Wednesday, 24 March 2010

The day after the IMF's tomorrow

Michael Taft: The IMF has suggested that the Irish Government’s growth projections are too optimistic and should be scaled back. So has the EU Commission. This has grave implications for the Government’s current strategy; if growth doesn’t come right, fiscal targets will be missed, debt will pile up, unemployment will remain high and living standards low. The Government may well end up sinking further into deflationary quicksand.

The IMF has projected growth for Ireland up to 2014. While these projections were initially produced in the middle of last year, the IMF reconfirmed them in their recent World Economic Outlook. What would be that impact on the deficit given these growth projections? The following examines only the tax revenue side of the equation.

First, we find IMF growth projections much lower than the Government’s. Between 2010 and 2014, the Government expects the economy to grow by 17.4 percent in real terms; the IMF, 8.8 percent. This will have considerable implications for public finances, as tax revenue is a function of GDP – low economic growth equals low tax revenue growth.

If the Government’s ‘tax burden’ or ‘tax ratio’ holds, under the IMF scenario we would find that not only will we fail to meet the Maastricht guidelines by 2014, we will pile up considerably higher debt in the process. Under the IMF scenario, the annual deficit is unsurprisingly higher each year; by 2014 it still remains above Maastricht guideline levels by 2014.

More alarmingly, is the growth in overall debt levels. The Government expects gross debt to be at 80.8 percent of GDP. However, if the IMF projections hold, overall debt will soar to over 93 percent – a result of higher annual deficits, and lower nominal GDP. This is what the TASC letter referred to as the ‘low-growth, high debt’ future.

There are two major caveats: first, this doesn’t include higher unemployment costs. We should expect unemployment, under the IMF’s lower growth scenario, to remain higher than the Government’s forecasts. If so, spending will rise above current projected levels. Second, higher borrowing levels will incur higher debt service costs. Factor these in, and the deficit and overall debt levels will be higher still.

This is all of a piece. In a previous post, Michael Burke and I showed how the Government’s current strategy will depress future growth. That is because the Government, rather than reducing the deficit, is embedding the deficit into the economic base.

So which scenario is more likely? The IMF projections are clearly pessimistic. The Government will take some comfort from recent projections. For 2011, Bloxham is projecting 3 percent growth; Friends First 3.1 percent. IBEC, however, is slightly more cautious, with a projection of 2.1 percent while PwC projects growth at 1.8 percent.

Some comfort, yes; but even the Department of Finance warns that GDP growth may not be tax-rich. This is because growth may be driven by exports from the multi-national sector.

So do all these numbers matter? Yes, very much so. NCB’s growth projections come up only slightly less than the Government by 2014, but even this has the potential to knock the Government’s fiscal targets off course. They, too, accept that the Government will miss its 2014 target, while piling up more debt than the Government expects.

In short, the Government’s fiscal strategy is built on quicksand. Its growth projections are optimistic and it has failed to factor in the deflationary effects of its current spending cuts policies. If they resort to further fiscal tightening to make up for this, all that will happen is that they will sink even further.

And the rest of us along with them.


Donal Palcic said...

Excellent post. I gave a (depressing) lecture to my final year undergraduate students yesterday on the debt dynamics in motion in Ireland and the EU and what is required in order to stabilise debt/GDP ratios and I think I scared the hell out of them (and myself)!

Daniel Gros at the CEPS recently uploaded an interesting working paper on the obstacles for a successful adjustment in the 'GIPSY' (PIIGS) countries.

Gros questions the feasibility of a huge fiscal adjustment in the GIPSY group. Although he only uses a very simple Keynesian fiscal multiplier to measure the cost of the required fiscal adjustment on output, he suggests that the fiscal adjustment required in the GIPSY group would have
a significant negative impact on output, leading to lower tax revenues and potentially creating a vicious circle.

His paper is well worth a read and I've linked to it below:

Anonymous said...

The Anglo Money Pit:

Worth a blog post.