likely that the subset of households who hold the €96 billion of deposits is a different subset to those who are carrying the €138 billion of loans.  The indebtedness of many households in Ireland is enormous.  Secondly, the decline in deposits in Irish banks could be a reflection of the ongoing crisis our banks face and it may be that people are not necessarily using up their savings but transferring it to banks in other countries.

The banking crisis is having an effect on the category of deposits used by households.  Households are less willing to have their money tied up in accounts which can have maturities of up to two years.  Accounts with notice periods of no more than three months are seeing more money placed into them.

Household Deposits by Category

Finally, here are the total deposits of Irish businesses since January 2009.  Businesses are being squeezed on all sides with credit falling as we have seen above and the graph below showing that the amount of deposits businesses have access to also falling.

Business Deposits

Monday, November 29, 2010

Fall in Retail Sales halts for now

The release of the October Retail Sales Index by the CSO has been largely overshadowed the dramatic economic developments elsewhere.  The headline figures are positive with October retail sales up 0.5% by volume and 0.7% by value on September.  Annual sales by volume are up 2.0% and sales by value are down 0.1% reflecting the deflationary pressures that persist in the economy.

As is usual we will focus on the Retail Sales Index that excludes the motor trades.  In October the motor trades make up 18.2% of the index.   Here are the value and volume indices excluding the motor trades.

Ex Motor Trades Index to Oct

After recording monthly falls by value and volume, both indices were largely unchanged in September.  Here are the monthly changes since January 2009.

Monthly Change Ex Motor Trade Index to Oct

This moderated the annual decreases that have been recorded in retail sales for all months since July 2008 (bar April 2010 for the volume index).

Annual Change Ex Motor Trade Index to Oct

For the five-month period from December 2009 to April 2010 the retail sales index did exhibit some “turning the corner” momentum.  This has subsequently been reversed.  Between December 2009 and April 2010 both the volume and value indices excluding motor trades rose by about 3.5%. 

We are unlikely to see a similar upswing this year as reduced social welfare and increased taxes reduced household disposable incomes.  When we get the releases of the Retail Sales Index we will see an increase in the annual declines in the indices.

Surely, something is wrong with this picture

Taken from Bloomberg.  Irish 10-year bond yields Monday 29th November.

Bond Yields 1D 29-11-10

The one positive to be taken from this is that the average interest rate on the EU/IMF package of 5.83% is lower than the 9.25% it appears we would apparently have to pay if we were borrowing from bond markets.  But surely the release of the details of the EU/IMF package should have brought yields down and not sent them up.

And stop calling me Shirley!

Thursday, November 25, 2010

Cash transfers

According to the Household Accounts, disposable income in 2009 was supported by record payments of €26.3 billion in direct cash transfers from the State.  This represents 29.3% of the €89.6 billion net disposable income that households had in 2009 and 15.4% of GNP.  Here is a breakdown of the €26.3 billion in cash transfers provided by the State in 2009.

Cash Transfers

The €26.3 billion paid out by the State to supplement the incomes of those in need (or not in some cases) exceeds the €20.6 billion collected in Income Tax and PRSI contributions from those with earned income. 

Cash Transfers versus Income Taxes

Over the past ten years the proportion of Income Tax and PRSI contributions to GNP has remained relatively stable, and at 15.7% in 2009 were actually greater than then the 15.0% figure of 2000.  On the other side, cash transfers from the State have increased from 9.8% of GNP in 2000 to 20.1% in 2009.

We now have apparently “high-cost” services in a so-called “low-tax” economy.  Much as we’d like, we cannot have both.  I would like to hear social and economic reasons to justify why we should try to balance this inequality rather than have the outcome the result of a piece of arithmetic.  Social welfare recipients and tax payers deserve more than that.

Wednesday, November 24, 2010

Pension rates

In 1997 the contributory old-age pension was £80.30 per week (€101.96).  As of today the contributory old-age pension is €230.30.  This represents an increase of 126%.  The progression of this payment is shown below. 

Contributory Old-Age Pension

Here is the same data in a table with some additional CPI inflation numbers.

Contributory Old-Age Pension Table

Prior to 2010 there was only one year since 1998 when the increase in the contributory old-age pension was less than the rate of inflation.  This was in 2000 when the pension was increased by 5.1% while inflation was running at 5.6%.  In each subsequent year to 2009 the increases in the pension outstripped inflation.

We can also see that the total amount paid by the State in contributory old-age pensions has increased from €413 million in 1997 to €3,340 million in 2009 – an increase of 709% which is driven by demographic changes as well as increases in the rates.

Here is a graph comparing the contributory pension rates to the consumer price index can be seen here. 

Pension and CPI

This comparison is similar to a previous comparison we did with one public sector worker’s salary.   Some of the same caveats to that comparison also hold in this instance.

First, the CPI is a price index and not a cost-of-living index.  Second, we are not making a judgement on what the “right” weekly pension rate is.  The pension could have been “too low” in 1997 just as easily as it might be “too high” in 2010.  These are judgement calls.  Here we just make a comparison of two series.  Make of it what you will.


Some sums by Brian Lucey on last night’s Tonight with Vincent Browne seemed designed to spook people.  You can watch the show here.  But don’t.  The question Prof Lucey was asked was “put together the total state debt after this EU bailout”.  This table summarises his answer.

Lucey Sums

During this segment I heard the word “trillion” used in the Irish context for the first time. (How big is a trillion?).  Further scaremongering ensued when the calculators hummed into life and suggested that the annual interest bill on this debt would be somewhere of the order of €14 billion.  That is more than we collect in Income Tax in a year.  How do the sums stack up?

