Jonathan O'Brien (Cork North Central, Sinn Fein)
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151. To ask the Minister for Finance if he will identify both the cyclical element and structural element of the fiscal deficit. [45699/13]

Jonathan O'Brien (Cork North Central, Sinn Fein)
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152. To ask the Minister for Finance his plans to resolve the cyclical element of the fiscal deficit. [45700/13]

Michael Noonan (Limerick City, Fine Gael)
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I propose to take Questions Nos. 151 and 152 together.

At the outset it must be stressed that decomposing the fiscal deficit into its cyclical and structural elements is based on complex statistical techniques. As these techniques involve the estimation of unobserved phenomena they can be prone to large revisions. Whilst the estimates below provide an intuitive picture, the standard 'one size fits all' methodology employed by the European Commission has in the past produced counterintuitive results when applied to a small open economy characterized by nominal wage rigidities such as Ireland.

Specifically, decomposing the headline deficit into its cyclical (portion owing to the position of the economic cycle) and structural (underlying) components is done in line with standard European Commission-approved methodology. This approach relies on approximating the 'output gap' - the difference between observed real output levels and those (unobserved) levels that would prevail in the absence of price or wage pressures in the economy. Applying a measure of the link between the economic cycle and the budget (a semi-elasticity budgetary parameter) to the output gap produces the cyclical-component of the budget balance.

The structural balance is calculated as the headline general government deficit less the cyclical component, less the impact of one-off temporary measures impacting the deficit.

On the basis of Budget 2014 arithmetic, the table sets out the profile of the headline balance decomposed into its cyclical and structural components over the 2012-2016 period. Future data revisions or statistical changes render these estimates subject to change.

Decomposition of General Government Balance (% GDP) 2012-2016

The cyclical component (item 2 above) is the part of the deficit that will improve naturally as the economy recovers. The structural deficit is the focus for policy and EU fiscal rules. The impact of discretionary fiscal policy can be proxied by the change in the cyclically-adjusted primary budget balance [change in item 5 in Table above]. This change reveals policy’s contribution to resolving the structural component of the deficit.

Given relatively good growth potential, it is important to highlight improvements in the structural budgetary position can be achieved without necessarily involving additional taxation increases or expenditure reductions. This can be achieved by maintaining expenditure growth below the nominal growth rate of the economy.