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Tom Ferris is a Consultant Economist specialising in Better Regulation. He was formerly the Department of Transport’s Senior Economist.

In publishing unpopular advice, the Irish Fiscal Advisory Council (IFAC) is doing its job. It has now given a timely reminder that there are real limits to the amount that the new Government can spend. It warns that:

“The Government should publish detailed plans that demonstrate how the policy commitments in the programme will be funded within the estimated remaining fiscal space, allowing for the cost of maintaining existing public services”.

The Council’s views were produced specifically in response to the Department of Finance’s Stability Programme Update 2016.

 

Main areas of concern

Space does not enable all of the areas of concern to be addressed in this blog. Instead the headlines from the eight themes of the Report are re-produced. In general, these themes recognise the good work that is being done to keep the economy on a steady growth path. But they also point out where additional action is needed. The themes are as follows:

  1. The IFAC believes that there is uncertainty about the fiscal position over the coming years owing to a lack of published detail on the commitments in the programme for government;
  2. The IFAC welcomes Ireland’s pending exit from the European Commission’s Corrective Arm of the Stability and Growth Pact (SGP), but notes that it is now important that the requirements of the Preventive Arm of the pact and the domestic Budgetary Rule are followed;
  3. The IFAC notes that projections in Stability Programme Update 2016 show only a modest improvement in the public finances in 2016 and do not fully comply with the requirements of the domestic Budgetary Rule or the Preventive Arm of the Stability and Growth Pact;
  4. The IFAC is of the view that preliminary estimates suggest the availability of €0.9bn for tax cuts and spending increases in Budget 2017 under the fiscal rules.
  5. In the view of the IFAC, provided the economy is growing at a sustainable rate, it would likely be appropriate for the Government to use the available fiscal space under the rules after 2017. However, the IFAC believes that a tighter stance than required by the rules might be needed to prevent overheating in the economy and to ensure the Government has scope to increase spending during a future downturn [see Box A for more on the Fiscal Space];
  6. The IFAC states that the medium-term projections in Stability Programme Update 2016 for 2017–2021 understate likely future expenditure pressures and do not present an informative picture of the public finances after 2016;
  7. The IFAC concludes that the public capital investment in the Stability Programme Update 2016 projections is projected to remain low by historical and international standards; and
  8. The IFAC recommends that the Department of Finance should continue to develop additional models for estimating Ireland’s medium-term potential growth to ensure signs of overheating are detected.

BOX A: The Fiscal Space keeps appearing

We explored Fiscal Space in a PAI Blog last February. Put simply, the fiscal space represents the “spare” funds available to government for additional expenditure and/or tax reductions, while meeting day-to-day expenditures under the new EU fiscal rules.
Speaking on RTÉ’s Morning Ireland on 8 June, IFAC Chairman Prof John McHale said €6bn is available to the Government, and not the €12b suggested by Government in the run-up to the General Election. Prof McHale does acknowledge that the Government will be providing an updated estimate toward the end of June.

There is an explanation for the difference between the two sets of figures. Put simply, the two organisations use different assumptions to come up with their estimates.

  • Department of Finance clearly stated that the economic and fiscal forecasts figures contained in the Stability Programme Update 2016 were prepared on a technical, no-policy change basis. Or, as the IFAC puts it, the Department of Finance

“… do not allow for the rising costs of providing public services in line with inflation and it is assumed that none of the available fiscal space in the coming years is used for new spending or tax policies in line with those contained in the Programme for a Partnership Government”.

  • Irish Fiscal Advisory Council makes different assumptions. It states

“The Council’s stand-still expenditure estimate – maintaining the current level of real public services and benefits given a full accounting for demographic changes and inflation – would result in government spending being around €6 billion higher by 2021 than in the SPU 2016 projections”.

 

Rainy Day Fund

The IFAC is quite positive about having a Rainy Day Fund. The Programme for a Partnership Government has given a commitment for such a fund. Quite simply, the Programme states: “We will also establish a rainy day fund”.[iii] Box B gives a flavour what rainy day funds do.

BOX B: Some examples of Rainy Day Funds

General: There are relatively few examples of Rainy Day Funds in operation. In cases where such funds exist, they vary in both their purpose and their operation. The motivations include:

  • counter-cyclical policy to dealing with known long-term structural problems, and
  • providing insurance in the event of financial crises.

Structural Issues: The most common type of sovereign wealth fund appears to be those set up when a country experiences large economic gains from a temporary or uncertain source. The classic case of this is countries with natural resources such as Norway’s sovereign wealth fund. Because of their long-term goals, these funds typically act as investment vehicles that have low liquidity in the short-term. This may be appropriate for providing funds to allow for economic transition away from an oil-based economy or to provide for the cost of future pensions.

Counter-cyclical funds: Several US states use Rainy Day Funds to smooth their expenditure over time. Because many states are prevented by law from borrowing, the fall in state revenues that comes with cyclical downturns would, in the absence of a fund, require cutting back on expenditure. The only example of a counter-cyclical fund in the Eurozone appears to be in Finland. However, this operates quite differently to the relatively simple US-style funds. In Finland’s case, cyclical buffers are accumulated in an unemployment insurance fund.

 

Source material: Fiscal Assessment Report, IFAC, June 2016

 

Fiscal Council doing its job

While Council was initially set up on an administrative basis, it was formally established as a statutory body in December 2012 under the Fiscal Responsibility Act. Two strands of its mandate are particularly relevant when it comes to assessing the IFAC’s annual Fiscal Assessment Reports. They are:

  • To assess government compliance with the Budgetary Rule as set out in the Fiscal Responsibility Act, and
  • To assess whether the fiscal stance of the Government in each Budget and Stability Programme Update is conducive to prudent economic and budgetary management, including with reference to the provisions of the Stability and Growth Pact.

In its most recent report, the IFAC does acknowledge a number of positive features on the economic front. It notes that the recovery in the Irish economy has been impressive and is helping to alleviate the on-going legacy problems of the crisis; given the gravity of the recent recession and financial crisis, the Irish economy has recovered at a stronger pace than expected. And the Council recognises that

“The Government’s cost of borrowing is currently at historically low levels, helped by initiatives at a European level and the actions of previous Governments in broadly adhering to an effective fiscal adjustment programme”.

Final note of caution

The IFAC raises a flag of caution when it warns that

“… hard-won credibility can quickly be eroded unless budgetary responsibility is maintained. Although falling, the still high level of the debt-to-GDP ratio leaves the public finances vulnerable to domestic and international risks or renewed tensions in sovereign debt markets.”

However, if there is full implementation of Ireland’s budgetary framework, the new Government can copper-fasten Ireland’s restored creditworthiness and prevent a return to the boom-bust cycle.

NOTES


[i] http://www.fiscalcouncil.ie/wp-content/uploads/2012/01/FAR_Draft_08.06.16_Website_Final.pdf

[ii] http://opac.oireachtas.ie/AWData/Library3/FINdoclaid270416_094247.pdf

[iii] http://www.taoiseach.gov.ie/eng/Work_Of_The_Department/Programme_for_Government/A_Programme_for_a_Partnership_Government.pdf

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