Download No.374 / September 2011 The Cyclical Conduct of Irish Fiscal Policy

IIIS Discussion Paper
No.374 / September 2011
The Cyclical Conduct of Irish Fiscal Policy
Agustín S. Bénétrix, Trinity College Dublin
Philip R. Lane, Trinity College Dublin and CEPR
IIIS Discussion Paper No. 374
The Cyclical Conduct of Irish Fiscal Policy
Agustín S. Bénétrix, Trinity College Dublin
Philip R. Lane, Trinity College Dublin and CEPR
September 2011
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The Cyclical Conduct of Irish Fiscal Policy
Agustín S. Bénétrix
Trinity College Dublin
Philip R. Lane
Trinity College Dublin
and CEPR
September 2011
Abstract
This paper provides an overview of the cyclical conduct of …scal policy in Ireland
both before and during the crisis. It shows that …scal policy has been procyclical, with
…nancial shocks amplifying the …scal cycle. In addition, it highlights the importance
of institutional reform and outlines the case for a formal …scal framework.
This is a revised version of the paper presented at the Irish Economy conference at Lehigh University,
April 7-8 2011. We thank Brendan Kennelly and the conference participants for helpful feedback. Email:
[email protected]; [email protected].
1
1
Introduction
The goal of this paper is to describe and critically assess the conduct of Irish …scal policy,
both during the pre-crisis period and during the crisis that has taken hold of the Irish
economy since 2008.
Ireland is an important case study for the conduct of …scal policy. As a volatile economy,
it is essential that macroeconomic policy is conducted with a view towards contributing to
stability. Since an independent monetary policy or exchange rate policy is not available to
individual members of a monetary union, the stabilisation properties of …scal policy have
been especially important since the creation of the single currency in 1999.
We divide the analysis into three parts. In Section 2, we analyse …scal policy during the
pre-crisis period. To this end, we pursue two strategies. Initially, we provide a narrative of
the conduct of …scal policy during the 1999-2007 period. Next, we report some econometric
results concerning the cyclical behaviour of …scal policy over a longer time span from 1970
to 2007.
In Section 3, we turn to a description of the conduct of …scal policy since the onset of the
crisis in 2008. The scale of the …scal deterioration during the crisis has been extraordinary
and is only partially connected to the massive bailout of the domestic banking system.
Rather, the gigantic collapse in nominal GDP and the sharp contraction in net capital
in‡ows has been associated with the revelation of a very large structural budget de…cit. In
turn, this has required considerable …scal tightening, with yet more austerity scheduled for
the 2011-2014 period.
The high costs of the boom-bust cycle have underlined the importance of institutional
reform to make sure that such instability can be avoided in the future. Accordingly, in
Section 4, we outline the case for a formal …scal framework. Through a combination of
numerical …scal rules and the establishment of an independent …scal council, the degree of
…scal sustainability and counter-cyclicality may be substantially improved.
2
2
Pre-Crisis Fiscal Policy
Our goal in this section is to examine the conduct of …scal policy during the pre-crisis
period. This is important, since the origins of the crisis lie in the scale of the pre-crisis
boom, and it is important to assess the role of …scal policy in macroeconomic stabilisation
during this period.
Moreover, the capacity for Irish …scal policy to combat the crisis
depended on the accumulated …scal position, such that the conduct of …scal policy during
the prior period determined the extent of “…scal space”at the onset of the crisis.
2.1
The Fiscal Stance during 1999-2007
Our focus in this subsection is on the cyclical conduct of Irish …scal policy in the period
since Ireland joined EMU in 1999.1 The late 1990s was a remarkable period in Irish
economic history, with very rapid output growth far in excess of historical averages and
the attainment of e¤ective full employment. Moreover, in addition to joining EMU, there
were further important structural shifts in the nature of the Irish economy, most notably
associated with the increased integration of the European labour market with the EU
accession of the ten Central and Eastern European new member states in 2004. In common
with other countries, the structure of the Irish economy has been a¤ected over the last
decade through the increasing economic role of the emerging market economies and the
growth in international …nancial ‡ows.
