Additional Fiscal Effort: Scaremongering?

We pretty much know what is in store for us when it comes to fiscal adjustment over the next three years.  Here is a table take from last week’s Stability Programme Update.



We are looking at a further €8.6 billion of “consolidation” over the next three budgets.  The table shows the proposed spilt between expenditure cuts (€5.55 billion) and tax increases (€3.05 billion).  As we are in an Excessive Deficit Procedure there is nothing in the Treaty on Stability, Coordination and Governance that will change the targets.

The period after this has received some attention and there have been a number of claims that either or both of the 0.5% of GDP structural deficit limit and the “1/20th” debt reduction target will require further €X billions of fiscal adjustment in the post-2015 period.  Over the past few days I have heard a number of these claims in various debates.  Here are a few unearthed from a very quick search.

(1) “The Austerity Treaty would turn this recession into an economic depression. It would bring at least €5.7 billion additional cuts and taxes from 2015, on top of the €8.6 billion austerity up til then.”
(2) “This treaty will mean an extra €6 billion in tax increases and spending cuts post 2015. This will further depress consumer demand, pushing the domestic economy further into recession.”
(3) “On May 31, we are being asked to support an austerity treaty that will result in €6bn of extra spending cuts and tax increases being imposed on people post 2015. This is on top of the €8bn the Government intends to cut in the coming four years. If you are against austerity, you must vote against the austerity treaty.”
(4) “Debt should be 60 per cent of GDP. If debt is greater than 60 per cent, it will be reduced by 1/20 per year over the next 20 years. This would start in 2018, when the bailout terms expire, and could require up to €5 billion a year in savings to 2038.”
(5) “Ireland's debt to GDP ratio is likely to be around 120% in 2015 when we exit the bailout. Reducing the debt to GDP ratio by one twentieth of the excess per year will therefore mean reducing it by 3% of GDP per year. Without significant economic growth, that means paying back €4.5 billion per year in principal”

I’m not sure where the figures have come from but a figure of around €6 billion is attributed to the structural deficit rule and one of around €5 billion is attributed to the debt reduction requirement.

Over on irisheconomy.ie, Prof. John McHale has an excellent post on some budgetary arithmetic for fiscal rules that teases out some of the implications for Ireland after we leave the Excessive Deficit Procedure in 2015.  The conclusion is that there will actually be very little additional effort required to meet the requirements of the fiscal rules post-2015.

1. The Debt Reduction Rule

This is the straightforward one and it is one we have looked at before.  For a start it is important to note that Ireland will not be subject to the debt reduction rule until three years after we leave the excessive deficit procedure.  The rule will begin to apply from 2018.

Here is a table that shows the IMF projections for Ireland for 2017 and shows the overall budget balances that would be allowed if nominal growth was 3.5% per annum.



The starting nominal GDP from 2017 is the IMF projection.  The figures for 2018 to 2021 are based on a nominal growth rate of 3.5% per annum.  This is lower than the 4.5% per annum that the IMF are projecting for 2015, 2016 and 2017.

The 2017 gross debt is also the IMF projection which gives the starting debt ratio of 109.2% of GDP.  The debt ratio from 2018 onwards are those that would be required to satisfy the “1/20th” debt reduction benchmark.

The change in gross debt is the annual change in debt that is allowed.  It can be seen that this is always positive.  The level of debt can increase in each year.  There is no requirement to repay debt and definitely no requirement for annual payments of €5 billion per annum. 

The final column is the key one.  This gives the allowable budget balance to satisfy the debt brake rule.  The €8.6 billion of adjustments is designed to bring the deficit below 3% of GDP by 2015.  The IMF projections for 2016 and 2017 are based on a “no-policy change” scenario.  By 2017 they project that the deficit will be down to 1.9% of GDP. 

Continuing the IMF scenario into 2018 it is likely that the deficit would be around 1.4% of GDP in 2018.  This is only 0.3% of GDP (€0.6 billion) away from the deficit required to satisfy the debt brake rule.  As the debt reduction requirement is calculated over a three-year average it is likely that the expected outcomes for 2019 and 2020 would allow us to satisfy the debt reduction requirement.

Using the IMF’s projections and assuming 3.5% nominal GDP growth from 2018, Ireland can satisfy the debt reduction rule with no additional fiscal effort.  There is no guarantee that this scenario will come to pass but it is difficult to see how the kind of assumptions that would give arise to annual repayments of around €5 billion per annum could come to pass.  It is far more likely that we will be allowed to borrow small amounts rather than have to make the repayments suggested.

2. The Balanced-Budget Rule

The balanced-budget rule is a little more involved.  This is the rule that requires a cyclically-adjusted or structural budget balance of no more than –0.5% of GDP.  Last week’s Stability Programme Update says that using the European Commission methodology it is forecast that Ireland will have a structural deficit of 3.5% of GDP in 2015.

There is no transition period when a country leaves an EDP so the balanced budget rule becomes applicable in 2016.  What matters here is the pace of reduction and as we pointed out previously the requirement is an improvement of 0.5% of GDP towards the budget objective.  What will happen in Ireland post-2015?  Will be have to undertake €6 billion of additional fiscal adjustment to satisfy the balanced-budget rule?



The starting point here is the structural deficit of 3.5% of GDP given in the SPU.  Next it is assumed that nominal GDP will go by 3.5% per annum (this is lower than the IMF projections of 4.5% per annum).
The coefficient of elasticity is the impact of the growth rate on the structural balance.  There is no way of knowing what this is but we will follow the figure of 0.2 used by Prof. McHale.  Using this figure a nominal growth rate of 3.5% is expected to improve the structural balance by 0.7 percentage points of GDP per annum under the assumption of “no policy change”, i.e. no additional adjustment.  This is in excess of the 0.5% of GDP improvement required under the Stability and Growth Pact.

By 2019 it can be seen that the structural deficit would be down to –0.7% of GDP.  Using the projections here this is achieved with no additional fiscal effort and is in line with Council Regulation 1055/2005 which says that countries should aim “to gradually reach the medium-term budgetary objective”.

There is no guarantee that this is what will happen.  The IMF’s debt projections for 2017 and the DoF’s structural deficit projection for 2015 are only estimates.  They are very unlikely to be wholly accurate.  The assumed 3.5% nominal growth rate in the subsequent four year period is only a conjecture.  For what it’s worth Ireland’s nominal GDP growth rate from 1971 to 2010 averaged 11.5% per annum.  However, the scenarios do show what could happen and, in my opinion, are based are fairly prudent assumptions.

It is possible that Ireland could satisfy the conditions of the debt-reduction rule and the balanced-budget rule without any additional fiscal adjustment after 2015.  There are plenty of accusations of scaremongering in relation to official funding floating around.  Are claims of €5 billion and €6 billion of additional fiscal adjustment after 2015 more of the same?

Of course, it should also be pointed out the the result of the referendum will not change the necessity to satisfy the fiscal rules.  These rules are all elsewhere in EU regulations and the Fiscal Compact element of the Treaty just restates them.  We have already committed to adhere to them.  In fact, even if the referendum is defeated we could still introduce a Fiscal Responsibility Bill that incorporates these fiscal rules.  The referendum is to allow us to ratify (become a signatory of) the Treaty.