The Fiscal Treaty Files: What the Government Really Thinks About What’s in the Treaty

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A kind of surprising question, you might think.  Sure, they’re the ones who negotiated it, signed it and now asking people to vote for it.  They must think it’s great.  Yet they publish documents criticising one of the main elements in the Treaty; namely, the structural deficit.  In short, the Government’s position is: ‘these are bad measurements, now please put them into the constitution.’

The structural deficit attempts to tell us how much of the deficit is cyclical (or will disappear when the economy returns to full growth) and how much is structural (will remain with us even after the economy returns to full growth).   A structural deficit means the Government must take action – it must raise taxes, cut spending or do a bit of both to get rid of the structural bit.

It does this by estimating the gap between our actual growth rate and our potential growth rate – this is called the output.  The potential growth rate is estimated on the basis of what our growth rate would look like if we were fully utilising all our capacity (capital, labour, production, etc.).  The higher the gap between the two, the lower the structural deficit; the lower the gap, the higher the structural deficit.  Ok, a bit abbreviated but that’s the gist.

You can immediately see the problems:  both the structural deficit and the ‘output gap’ are artificial measurements.  You can’t actually measure these, you have to estimate them.  Nothing in principle wrong with that – but not the stuff you’d lay a bet in the bookies.  Indeed, Davy Stockbrokers said:

‘Structural budget deficit target is a poor choice as official estimates differ starkly and are prone to revision over time.  The choice of the 0.5% structural budget target is exceptionally poor . . . as a theoretical concept, the structural budget deficit is unobservable as the estimates are prone to revision and subject to dispute long after the event.’

Hmm.  ‘Exceptionally poor’, ‘theoretical‘, ‘estimates differ starkly’, ‘subject to dispute’ – just the thing to stick into our constitution.

The funny thing is that the Government s says much the same thing.  In the last budget, in their Economic and Fiscal Framework, this is what they said about the structural deficit:

‘ . . . the exact size of the structural element is, of course, highly uncertain.’

But that’s the mild bit. When the Department of Finance used the EU’s method of estimating the ‘output gap’ upon which the structural deficit is determined, they found a big big problem.

‘Moreover, further out the forecast horizon, the production function methodology [the EU method] implies a positive output gap – that overheating pressures are emerging, which does not appear realistic.’

The Department used the EU method and found that the economy was overheating by 2015.  Overheating?!  Unemployment is estimated to be 12 percent, GDP has still to return to pre-recession levels, all the components of domestic demand (consumer spending, investment, etc.) are well, well below pre-crisis levels, we have more people – yet the EU says the economy will be overheating.

No wonder the Department of Finance said it appeared ‘unrealistic’.  That’s diplomatic-speak for ‘this is a pile puppy-poo‘.

And yet, the Government – having described one of the main measurements in the Treaty as ‘highly uncertain’ and ‘unrealistic’ – still want us to put this into the constitution.

Thank god it’s Friday.  I wish everyday up to the referendum was Friday.

But I fear this debate will be a permanent Monday.

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