For these reasons, an accurate assessment of the cyclical state of the Irish economy is
not an easy task over this period. However, by the same token, these structural factors also
raised the level of uncertainty about the appropriate cycle-trend decomposition, which reinforced the importance of adopting a prudent …scal stance. This consideration is especially
1
See also the extended discussion in Lane (2010). See Lane (1998a) and Hunt (2005) for econometric
studies of …scal cyclicality in Ireland over longer sample periods and Lane (2003) on the international
evidence.
3
relevant in assessing …scal policy during the 2003-2007 credit and housing boom, in view
of the historical frequency of credit/housing booms being succeeded by severe recessions.
The Economic and Social Research Institute (2009) have provided a set of estimates
for the …scal stance. This approach compares the actual budget balance in each year to
the budget balance that would have transpired under a simple indexation rule by which
the previous year’s expenditure and revenue plans are passively updated by assuming that
revenues and cyclical expenditure items will grow in line with actual output growth while
non-cyclical expenditure items will grow in line with trend output growth. The di¤erence
between the actual and indexed balances captures the discretionary change in the …scal position. By this method, it is calculated there were substantial pro-cyclical …scal expansions
during the 1999-2002 and 2003-2008 periods of relatively-high output growth.
Another perspective is obtained by conducting an ex-post review of the cyclicality of
…scal policy, using the current European Commission estimates of the output gap during
these years. Over the 2001-2007 period, the average value of the general government surplus
was just one percent of GDP despite an average GDP growth rate of 5.6 percent and an
average positive output gap of 2.1 percent. The failure to run larger surpluses during this
period meant that the sizeable swing in the …scal position in 2008-2009 drove the overall
…scal balance into a deep de…cit position.
In turn, the average cyclically-adjusted budget balance was approximately zero during
this period. An important issue is that the standard OECD method to calculate the cyclical
component of the budget balance is narrowly de…ned to just refer to those revenue and
expenditure items that systematically vary with aggregate GDP. In particular, it does not
take into account revenue windfalls that are attributable to asset price booms or sectorallyconcentrated output expansions (such as a construction boom). That the normal cyclical
adjustment is misleading under such conditions has been well established for some time
(Eschenbach and Schuknecht 2004, Girouard and Price 2004). Accordingly, the true state
of the structural budget balance was worse than reported under the standard methodology.
4
Moreover, taking the reported structural balance at face value, the inherent potential
volatility of the Irish economy plus the well-documented risks associated with rapid expansion in credit and housing prices meant that a target of substantially positive structural
balance during expansionary periods would have been more prudent in order to allow for
greater ‡exibility in the event of a sharp downturn.
In relation to the structural balance, there are two more factors to consider. In one
direction, the relatively high level of public investment during this period may have justi…ed
running a lower structural surplus or a structural de…cit. However, in the other direction,
the predictable future growth in ageing-related public spending calls for the running of
larger structural surpluses in order to minimise the distorting impact of a higher future
tax burden. Moreover, a detailed assessment of the optimal …nancing of public investment
also requires a quantitative evaluation of the return on the public investment and the
economically-relevant split between public capital replacement (due to past depreciation of
the existing public capital stock) versus net additions to the public capital stock.
Further insights into the conduct of …scal policy during this period can be obtained by
comparing ex-ante …scal plans to the ex-post …scal outcomes, where the ex-ante projections
for GDP growth, the output gap and the general government balance can be obtained from
each year’s budget documents (available from the website of the Department of Finance).
One basic problem was the ex-ante projection for the output gap averaged -1.6 percent
of potential GDP during 2003-2007, whereas the ex-post retrospective estimate for the
average output gap for this period is +2.1 percent. In e¤ect, this over stated the cyclicallyadjusted budget balance by an average of 1.5 percent of potential GDP (based on a 0.4
elasticity of the budget to the cycle under the standard method). (We leave aside the
further adjustments that are required on account of the sectorally-unbalanced nature of
growth during this period and the boom in asset prices.)