The first item is correct. Per the NTMA we have €89.7 billion in outstanding government bonds.

The way I see it, the second item is incorrect.  This €20 billion is money the NTMA has borrowed therefore should be part of the €90 billion in the first item.  Thus it should be not added in this calculation.  In fact this €20 billion is an asset we have on deposit somewhere.  Not only should it not be added, it is possible it should be subtracted! Anyway even if this €20 billion is in addition to the €90 billion national debt figure, it must be netted against the asset of the €20 billion on deposit somewhere. 

Of course, this isn’t the first time Prof. Lucey has struggled with the difference between assets and liabilities.  See here.  “Anglo can be wound up cheaply -- here's how. Sell the €28bn deposit book.”  Discussion here.

The third item is also incorrect.  First of all, we have  €16 billion in bonds maturing in the period 2011-2013 so I cannot see where the €23 billion number comes from.  See the document from the NTMA linked above.  But redeeming bonds does not add to our debt.  We have to borrow the money, but we use it to pay back the maturing bonds.  The net debt position at the end of the process is exactly the same.

Item four on the ongoing funds required to recapitalise the banks is still a shot in the dark and it is difficult to argue with any quoted figure.  This may or may not be true.

Item number five looks ok.  We have a €19 billion annual fiscal deficit.  Assuming an average of €15 billion per annum for the next three years seems plausible and will add €45 billion to the national debt.  Some of this will also be funded by the  €20 billion on deposit we have because of item two above.

Items six and seven are debt but it is a bit of a stretch to include them in the same category in a question on “state debt”.  These funds (and it is difficult to verify the actual amounts) are being provided to Irish banks by the ECB and ICB to keep the banks open.  In “normal” times this money would be sourced from inter-bank markets.  The problem is that Irish banks do not have access to these funds in current circumstances. 

This money is not going into a black hole to fund the recapitalisation of the banks.  This money is used to finance the assets the bank have – interest earning loans to borrowers.  The interest cost of this ECB and ICB money will be subtracted from the profits of the banks.  Remember on a day-to-day or operating basis Irish banks are hugely profitable.   The huge hole is in their balance sheets and this money is not going to fill that hole.

Also, this money is just replacing debt that was already on the banks books.  Previously the banks had received the money from the inter-bank market and large corporate deposits.  They had to pay interest on this money.  Now the inter-bank funds and withdrawn deposits have been replaced by funds from the ECB and ICB on which the banks again have to pay interest.  These liabilities have been on the bank’s books the whole time.  Why is Brian Lucey getting so excited about this money now just because they owe it to the ECB and not the inter-bank market and corporate deposit holders as was previously the case?

Finally, while we do own the banks, we also own Bord Gais, the ESB, the DAA and a raft of other state companies.  Why didn’t our hero include the substantial debts of all these companies in his measure of state debt?  Not enough time?  He had guessed on lots of other things why not guess on this.

We are in a very serious position, but this ridiculous scaremongering helps no one.  The numbers are immense but makey-uppy sums to get to €343 billion are offside, €200 billion is scary enough.

Bond yields heading back to 9%

A “bail-out” is good, right?  The reaction of bond markets to Ireland’s IMF/EU “rescue” has not been stellar.  Yields on Monday were largely unchanged as markets digested the fallout from Sunday’s announcements.  Yesterday yields on 10-year Irish Government bonds rose from 8.1% to 8.4%.  Already today they have risen by the same amount.  From Bloomberg.

Bond Yields 1D 24-11-10

Heading for 8.7%, fast. 

Tuesday, November 23, 2010

More on closing the gap

Update on this.

With the IMF in town and the EU’s 3% GGB target by 2014 now seemingly the drivers of our economic policy it is probably worth a moment to take stock and look into the numbers behind our fiscal crisis.  This may be moot at the banks threaten to pull the country into the abyss regardless of what Budget is or is not agreed in the next few weeks.

The public finances have a €19 billion hole to be filled.  In 2009 the government had €53 billion in receipts and spent €72 billion running the country.  We will look at both of these in turn.

First, let’s take the revenue side. 

Looking at the euro amounts shows the drop in tax revenue that has occurred since 2007.  See here.  However, it is more intuitive to look at how much of our income (i.e. Gross National Product) the government is collecting in revenue.

Revenue and Tax Receipts

This is not showing much movement for an an economy that has shown a dramatic swing from boom to bust.  In 2009, government revenue as a percentage of GNP was 40.4%.  This is a slight drop from the 41.6% recorded in 2006.  Although this measure hasn’t show much variability over the past decade, it my view it is (and has been) too low.  We should be aiming for a tax/GNP of around 46%.  In terms of 2009, this would require an increase in government receipts of close to €7.5 billion.

Now we’ll turn to expenditure.

Again it is not the euro amounts which are most intuitive but they are revealing.  See here.  Again we will look at the expenditure figures as a percentage of GNP.

Expenditure and Current Expenditure

Wow! And this is just “normal” government expenditure as it excludes the monies used to start our ill-fated bank bailout in 2009.  As a proportion on our income, government expenditure has risen from 38.5% in 2006 to 55.3%.  Many of the most socialist regimes in Europe would not a level of government expenditure this high.  

With a stated revenue target of 46% of GNP, this would ‘allow’ a expenditure level of just under 50% of GNP to meet the 3% GGB target.   Again in 2009 terms, this would require an expenditure cut of about €7.5 billion.  Equal pain between tax and expenditure.

Here are the total revenue and total expenditure graphs combined.

Total Revenue and Expenditure

The expenditure graph above also shows that the driver of the increase in total expenditure has been current expenditure.  Lets looks at the components of current expenditure.

