Written answers

Tuesday, 8 July 2014

Department of Finance

Structural Budget Balance

Photo of Kevin HumphreysKevin Humphreys (Dublin South East, Labour)
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203. To ask the Minister for Finance if his attention has been drawn to the ESRI Bergin and Fitzgerald note on the structural balance for Ireland; the definition his Department uses for defining our structural balance; if his Department accepts the conclusion that the EU approach is inappropriate for calculating Ireland's structural balance; the action he is taking on same; if Ireland will reach structural balance next year as the paper argues; the implications this will have for Ireland and our EU treaty and commission commitments; and if he will make a statement on the matter. [29637/14]

Photo of Michael NoonanMichael Noonan (Limerick City, Fine Gael)
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My Department maintains an open dialogue on the issue of estimation of the output gap for Ireland (and its associated implications for estimation of the structural budget balance) with members of the economics community, including the ESRI. The recent Quarterly Economic Commentary Special Article by Bergin and FitzGerald outlining the limitations of the EU harmonised approach to estimating the output gap is a welcome addition to discussions on this important issue.

Definition used

As official publications from this Department have repeatedly highlighted, the harmonised EU approach is not well suited to  capturing in full the dynamics of the Irish economy. For the purposes of assessing compliance with EU fiscal rules, however, all Member States must apply the standard methodology as outlined in detail in D'Auria et al. (2010), together with the recent modifications to how the level of structural unemployment is estimated (as outlined in the April 2014 Stability Programme Update). Official estimates of the structural budget balance submitted to the European Commission for assessment must comply with this definition. The definition used by my Department thus follows the above approach where potential output corresponds to the level of output consistent with price and labour market equilibrium. As the ESRI paper highlights, this approach does not directly incorporate imbalances in the goods market captured through the current account. Movements in terms of trade, however, do feature in how the level of structural unemployment is modelled under this approach. My Department shares the view that the requirement to deliver continued structural adjustment following this harmonised approach will imply sustaining a significant current account surplus over time.

Appropriateness of approach

There are a number of well-flagged limitations to this methodology: namely the implausibly high levels of structural unemployment the approach implies, and the tendency for these estimates to be revised over time. Whilst all estimates of the output gap are prone to revision (since they are, by definition, based on unobserved trends), the extent of these revisions remains a source of concern.

Actions taken

My Department continues to monitor the implications of applying this harmonised methodology in Ireland. At EU working group level, my staff have been closely involved in lobbying for and successfully implementing improvements in how structural unemployment is calculated under the harmonised approach. Notwithstanding these improvements, my Department still views the implied rate of the latter for Ireland as both implausibly high and overly cyclical in nature.

My Department will continue to lobby to improve the fit of the harmonised methodology for Ireland. In this regard, I welcome the forthcoming report by the European Commission to the European Parliament on the application of the EU governance framework in December 2014. At technical level, my Department will continue to engage actively in this report process.

Position of structural balance

Whilst my Department is of the view that the output gap is likely to be more negative than that currently implied by the standardised methodology, it does not share the view outlined in the paper that all of the 2014 deficit (-4.8% of GDP) is due to the effects of the economic cycle. For this to be the case - consistent with the harmonised methodology - this would imply an equally implausible negative output gap of 9 1/2 % of GDP.

Implications for EU commitments

Estimation of the structural balance has assumed a central role in the domestic conduct and European assessment of fiscal policy. It will become even more central to Irish policy decisions once we are subject to the preventive arm of the Stability and Growth Pact from 2016 onwards. Ireland will then be obliged to deliver a correction in the structural balance of at least 0.5 percentage points  per annum from 2016 onwards, until we achieve a position of structural budget balance. Assessment of compliance with this requirement will be based on application of the harmonised EU method for calculating the output gap.

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