It is useful to examine the co-movement between “growth surprises”and “…scal balance
surprises” where each is de…ned as the di¤erence between the realised value and ex-ante
5
expected value. During 1999-2007, the growth surprise was positive in each year, with
the sole exception of 2001. In two of these years (2002 and 2007), the …scal surprise was
negative despite the positive output surprise. Moreover, in 1999 the positive …scal surprise
was mild relative to the strongly positive growth surprise, falling below the level indicated
by the standard cyclical adjustment.
However, the …scal surprise exceeded the growth surprise during 2003-2006, such that
the level of surpluses exceeded expectations during this period. These strong …scal surprises
re‡ect the revenue windfalls collected during this boom phase (see also Addison-Smyth
and McQuinn 2010).2 While these unplanned additional …scal surpluses narrow the gap
between planned and optimal …scal balances, the low average ex-post surpluses remained
insu¢ cient to allow a counter-cyclical discretionary …scal response to the 2008-2009 (and
ongoing) crisis.
Put di¤erently, the ex-ante …scal plans during 1999-2007 were insu¢ ciently prudent.
While the pro-cyclical stance of …scal policy during 1999-2001 was criticised at the time
in the annual European Commission opinion on the Irish stability and convergence programme, it is important to acknowledge that the ex-ante …scal plans were generally well
received by Brussels during the 2003-2007 period.3 However, both sides also routinely
acknowledged that the cyclical position of the Irish economy was chronically di¢ cult to
ascertain. Under such conditions of uncertainty, the bias in …scal policy needs to err on
the side of caution.
Having provided a narrative overview of the conduct of …scal policy during the pre-crisis
period, we now turn to an econometric analysis of …scal cyclicality during this period.
2
In addition, as is noted in the budget documentation, the 2004 …scal surprise is in part attributable to
the substantial one-o¤ proceeds from Revenue investigations during that year.
3
The 2001 budget was su¢ ciently pro-cyclical in its planned stance that the European Commission
issued a formal recommendation against Ireland under Article 99.4 of the Maastricht Treaty, to much
controversy at the time.
6
2.2
Fiscal Cyclicality
To further investigate the behaviour of pre-crisis …scal policy, this section formally studies
the cyclicality of di¤erent …scal indicators.
We write the baseline speci…cation as follows
F ISCALit =
i
+ CY CLEit + Zit + DEBTit
1
+ F ISCALit
1
+ "it :
(1)
where F ISCAL is the …scal variable of interest. The CY CLE variable captures the cyclical
state of production. The coe¢ cient
captures the responsiveness of the …scal variable to
the output cycle. In the case where the …scal variable of interest is the government balance,
> 0 indicates a countercyclical pattern, while
< 0 a procyclical one.4
The Zt vector comprise two …nancial variables that are included jointly as additional
regressors.5 These are the current account balance and the growth in private credit, both
scaled by GDP.6 Since the output cycle is always included in the speci…cation, these variables should only be important if …nancial factors have additional …scal e¤ects, over and
beyond their in‡uence on output dynamics.
In addition, we include the lagged level of the public debt (DEBT ), since a positive
relation between the stock of public debt and the primary …scal balance is typically required
to support non-explosive debt dynamics.
We also include the lag of the …scal variable,
since …scal variables typically exhibit considerable persistence.
4
In some of our speci…cations, the …scal variable is scaled as a ratio to GDP. Accordingly, there is some
terminological ambiguity about the meaning of cyclicality for such a ratio. For instance, a constant de…cit
to GDP ratio over the cycle may be termed acyclical in one sense but is procyclical in terms of underlying
dynamics, with revenue gains during upswings used to …nance spending increases or tax cuts and revenue
declines during downturns inducing spending cuts or tax rate hikes. However, in other speci…cations, we
do not scale by GDP and this is a useful cross-check.
5
See Bénétrix and Lane (2011) for a discussion on the di¤erent channels through which the current
account and credit growth a¤ect …scal variables.
6
That is, credit growth is measured as the change in the credit/GDP ratio between t
7
1 and t.
In terms of a cyclical measure, we use the deviation of GDP from its trend value
(expressed as percentage point deviations). The GDP trend is obtained as the predicted
values of a model regressing GDP on a linear and quadratic trends.7 Since both are derived
from underlying stock positions, we consider the current account balance and credit growth
as stationary variables, even if these may be quite persistent.