Components of Current Expenditure

All of these have been increasing, but the rise has been greatest for social transfers (up from 15,4% of GNP in 2006 to 22.8% in 2009)  and the public sector pay bill (up from11.2% of GNP in 2006 to 15.1% in 2009).  Debt service costs have started to edge up (from 1.2% of GNP in 2006 to 2.4% in 2009) and we can expect this to increase substantially further over the next few years as our borrowing escalates.

The last issue we will consider in this post is the breakdown of the increase in transfer payments.

Components of Social Transfer

The increase in unemployment benefits is readily observable but these transfers remain the fourth biggest category of social protection transfer payments.  The largest area of expenditure here is on old-age benefits which have increased from 3.4% of GNP in 2006 to 5.5% in 2009.

Here are the details of some of these payments in €millions.

OAP Payments The table excludes old-age health-related benefits provided (medical cards, drug purchases).

Highlighting these payments is not to suggest that they should be cut, but with the ‘Croke Park Deal’ supposedly ruling out pay cuts in the public sector and politicians from all sides voicing opposition to pension cuts it is hard to see where the announced expenditure cuts can be found without affecting these areas.

A related point is that if we want to maintain public services and social protection payments at existing levels we have to be willing to pay the taxes to finance them.  We cannot be a “low-tax economy” and cry out for high-cost public services. 

The current strategy of a €15 billion adjustment with a €10 billion expenditure cut and €5 billion tax increase split is being undertaken as a mere accountancy exercise.  Our target should be where we want to the country to be in five years , not aiming for some artificial goalpost. 

Let’s get government revenue up to about 46% of GNP in the next two to three years and have a four to five year plan for getting government expenditure down to a similar level.

Let’s all meet up in the year 2000

HT: Stephen Kinsella

UPDATE: Here’s another from 1998

Saturday, November 20, 2010

The interest cost of household debt

We have been considering the household sector in recent weeks.  We look at the aggregates from the household sector accounts, the use of the €11 billion saved in 2009 and the components of the €84 billion of private consumption expenditure.

One further issue to consider is the role of debt and interest in the household account.  Interest form parts of “property income” which was part of the table produced with the first post linked above.  Household debt is a feature of the capital account which we have not yet considered.

Interest expenditure does not form part of private consumption expenditure.  The graph below shows household interest outgoings since 2002 while a comparison of this to interest earned can be seen here


After rising to a peak of €8.1 billion in 2008, the household interest bill fell to €4.0 billion in 2009.  This is likely because of the fall in the ECB base rate which was raised to 4.25% in July 2008 but had plunged to 1.00% by May 2009.

There  was also a decrease in the amount of debt on which this interest was accruing.  According the Central Bank data outstanding household loans in December 2007 was €153.0 billion.  By December 2008 this had fallen to €144.6 billion with a further fall to €140.1 billion by December 2009.  This €140 billion in debt was made up of €110 billion of loans for house purchase, €24 billion of consumer credit and €6 billion of other loans.

The household sector capital account for the period 2006-09 is shown below the fold

Household Capital Accounts

It can be seen that 2009 was the first year in which the household sector was not a net borrower (and this is actually the case since this series began in 2002).  This is was driven by the surge in savings to €11 billion and the collapse in capital formation (house purchases).

Friday, November 19, 2010

Components of Consumption

The release of the Non-Financial Institutional Sector Accounts prompted us to the consider the Household Sector.  In a subsequent post we looked at what we had done with the close to €12 billion we had saved in 2009.  It is clear that this money was used to pay down debt rather than build up deposits.

We now turn to an examination of the money used for personal consumption expenditure.  In 2009 personal consumption was €84.3 billion down from a peak of €94.8 billion in 2008.  In nominal terms these are increases from the €29.7 billion in personal consumption expenditure in 1995.  Here is the pattern of the nine components of consumption expenditure in current prices as reported by the CSO since 1995.

Components of Consumption at Current Price

The graph shows dramatic increases across a number of sectors, particularly food, housing, transport, recreation and education.  The largest increase over the 15 year period is seen in the category labelled miscellaneous goods and services.   The effect of the recession is most visible in the miscellaneous, housing and transport and communications categories, all of which recorded drops of more than 10% in 2009.

Using current prices it is clear that some of these changes in nominal consumption could be due to price effects.  Here is the same graph using constant prices.

Components of Consumption at Constant Price

Looking at the aggregate figures is reasonably information but it is probably more intuitive to look at the relative proportions of the components of personal consumption expenditure, i.e. the proportion of consumption was devoted to each category.

Components of Consumption Proporations

The stand-out feature of this graph is the drop in the proportion of expenditure that goes on food, beverages and tobacco.  The category comprised 29.6% of expenditure in 1995.  This had dropped to 18.8% by 2008, though increased slightly to 20.2% in 2009.   The breakdown of this category can be seen here.   The sub-category food (excluding meals out) has fallen from 14.0% of consumption in 1995 to 8.9% in 2009.  The other sub-categories have also shown declines in the proportion they comprise of consumption: non-alcoholic beverages (-0.2%), alcohol (-2.8%) and tobacco (-1.3%).  This reduction in the amount of our income we have to devote to food expenditure was the subject of a previous post.

With less of our expenditure devoted to the food, beverages and tobacco category we used a greater proportion of consumption on housing (as a proportion up 4.6% from 11.9% in 1995 to 16.5% of consumption in 2009), miscellaneous goods and services (up 4.4% to 22.3%) and expenditure outside the state (up 2.4% to 6.8%).  There are no sub-divisions provided for the housing and expenditure outside the state categories, and the rather inconclusive sub-categories of the miscellaneous category can be seen here, though there does appear to be an increase in the proportion of consumption on health services.  It is also worth noting that the housing category does not include mortgages as these are treated as investment expenditure.