Columns (1) and (2) in Table 1 report the estimates for cyclical behavior of the general
government balance.8 According to these estimates, the …scal balance did not vary with the
output cycle during the sample period. Since a neutral …scal position should be associated
with surpluses during upswings and de…cits during downturns, an acyclical pattern for the
…scal balance indicates that the …scal position was procyclical.
The addition of the …nancial variables in column (2) raises the overall explanatory
power, with both variables individually signi…cant. A current account de…cit is associated
with a worse …scal balance, while faster credit growth is associated with a stronger …scal
balance. While the latter result is in line with the expectation that credit booms are good
for tax revenues, the former result is surprising to the extent that a current account de…cit
should be associated with more revenues as a result of higher domestic spending. However,
this pattern is also found for a broader panel of countries (Bénétrix and Lane 2011).
Next, we study the cyclical pattern of Ireland’s underlying …scal stance in columns (3)
and (4) by using the cyclically-adjusted primary balance scaled by GDP. The results show a
similar cyclical pattern to that for the overall …scal balance.9 Accordingly, Ireland failed to
7
An alternative could have been the use of output gap. However, these data are not available for the
full time span.
8
We follow the literature and use government balance scaled by GDP as the …scal indicator. However,
this may have the limitation of the …scal ratio being driven by movements in the GDP denominator, rather
than in the …scal measures. We also estimated these speci…cations using an index of the …scal balance and
obtained the same qualitative results.
9
As a robustness check, we also estimated the models in columns (1),(2) and (5)-(8) using the shorter
time span of columns (3)-(4) and found that our …ndings are una¤ected.
8
run the counter-cyclical pattern in the structural balance that is required if …scal policy is
to actively contribute to stabilisation. Moreover, both …nancial variables are signi…cant in
explaining the time variation in the cyclically-adjusted balance. It follows that, according
to these estimates, the negative impact on the structural balance of the turnaround in the
current account and the end of the credit boom was predictable.
To complete this assessment, columns (5)-(6) and (7)-(8) report similar regressions but
for real general government revenues and expenditure relative to trend, respectively. For the
former, the cyclical indicator is typically positive and statistically signi…cant, supporting a
procyclical pattern in government revenues in the 1970-2007 period. In addition, column (6)
shows that revenues systematically covary with …nancial indicators - large current account
de…cits and credit booms are associated with faster revenue growth.
For real general government expenditure, columns (7) and (8) show an acyclical pattern in total government spending. Since some components of government spending are
mechanically counter-cyclical (such as unemployment bene…ts), this implies that the discretionary component of government spending was procyclical during this period. In terms
of the …nancial cycle variables, a striking …nding is that a larger current account de…cit is
associated with more government spending. Taken together with the results for the …scal
balance and revenues, this indicates that the boost to tax revenues from a current account
de…cit was dominated by an increase in public spending. Finally, we do not …nd a link
between credit growth and faster government spending in this speci…cation..
Since the above results may partly re‡ect reverse causality, Table 2 reports the instrumentalvariables versions of these models. More precisely, we instrument the current account balance with the oil price (multiplied by the net oil trade position), since the oil price is a
major source of exogenous ‡uctuations in trade balances. This approach is also implemented in Lane and Milesi-Ferretti (2011) and Bénétrix and Lane (2011). In addition, we
instrument the GDP cycle with its own lag.10
10
We test the signi…cance of these instruments for the …rst-stage regression to make sure that these do
9
The regression outputs reported in Table 2 are consistent with the OLS results, with
some small di¤erences in terms of the size of coe¢ cients and statistical signi…cance. For
instance, the previous …nding of a positive link between revenues (or expenditures) and
current account de…cits is stronger when the latter is instrumented. A similar quantitative
di¤erence appears in the model using the general government balance and the cyclicallyadjusted balance. More speci…cally, the correlation between the current account and these
…scal indicators become stronger in the IV version. As is the case in Bénétrix and Lane
(2011) that provides similar estimates for a panel of countries, our previous OLS results
survive instrumentation.
Overall, we …nd that there is evidence of the …scal balance behaving in a procyclical
fashion.11 In addition, the results for the current account balance and credit growth variables suggest that …scal cyclicality has been in‡uenced by the …nancial cycle, in addition
to the GDP cycle. Having empirically examined pre-crisis …scal cyclicality, we next turn
to the conduct of …scal policy since the onset of the crisis in 2008.
not su¤er from the ‘weak instruments’problem. The F-statistic for the joint signi…cance of the instruments
in the …rst-stage regression as well as the Cragg-Donald Wald F statistic indicate that these instruments
perform well. The former is always greater than 10. In addition, the Kleibergen-Paap rk statistic indicates
that these are su¢ ciently strong instruments and span the endogenous regressors.
11
For a panel of countries, Bénétrix and Lane (2010) …nd that there has been some time variation in
the cyclical behaviour of …scal policy. In particular, in line with the related literature, the introduction
of the Maastricht Treaty was associated with a shift towards more counter-cyclical …scal policy. However,
the formation of EMU in 1999 was not associated with any further improvement in the cyclical pattern
in …scal policy. At a qualitative level, these results hold for Ireland, but the number of observations are
not large enough to make strong statistical inferences concerning time-varying coe¢ cients on the basis of
a single-country study.
10
3
Fiscal Policy during the Crisis
The general government budget balance was in slight surplus in 2007.12
However, the
de…cit expanded quickly, reaching 7.3 percent of GDP in 2008, 14.4 percent in 2009 and
an extraordinary 32 percent in 2010. The latter …gure was composed of a ‘core’de…cit of
about 11 percent of GDP, together with large capital transfers to the failing Anglo-Irish
Bank and Irish Nationwide.
The downturn in domestic spending and the decline in transactions in the property
market from 2008 onwards meant that tax revenues fell very quickly, to the extent that the
government had to introduce a series of measures to obtain other sources of tax revenue
and limit public expenditure growth. This included the introduction of graduated income
levies, which had the e¤ect of sharply increasing the marginal income tax rate for middle
and high earners while also extending the tax net to include lower-income groups. For
public sector workers, pay levels were de facto reduced by the introduction of a public
sector pension levy, while a recruitment freeze was also implemented. Further measures
were taken in the 2010 budget, including further sizeable reductions in public sector pay
levels, a reduction in social bene…t levels and a contraction in spending commitments.
Despite these measures, the underlying weak state of the economy and the collapse of the
tax base meant that the core …scal de…cits in 2009 and 2010 were still extraordinarily large,
with a sizeable non-cyclical component. A key problem is that the windfall revenues from
asset-related sources during the boom were partly used to reduce the direct tax burden on
low and middle earners which was signi…cantly reduced during this period. In addition, the
Irish tax base is quite narrow, with no signi…cant role for sources such as annual property
taxes or local-level taxes. Accordingly, a major challenge is to expand the tax base.
On the spending side, public pay levels and social bene…t payments had been increased
quite sharply during the good years. The initial phase of …scal adjustment has already
12
See also the extended discussion in Lane (2011).
11
rolled back some of these gains. However, the goal under the 2010 ‘Croke Park’agreement
with public sector unions is to avoid further reductions in the nominal levels of public sector
pay (barring exceptional circumstances), with savings to be obtained from a combination
of a recruitment freeze and productivity reforms in the delivery of public services. A saving
grace is that the decline in the construction sector means that the cost of public investment
projects has greatly declined, allowing cuts in nominal investment spending far in excess
of the decline in real spending.
Taken together, the cumulative size of the discretionary …scal tightening over 20082010 amounts to e14.6 billion, which is 9.3 percent of 2010 GDP. In November 2010, the
government announced a four-year …scal plan for 2011-2014 which would involve a further
e15 billion in discretionary …scal tightening. In turn, this four-year plan forms the basis
for the …scal component of the EU/IMF deal. Under the most recent forecasts, this …scal
austerity package is projected to stabilise the debt/GDP ratio by 2013 at 118 percent of
GDP, taking into account the considerable gross …scal cost of further re-capitalisations of
the banking system and the …scal cost of accelerated deleveraging of the Irish banks.