The only other category for which notable sub-categories are provided is the transport and communication category which up 13.2% of consumption expenditure in both 1995 and 2009 though it had risen to 15.7% in 2006.  The breakdown of this category can be seen here which shows a sharp decline in expenditure on personal transport equipment (down from 6.1% in 2000 to 2.4% in 2009) in the last two years with expenditure on communication showing a steady increase (up from 2.0% in 1995 to 3.3% in 2009).

[ASIDE: One side issue that this analysis raises is the weighting given to the group ‘Motor Trades’ in the CSO’s Retail Sales Index.  Across the year this category makes up about 23% of the Retail Sales Index.  Within this group 82.2% of the weighting is given to the purchase of vehicles.  This would indicate that the purchase of vehicles has a weight of about 19% in the Retail Sales Index. 

The consumption figures explored here suggest in 2005 (the year in which the Retail Sales Index weights are based) that expenditure on personal transport equipment made up 4.6% of total consumption expenditure.  Although the Retails Sales Index only deals with the purchase goods while the consumption expenditure data cover goods and services this would not to sufficient to close the gap.  If expenditure was split evenly between goods and services this would suggest a weighting of 9.2% for the purchase of vehicles.  Why then is the weighting over twice as large at 18.9% in the Retail Sales Index?

Could it have to do with how vehicle purchases are financed, i,e,  cash versus finance?]

UPDATE: A little thought suggests a possible answer.  Figures in the Retail Sales Index are likely to include only the value of the car sold.  This is a measure of turnover which is the total value of sales.  Personal consumption expenditure is likely to be the value of the car purchased less the value of any trade-in used as part of the deal.  The measure of expenditure is likely to be the amount spent above any trade-in value. Q.E.D?

Exports show some real improvement

The CSO have released the latest External Trade Statistics giving details of our merchandise trade up to the end of August (with some preliminary figures for September).  The performance of our exports and imports up to the end of September is shown below.

Exports and Imports to September 2010

Compared to August exports rose 2.0% in seasonally adjusted terms while imports rose 1.2%.  This resulted in an increase in the trade balance for September.

Trade Surplus to September 2010

In our analysis of previous external trade releases from the CSO we have attributed this improvement in out balance of trade to the Chemical and Pharmaceutical sectors which make up 60% of our total exports.  That may not be the case with the trade balance up to the end of August (the categorical breakdown of exports for September are not part of the preliminary estimates).  Here are our monthly Medical and Pharmaceuticals exports for the past four years.

Pharmaceutical Exports to August 2010

After the record monthly exports in this category of €2.34 billion in July, exports medical and pharmaceutical exports dropped 28% to €1.68 billion in August.  With our exports falling by ‘only’ 3.5% in August this suggests that the performance of exports excluding medical and pharmaceutical exports was strong.  Here we see that this was indeed the case.

Exports excl. Med and Pharma to August 2010

The poor performance of our exports excluding medical and pharmaceutical exports that was seen up the end of 2009 has been replaced by a strong performance for the first eight months of 2010.

With all the negativity concerning the Irish economy this week here is a table that is virtually entirely positive.

Exports by Category to Aug

Exports have risen in nine of the ten categories reported by the CSO.  The only category to show a decline is in the Machinery and Transport Equipment category which is down 25% on the same period last year.  This is largely of a result of a drop in computer exports from €4.2 billion in 2009 to €2.8 billion in 2010.  That aside, virtually all other merchandise export categories are on the way up.

Our exports are still dominated by the chemical and pharmaceutical sector but there are signs that exports are “turning the corner”.  Now we need to know if these increases are leading to an increase in employment

Wednesday, November 17, 2010

Eurogroup statement

The statement from the Eurogroup of EU Finance Ministers on the Irish situation can be read here.  An extract.

“We nevertheless invite the Irish authorities to include an annual review in their strategy that will allow them to cope with the implications of less favourable macro-economic developments were they to arise.”

Could they be concerned about our growth projections?  Over the past fortnight we have looked at the forecasts for nominal GDP, real GDP and the components of GDP.  You bet they’re concerned.

Crisis? What crisis?

Minute by minute updates here

10.20am: Brian Lenihan is late, again, for this morning's EU finance minister's meeting in Brussels, Elena Moya tells us. The meeting was due to start at 9.30am GMT.

Tuesday, November 16, 2010

Under pressure with deadlines?

Consider what one ‘student’ can achieve.

“On any day of the academic year, I am working on upward of 20 assignments.”

There are so many economic concepts in this piece that a whole course could be built around it.  The key – people respond to incentives. Always. Even Charles Dickens.

Budget deficits and all that

Here is the unedited version of an article printed in tonight’s Evening Echo.

In 2009 total expenditure by the all the sectors of Irish government was €72 billion. At the same time total receipts of the Irish government were €53 billion. This represents a gap or fiscal deficit of €19 billion. Unlike the costs of our banking collapse, which we hope are once-off, the huge gap in our public finances will continue year after year unless something is done to address it.

The most pessimistic estimates of the total cost of the bank bailout are for a debt of approximately €70 billion to be assumed by the State. However, if left unchecked, the annual deficit in the State’s own finances would match this amount in less than four years and would quickly run ahead of it. To fund this deficit each we year we have to borrow money from international bond markets, and it is clear that such investors now have growing doubts about our ability to repay this money.