The …scal tightening measures are certainly a procyclical force that has contributed to
the scale of the recession. It would have been better to have run larger surpluses during the
good years and even accumulated a liquid rainy-day fund that might have been deployed
as a bu¤er against the impact of the severe negative economic shock (Lane 1997, Lane
1998b, Lane 1999, Lane 2000, Lane 2007, Lane 2010). However, it is also important to
appreciate that the openness of the Irish economy means that the plausible calculations
of the …scal multiplier lie well below unity, since a substantial part of the negative …scal
impulse is absorbed through a decline in imports. Indeed, in line with this pattern, the
Irish current account balance has substantially improved during the crisis period, with the
decline in domestic demand outstripping the fall in domestic output (see also Lane and
Milesi-Ferretti 2011).
The market focus is now fully directed at the many open questions concerning Ireland’s
12
…scal position. A core issue is whether the new government can successfully implement
the …scal adjustment that has been agreed with the EU-IMF-ECB Troika. In relation to
the sustainability of the high public debt, the July 2011 announcement of a signi…cant
reduction in the interest rate on European o¢ cial funding is helpful. However, in order to
assure investors of its commitment to …scal sustainability, the savings from such an interest
rate reduction should be applied to reducing the debt level, rather than scaling back the
volume of …scal adjustment. Furthermore, the decline in the overall …scal environment in
Europe during 2011 suggests that the Irish government should accelerate the pace of …scal
adjustment.
More broadly, the key problem facing Ireland is that there is a wide dispersion of beliefs
concerning the prospective growth rate of the Irish economy. Importantly, this uncertainty
will not be resolved in the near term, since the biggest divergence in views concerns growth
rates in 2013 and beyond. An important line of thinking rests on the robust international
pattern that output growth tends to be very slow for up to a decade in the wake of a major
banking crisis. A more optimistic view points to the capacity of a small, ‡exible economy
to adopt an export-led strategy that can deliver a more rapid recovery.
Since the medium-term growth path for Ireland will not be revealed for a considerable
period, the ability of the Irish government to re-enter the sovereign debt market would be
facilitated by a redesign of the Troika loan that allows for this core uncertainty. In particular, the repayment terms of the loan (the interest rate and/or the duration of the payback
period) should vary with the performance of the economy, with greater net payments if
the economy does well and lower net payments if economic growth is disappointing. As
with any insurance scheme, such a facility would require intense monitoring by the funding
agencies to ensure that Ireland pursues maximal pro-growth policies. But Ireland’s …scal
position would be signi…cantly stabilised by such a reform, to the bene…t of Irish taxpayers
and international creditors.
13
4
Fiscal Reform
The boom and bust in Ireland has generated an appetite for substantial institutional reform
to ensure that “never again”will Ireland endure the avoidable costs of such volatility. One
element in a broad package of institutional reforms is to implement a formal …scal framework
that may help insulate the conduct of …scal policy from pro-cyclical pressures. Indeed, a
new Irish Fiscal Advisory Council was formed in July 2011, and a Fiscal Responsibility
Law is to be published before the end of 2011. Department of Finance (2011) outlines the
proposed …scal framework, while Lane (2010) provides a detailed analysis of the potential
gains from such an institutional reform for Ireland.
The over-riding principle in designing …scal rules for Ireland should be to preserve
medium-term …scal sustainability. To this end, it is appropriate to target an annual surplus
in the structural …scal balance for several reasons. First, Ireland faces the prospect of
higher future public spending needs on healthcare and pensions due to the ageing of the
population. Second, the public debt of Ireland will be quite substantial by the end of the
current …scal adjustment process: returning the level of public debt to a safe level (far below
the 60 percent ceiling speci…ed in the SGP) will require a sustained period of structural
surpluses. Third, it is appropriate to target a structural surplus during normal times in
order to provide a bu¤er against the occurrence of a major negative macroeconomic shock.
In tandem with the last point, the structural balance …scal rule should be implemented
on a “through the cycle” basis, such that the structural …scal balance can move countercyclically to address major recessions or (in the other direction) overheating episodes, which
may require extra …scal measures beyond the automatic stabilisers that are part of the
passive cyclical component of the budget.
Fiscal rules are more e¤ective if the setting of …scal policy incorporates a role for an
independent …scal council. In this regard, the new Irish Fiscal Advisory Council would
o¤er a myriad of potential bene…ts. First, such a council can play a role in identifying the
14
cyclical state of the Irish economy and the distribution of macroeconomic risk factors. Second, given the macroeconomic environment, it can make recommendations concerning the
overall budgetary stance that would be consistent with medium-term …scal sustainability.
Third, it can monitor compliance with the speci…ed …scal rules and make recommendations
concerning the appropriate adjustment path in the event of non-compliance. Fourth, in
related fashion, it can make an ex-post evaluation of the conduct of …scal policy over the
preceding year. In addition to these direct budgetary roles, an independent …scal council
can also contribute to the transparency of the …scal process by acting as an independent
monitor of the quality and availablity of the …scal data and promoting the level of public
debate about …scal policy through engagement with parliamentary committees, media and
the organisation of policy workshops.
However, as is emphasised in Calmfors and Wren-Lewis (2011), an independent …scal
council is only sustainable and e¤ective if its role is fully supported by the political system.
Otherwise, a government may be tempted to neutralise an independent council (for instance
by reducing its budget or replacing its sta¤) if it dislikes the …scal opinions that it provides.
In addition, the e¤ectiveness of such an independent agency depends on the clarity of its
mandate and its capacity to act in an autonomous fashion - accordingly, the design of
the Fiscal Responsibility Law (due to be published before the end of 2011) is of critical
importance.
5
Conclusions
This paper has provided an overview of the conduct of …scal policy both before and during
the crisis. We …nd that Ireland failed to su¢ ciently adapt to the rigidities of EMU membership, in that the …scal stance was insu¢ ciently counter-cyclical during the pre-crisis period.
Moreover, the conduct of …scal policy failed to take into account the transitory nature of
windfall revenues associated with capital in‡ows and the credit boom. In turn, this limited
15
the …scal capacity to combat the crisis. In combination with a …scally-demanding approach
to resolving the banking crisis, this ultimately required Ireland to seek EU/IMF …nancial
support in November 2010.
In the near term, the EU/IMF plan requires Ireland to implement a demanding …scal
adjustment package over 2011-2014, having already executed a large-scale …scal tightening
over 2008-2010. There remains considerable uncertainty about whether the growth path
for Ireland will turn out to be su¢ ciently rapid to ensure a return to the sovereign debt
markets in line with the plan’s schedule. Accordingly, the next few years are set to be very
fraught in terms of the …scal sustainability debate.
Over the longer term, Ireland must learn from this sorry episode.
A formal …scal
framework is one element in the institutional reform process that can help underpin future
macroeconomic stability.
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24-34.
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Review 29, 1-16.
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2-10..
Lane, Philip R. (1999), “Budgetary Policy in Times of Plenty”, in Budget Perspectives
2000, Economic and Social Research Institute.
Lane, Philip R. (2000), “What Should We Do With the Surpluses?,” Administration,
Winter 1999/2000.
Lane, Philip R. (2003), “The Cyclicality of Fiscal Policy: Evidence from the OECD,”
Journal of Public Economics 87, 2661-2675.
17
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2008, Economic and Social Research Institute.
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and Social Inquiry Society of Ireland XXXIX, 144-165.
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Global Crisis,”IIIS Discussion Paper No. 369.
18
Table 1: Fiscal Cyclicality
CYCLE(t)
GGBAL/GDP
(1)
(2)
CABAL/GDP
(3)
(4)
(5)
0.11
(0.43)
-0.30
(0.61)
0.34**
(0.15)
0.04
(0.03)
1.03***
(0.08)
-2.20
(2.00)
0.50
(0.36)
0.38***
(0.13)
0.14**
(0.06)
0.03
(0.03)
0.67***
(0.15)
-2.65
(2.04)
37
0.89
37
0.93
CA(t)
PCREDIT(t,t-1)
DEBT(t-1)
FISCAL(t-1)
CONS.
Obs.