There are two ways which the deficit can be closed: increase revenue or reduce expenditure. Although much of the focus has been on expenditure cuts, the deficit has emerged largely because of a collapse in tax revenue. In 2007, tax receipts for the Exchequer were over €47 billion. This year they will struggle to raise €31 billion. We can attribute the main portion of the deficit to the €16 billion drop in tax revenue, which is largely the result of the evaporation of taxes associated with the now departed construction and property bubble.

So how will we close the gap? It is clear that up to a few weeks ago, the Department of Finance had pinned most of our hopes on increased tax revenue which would be generated by a growing economy that had “turned the corner”. We have a €19 billion budget deficit but the plan to address this presented last December suggested that €7.5 billion in budget ‘adjustments’ would be sufficient to close the gap. The remaining €11.5 billion of the deficit would be covered by the buoyant tax revenue provided when our economy returned to the stellar performance of a few years ago. Well that was the plan anyway.

A few weeks ago the finance spokespeople of main opposition parties trooped into the Department of Finance building on Merrion Street. As the day progressed Joan Burton, Arthur Morgan and Michael Noonan emerged ashen-faced and they were the ones to inform us that the ‘head-in-the-sand’ approach did not have much chance of success. It was Michael Noonan who said that “the adjustment required in the Government's four year budgetary plan will be 'significantly higher' than the €7.5 billion figure previously mentioned”.

Why it took so long for this reality to be grasped by all sides of Leinster House is hard to fathom. The European Commission reviewed our original budgetary plan and concluded that “the budgetary outcomes could be worse mainly due to the programme's favourable macroeconomic outlook after 2010”. This was published by the Commission back in March. Yet, it took until the end of October for this nettle to be finally grasped over here. We cannot expect to fill a €19 billion gap with €7.5 billion worth of changes.

And so, last week the Department of Finance produced outline information on some of elements of the new four-year plan it hopes to publish before the end of the month. These sketchy details informed us that the proposed adjustment between now and 2014 could be of the order of €16 billion. At first glance this appears to be much closer to reality.

Last December, when introducing his 2010 Budget, with €4 billion of adjustments, to the Dail, Minister for Finance, Brian Lenihan said that:

“A Cheann Comhairle, the worst is over. The international economy has exited recession. Recent indicators suggest that economic activity in this country is turning the corner, and my Department is now expecting a return to positive growth within the next six to nine months.

The effort demanded of every citizen in this Budget is substantial, but it is the last big push of this crisis. Further corrections will be needed in the coming years, but none as big as today’s.”

As we now know, the script of the Minister did not reflect the subsequent reality of the Irish economy. The 2011 Budget to be announced in a few weeks will feature €6 billion of adjustments. This will continue with further adjustments of €3-€4 billion in 2012, €3-3½ billion in 2013 and €2-2½ billion in 2014. The upper limit of this total is €16 billion.

The use of the word “adjustment” is akin to the ploy of misdirection used by an illusionist. We think we know what he’s doing, but out of sight the full effect of the trick is being prepared. Adjustment is just a word to hide the reality. Adjustment means expenditure cuts or tax increases, but using the word adjustment avoids specifics so we have no idea how this €16 billion of hardship will be distributed. At the moment it is just a number on a page.

Another key issue is the speed of this process. The €19 billion gap is evident to everyone but what is not so evident is why it has to be closed by 2014. This is an artificial target and one that has been largely self-imposed. When we produced the ‘pie-in-the-sky’ plan last December we said we would have the deficit down by 2014. The EU has taken this as our commitment and has tied us to it. Commissioner Ollie Rehn was here during the week and it is likely he was given further promises that we would cut the deficit by 2014.

The target we have to reach is a government deficit of less than 3% of Gross Domestic Product by 2014. Whatever the size of the economy is, as measured by GDP, the government have committed to having a deficit of less than 3% of this by 2014. This year we are likely to run a general government deficit of over 12% of GDP which we must reduce to 3% by 2014.

Our target is based on two elements: the size of the deficit and the size of the economy. The four-year plan is aiming for moving goalposts depending how big the deficit is and what happens to the GDP figures. Up to now the hope was that an economy returning to the growth rates of five years ago would help us reach the target by increasing our total GDP.

Last December we were told that the changes required for the 2011 budget would be €3 billion in adjustments. Now that figure is €6 billion and special-interest groups the length and breadth of the country are getting their message out that their funding and services are vital.

Why have we gone from €3 billion to €6 billion and what are we getting for this extra pain? There are three reasons that explain the jump to the €6 billion adjustment: a fall in GDP, a continued widening of the budget deficit, and a more ambitious deficit target for 2011.

The forecasted GDP number for 2011 has fallen because of a downward revision by the Central Statistics Office of prevision GDP figures. Also, projected GDP for 2011 has fallen because the government has announced they are going to cut more. Direct government expenditure on goods and services (on health and education services etc.) and government funded household expenditure (through social welfare benefits and pensions) are a major component of the economy. If these are cut, the size of the economy is reduced and the allowable budget deficit is reduced. We are cutting more because we have announced we are cutting more. This could be a vicious circle. These changes to the GDP numbers have added €1 billion to the adjustment.

Even with the €4 billion adjustment announced in last December‘s Budget the deficit for this year looks like being even larger than last year. This is because compared to last year, tax revenue is lower, social welfare expenditure is higher and the interest costs on our growing national debt are increasing. We’re trying to close the gap at the same time as the gap is getting wider. This has added a further €1 billion to the adjustment. It is like pouring water into a bucket with a hole in it.

The final reason we have moved to a €6 billion adjustment is the apparent wish to have ourselves viewed as gluttons for punishment. Last year, when we announced the plan to get to a 3% budget deficit by 2014 we said that we would get it down to 10% for 2011, from the 12% this year as an intermediate step on the road to reaching the 3% target. With the economy contracting and the public finances continuing to deteriorate, the Department of Finance has said that we should heap more pain onto the economy by reducing the original target. €1 billion has been added to the adjustment just for the hell of it.