R2
0.004
(0.04)
0.80***
(0.08)
0.30
(2.77)
0.64
(0.49)
0.49***
(0.10)
0.18***
(0.05)
0.08**
(0.03)
0.34***
(0.10)
-4.48*
(2.27)
27
0.84
27
0.93
REV
(6)
(7)
EXP
(8)
0.01
(0.01)
0.74***
(0.09)
-0.89
(0.63)
0.33**
(0.14)
-0.10**
(0.04)
0.05***
(0.02)
0.02**
(0.01)
0.44***
(0.13)
-2.03***
(0.69)
0.23
(0.24)
-0.01
(0.01)
0.93***
(0.07)
0.46
(1.01)
0.20
(0.21)
-0.10***
(0.03)
0.02
(0.03)
0.001
(0.02)
0.78***
(0.08)
-0.37
(1.23)
37
0.69
37
0.78
37
0.86
37
0.88
Notes: Robust standard errors in parentheses. * signi…cant at 10%; ** signi…cant at 5%; ***
signi…cant at 1%. These models are estimated with data for the period 1970-2007. GGBAL/GDP
is general government balance scaled by GDP. CABAL/GDP is the cyclically-adjusted primary
balance scaled by GDP. REV is general government real revenues relative to trend. EXP is general
government real expenditure relative to trend. CYCLE is real GDP relative to GDP trend. CA
is current account balance scaled by GDP. PCREDIT is the percentage point di¤erence in private
credit scaled by GDP. DEBT is public debt scaled by GDP. FISCAL(t-1) is the lagged value of
the considered …scal variable.
19
Table 2: Fiscal Cyclicality. Instrumental variables.
CYCLE(t)
GGBAL/GDP
(1)
(2)
CABAL/GDP
(3)
(4)
(5)
0.01
(0.57)
-0.41
(1.11)
0.68**
(0.30)
0.03
(0.03)
1.03***
(0.08)
-1.86
(2.33)
0.50
(0.48)
0.51***
(0.10)
0.16**
(0.06)
0.01
(0.03)
0.56***
(0.10)
-2.01
(2.36)
37
0.89
37
0.92
CA(t)
PCREDIT(t,t-1)
DEBT(t-1)
FISCAL(t-1)
CONS.
Obs.
R2
-0.002
(0.06)
0.79***
(0.08)
0.76
(4.61)
1.23
(0.97)
0.59***
(0.17)
0.21***
(0.07)
0.12*
(0.06)
0.25*
(0.15)
-7.08
(4.53)
27
0.84
27
0.92
REV
(6)
(7)
EXP
(8)
0.03*
(0.02)
0.66***
(0.12)
-2.17**
(1.09)
0.52***
(0.20)
-0.13***
(0.04)
0.06***
(0.01)
0.03***
(0.01)
0.30**
(0.15)
-2.99***
(0.85)
0.41
(0.32)
0.004
(0.02)
0.91***
(0.06)
-0.25
(1.27)
0.35
(0.28)
-0.14***
(0.03)
0.03
(0.03)
0.01
(0.02)
0.70***
(0.07)
-1.22
(1.42)
37
0.66
37
0.76
37
0.86
37
0.88
Notes: Robust standard errors in parentheses. * signi…cant at 10%; ** signi…cant at 5%; ***
signi…cant at 1%. These models are estimated with data for the period 1970-2007. GGBAL/GDP
is general government balance scaled by GDP. CABAL/GDP is the cyclically-adjusted primary
balance scaled by GDP. REV is general government real revenues relative to trend. EXP is general
government real expenditure relative to trend. CYCLE is real GDP relative to GDP trend. CA
is current account balance scaled by GDP. PCREDIT is the percentage point di¤erence in private
credit scaled by GDP. DEBT is public debt scaled by GDP. FISCAL(t-1) is the lagged value of
the …scal variable. The GDP cycle is instrumented with its own lag, while the current account
balance is instrumented with the oil balance. Diagnostic tests show that these instruments are
valid. Details are available upon request.
20
Institute for International Integration Studies
The Sutherland Centre, Trinity College Dublin, Dublin 2, Ireland