All in all, we will see very little benefit from increasing the budgetary pain from €3 billion to €6 billion. In terms of the EU target we will move from a projected deficit of 10% of GDP for 2011 to a deficit of 9.3% of GDP. We’re going nowhere and it’s like pushing a car with all your might while someone has left the handbrake on.

The government is focusing much of its budgetary efforts on the expenditure cuts and tax increases that it is hoped will meet the 3% target by 2014. We will not meet this target and nor should we be too concerned about this. Yes, the budget deficit has to be addressed, but dancing to a tune called by someone else is not what is required. It is clear that changes have to be made to our public services and our tax system, but they should be done to satisfy the needs of Irish people and not to satisfy an accounting ratio.

We have to decide what is best for Ireland. We have the chance to completely overhaul our public services and tax system but because we are so focussed on an artificial goal we are failing to see the wood from the trees. Making changes at the margin can only offer a temporary solution.

We must decide the kind of public sector and social welfare system we want to have in this country. Do we want a public sector that provides as many services and supports to as many people as possible? If so, we will have to design a tax system that will raise the funds to finance these services. Or do we want to maintain the view of Ireland as a ‘low-tax economy’? If so, we must realise that we will not have the money to provide everything we may wish from our public services. At present we have chosen the impossible. We want the high-cost public services but we cannot pay for them with our current tax base.

Our long-term plan for closing the budget deficit should be based on the type of Ireland we want to see in ten years time. Now is the time to be making these decisions and not fighting over percentage points.

Friday, November 12, 2010

Eggs, Cheese and “Angles”?

RTE reports on the egg and cheese reception the people of Nenagh laid on for Mary Harney when she was there today.

The eggs and cheese I have some understanding of, but this?

Angle of Death

UPDATE  23/11

Who are the  “TRATIORS”?


Thursday, November 11, 2010

Core deflation stubbornly remains

The CSO have published the October CPI release.  The headline is that annual inflation is up.  In October, the overall rate of inflation increased to +0.7% from +0.5% in September.  But what are the measure of core inflation we have been tracking.

This measure excludes the effect of mortgage interest and energy products and represents 85% of the overall index.   Mortgage interest represents a single product and you can see the components of the energy products sub-group here.

Deflation in this measure is proving much more stubborn.  Core deflation was –1.41% in September and was largely unchanged at –1.42% in October.  Excluding mortgage interest and energy products, consumer prices fell slightly in the month to October.

Core Inflation October

It is probably too much to expect that there will be no commentary relating the CPI figures to inefficiencies in the “state-controlled” sectors but if there is note this.

Mortgage Debt Forgiveness

The Irish Times carries an article today signed by 11 economists (including two affiliated to UCC) on the topic of debt forgiveness for mortgage holders.  I was asked to sign my name to the article but did not.

Here is my reply to a post by one of the signatories earlier in the week.  It is below the fold.

Hi Stephen,

I can agree to some extent with the problem you are diagnosing here but I cannot agree with the proposed cure. Apologies for the length. I should have escaped to bed before Vincent Browne came on. It is possible the empty rhetoric there got me even more worked up!

You are right, that this has very little to do with moral hazard, as it is usually defined. Those who are facing a mountain a debt are unlikely to want to be in this gut-churning situation again, while those who have avoided the debt glut this time around are unlikely to be encouraged to over-borrow because of a partial debt-forgiveness scheme in this instance.

So if moral hazard is not the problem, how else could one oppose a partial debt-forgiveness scheme?

It is clear we face the real prospect of a mortgage meltdown as this crisis prolongs. However, a mortgage is a long-term agreement (25 years plus) and most of those in negative equity are in the early part of these contracts. They expected to be able to pay back the full amount (plus interest) over the full life of the contract, but obviously are in severe difficulty meeting these repayments now.

While there are people struggling to pay their mortgages, there are many, many people who are meeting their mortgage obligations (and maybe even overpaying). Per Central Bank data there was €124.7 billion of loans for house purchase outstanding to Irish households in January 2008. The most recent figures (Sep 2010) show that this has reduced to €107.8 billion. This is a substantial reduction in just 2.75 years.

Some of this may be due to write-downs and revaluations, but I suggest that the vast majority of this is due to people paying off their mortgages. With a savings rate of 12% this is where the money is being put. Obviously, this is only being done by people who are in a surplus-income position to do so, but there are many people out there meeting their mortgages and we have to assume that many of these people are reducing their negative equity position because of this.

Should these people, who have borne the cost of their mortgages, lose out simply because they have committed their money to paying their mortgages rather than using it elsewhere? Can we equitably discriminate between those people who have met their mortgages payments and those people who have not?

What about those people who saved a large deposit to begin with for a house purchase and have repaid their mortgage since to the extent that they have reduced the negative equity they face? Can we fairly ask them to pay the mortgage of their neighbour who took out a 110% loan and has only being making interest-only payments?

I cannot also see how this scheme will have much of a positive effect on economic growth. As the figures suggest there are thousands of people who are not paying their mortgages. They are committing little, if any, of their income to their mortgage. If some or all of their mortgage is annulled this does not give them any extra money for consumption. They have gone from spending no money on a huge mortgage to no money on a not-so-huge mortgage. Where is the consumption gain from these people? Should we give them some spending money as well?

If there is to be a consumption gain, it will only be from those people who are paying their mortgage to begin with, but benefit from a reduced payment to a partially-forgiven mortgage. Why would be want to forgive the mortgages of those people who are actually meeting their mortgage payments? This might be placing a huge burden on them, but should we forgive their debt because we think they made a mistake and we feel sorry for them?

As I said right at the start [way up there and they end is still way down there!] I do agree that we face a potential mortgage meltdown but I would be opposed to forgiving billions of euro of mortgage debt and adding it to our mounting national debt. Like Nat proposed above, I see the merit in some form of ‘clawback’, but Nat’s suggestion only comes into play if the house is subsequently sold. Again why should we discriminate between people who sell their house versus those who don’t?

Do we know how much money is involved? Per latest released statistics to the end of June there was €6.9 billion on mortgage balances that were in arrears of 90 days or more. This is not small beer. There is probably a comparable amount being paid on an interest-only basis. This figure is not available. And this is only those are not meeting their repayments.

The proposed scheme is for those in negative equity which is likely to be a multiple of this. A debt-forgiveness scheme could see €15 billion (a complete guess on my part) transferred to the national debt with an accompanying €1 billion per annum interest payment. It would take more than promissory notes to creatively account our way out of that one.

My suggestion would not be a debt-forgiveness scheme where the State assumes the burden of the principle and interest payments of a portion of someone’s mortgage. In my view, someone has taken out a mortgage so it should be that every effort is made to ensure that they pay it back. I suggest that if we need to help people with mortgage debt in the current crisis, that the state assume the interest cost of a portion of the mortgage.

So using your example of the €600,000 mortgage. I would split this loan into two. Say €300,000 remains with the mortgage holder and they make principle and interest payments on this over an agreed term. The other €300,000 is split away and the State covers the interest payments on this loan – and only the interest payments!

The scheme lasts for a certain period, possibly anything from say 5-10 years. At the end of the period, the €300,000 is added to the outstanding balance of the mortgage that remained with the householder and they resume full repayments. By that stage, it is likely that inflation will have reduced the real value of this debt and hopefully the householder will be in a better position to meet the mortgage obligations they signed up to. In essence, this is what the current benefit of mortgage interest relief does but this scheme is much more explicit.

Using the, admittedly back of the envelope, aggregate numbers outlined above, this would impose an annual €1 billion interest cost on the State. It could be less as most mortgages are at lower rates than the State can borrow! This would be a substantial cost but we would avoid the €15 billion principle cost as we transfer the principle back to the original mortgage holder at the end of the scheme. There is a pre-determined stop on the period for which this interest cost must be carried, whereas the full debt-forgiveness scheme can see this cost carried in perpetuity.

This scaled-down or temporary debt-forgiveness scheme offers some short-term benefit to those currently in dire straits. It is essentially a zero-interest offer for a number of years that would give them a manageable repayment on the remaining debt. There may even be a consumption gain if the repayments of some of those who enter the scheme is below their existing payments. Of course, these people may save this amount in expectation of the returning debt amount, but if they can afford to save this money they probably weren’t in such a bad spot to begin with.

I have not given sufficient thought to how entry to the scheme would be administered. How would entry to your proposed debt-forgiveness scheme work?

Per your last paragraph, I cannot see how the benefits of a debt-forgiveness scheme can exceed the costs. In fact, where are the benefits? We cannot magic away the debt. We will not have “a large swathe of Irish society out of debt”. We will simply have transferred individual private debt to social public debt that Irish society still carries. The country will still have the same aggregate debt burden but we will have just changed who will have to pay it. Any increase in spending by those who benefit from the scheme will have to be offset by increased (future) taxation on those who have to pay for it. We have assumed the gambling debts of our developers into the national debt and I cannot see that working out too well for us.

Of course, we could renege on the debt entirely and “burn the bondholders!!” You might be able to sell me that one. But paying someone else’s mortgage. No thanks. Thanks, though, for raising an important issue and stoking debate. It is very necessary.

Wednesday, November 10, 2010

The real story

Our previous post looked at changes to DoF nominal GDP projections.  There are none.  What about our GDP in real terms?  In nominal terms it appears that the DoF expect the GDP figure to be no different than it was before, but what about the price effects that will determine the real changes behind these nominal figures?

We can compare the Department’s HICP predictions to the end of 2014 made in December 2009 to those produced last week.

DoF Inflation Predictions

The Department is predicting less inflation (or more deflation) for every year up to 2014.  This is particularly true for 2010 to 2012 with lower inflation of between 0.25% to 0.70% forecast.  For 2013 and 2014 the Department’s forecasts are largely unchanged and are probably influenced by the units the Department chooses to present their forecasts in.

If the Department expects prices to fall faster in 2010 and rise slower in 2011 and 2012, the only way they can meet their nominal GDP projections if they are expecting real GDP to rise by a greater amount than they thought last year.  There must be a greater increase in activity to offset the effect of lower increase in prices.

To see this in practice we will work through the numbers for 2011.  Last December’s SPU has a real growth rate prediction of 3.3% for 2011.  Last week’s EBO gives a predicted real growth rate of 1.75% for 2011.  Surely this is a reduction and is in line with all observer expectations.

The EBO gives 2010 nominal GDP at €157.3 billion.  The real GDP growth rate of 1.75% for 2011 would give a real GDP in 2011 of €160.05 billion at 2010 prices.  The EBO gives a nominal GDP figure for 2011 of €161.2 billion.  This increase in nominal GDP over real GDP is line with the 0.75% inflation expectation.

But we are not comparing like for like.  The 3.3% predicted real growth rate from last December was based on a €3 billion adjustment.  The 1.75% predicted real growth from last week is based on a €6 billion adjustment.  If we again use a fiscal multiplier of 1.0 for the first year and zero thereafter to allow us to simply add back this extra €3 billion that the government is going to cut from the economy, we get a revised real GDP figure of €160.05 billion plus €3 billion equal to €163.05 billion.

Without the extra adjustment the increase in real GDP is predicted to be from €157.3 billion in 2010 to €163.05 billion in 2011.  This is equivalent to a growth rate of 3.66%.

Last December there was a predicted real growth rate for 2011 of 3.3%.  Excluding the effect of the additional adjustment the current predicted real growth rate for 2011 is 3.66%.  We’re not reducing our GDP growth prediction for 2011– we’re increasing it!

If we carry through the same analysis for the years 2012 to 2014 we get the following results.Real GDP Growth Forecasts

We are pinning our hopes to higher growth rates in 2010 and 2011, a largely unchanged growth rate for 2012 and 2013, with the only notable decrease in 2014.  So much for moving away from a “favourable macroeconomic outlook”. 

And this is only achieved with very benign assumptions about the impact of the additional fiscal adjustment on the growth rate.  A more thorough consideration of this effect would probably reveal that the predicted real growth rates for all years have increased.

Did Ollie Rehn really buy into this?

The progression of projections

Here is the nominal GDP forecast that the Department of Finance produced as part of last year’s Stability Programme Update.  This was the path to the promised land of the 3% GGB.

Dof GDP Projections

This was an absurd projection then and appears even more so now.   Last week’s Economic and Budgetary Outlook presented revised nominal GDP projections for the same period.

Dec 09 and Nov 10 Projected GDP

Ah, surely that’s more like it.  It seems the GDP projections have been scaled back per the European Commission wishes and this is the reason we need a €15 billion plus ‘adjustment’ over the next four years rather than the €7.5 billion announced back in December.  The gap between the predicted nominal GDP for 2014 is a massive €21.3 billion (€204.8 billion versus €183.5 billion).  Here are the “revised” nominal growth forecasts. 

Dof Nominal GDP Forecasts

However, although both of these are nominal GDP projections they are not comparable as they are not based on the same underlying assumptions.  The gap between them may be more virtual than real.  We will see that this is an incongruous comparison.

We will begin with the December 2009 projections and work through the changes that have been made to this projection and try to get a meaningful comparison to the November 2010 DoF projections.

The first issue we have to consider is the revision carried out by the CSO on the GDP figures.  The DoF in last week’s Economic and Budgetary Outlook referred to this and claimed that “the overall size of the economy is now smaller, reflecting revisions by the CSO to the level of GDP in 2009 and to previous years (a methodological change)". 

I cannot find any evidence of the CSO undertaking “a methodological change”, but they did revise the GDP numbers.  This is a regular occurrence.  When first released by CSO the 2009 nominal GDP was stated as €163.543 billion.  (See Table 2 in 2009 Q4 National Accounts Quarterly here).

When June came around the CSO issued the revised GDP numbers and nominal GDP for 2009 was stated as €159.647 billion (see the equivalent table here).  This represents a drop of €3.896 billion or 2.4%.  With budget deficits and borrowings measured relative to nominal GDP this is a substantial change.

Anyway last December’s DoF GDP projections were based on a nominal GDP of €164.6 billion in 2009.  Their growth figures are projected from this number.  The true nominal GDP figure is now almost €5 billion below this.  If we keep the same growth rates as produced by the DoF what effect does this revision have on the projected GDP numbers?

Projected GDP with CSO Revision

Even using the same growth rate the revision by the CSO sees the projected 2014 nominal GDP decrease by about €6.2 million.  Here is the most recent GDP projections compared to this revision of the 2009 projection.

Projected GDP with CSO Revision Compared to Nov 10 Projection

The gap between the original GDP prediction and the new prediction for 2014 has narrowed from €21.3 billion to €15.1 billion.

Again, however, this is a false comparison as the Dec 2009 figures was based on a total ‘adjustment’ of €7.5 billion in the period to 2014, where as the Nov 2010 projections are based on an up-scaled adjustment of €15 billion plus. 

We will rescale the Nov 2010 projections as if adjustment had remained at €7.5 billion as announced last year.  We will do this very crudely.  We will assume that the fiscal multiplier is 1.0 for the year the adjustment is introduced and 0.0 thereafter.  With this assumption we can just add the amount of the cumulative extra adjustment to each year to get the nominal GDP figure as if the extra adjustment did not occur. 

This is crude but suffices in this instance, though it probably understates the true growth effect of the additional adjustment.  The extra adjustment is €3 billion for 2011, with an upper limit of an extra €2 billion for 2012, €2 billion in 2013 and €1.5 billion in 2014.

Revised GDP Projections Dec 09 and Nov 10

Hey, where did the gap go?  I thought we’d revised down our 2014 nominal GDP prediction by a massive €21.3 billion.  But a couple of logical revisions later and the gap is down to €6.6 billion.  And this is with the possibly benign assumption that the multiplier on the extra adjustment is 1.0 in the first year 0.0 in subsequent years.  If this was above unity in the first year or anything greater than zero the year after it could be that the relevant comparison is actually much closer to something like this.

Revised GDP Projections Dec 09 and Nov 10 with larger multiplier

And, just like that the gap is gone!

We haven’t revised our figures to account for “the programme's favourable macroeconomic outlook after 2010” as said by the European Commission back in March.  We have altered our GDP figures because the CSO revised the number down and the Minister has revised the adjustment up.  In nominal terms, if we factor out these two effects, everything is as it was before.

Oh dear.

Yields on 10-year Irish government bonds today.

Bond Yields 1D 10-11-10

And for the last three months

Bond Yields 3M to 10-11-10

No commentary required.

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