Irish Economic Environment

Dr. Stephen Kinsella & Ms. Claire HurstDepartment of Economics

University of Limerickhttp://stephenkinsella.net

Contact Details

• Office Hours: by appointment

• KB3-46

• stephen.kinsella@ul.ie/clairebhurst@gmail.com

• 061 23 3611

Learning Outcomes

• Learn Irish Economic History

• Interpret & Analyse Basic Economic Data

Today

• Introduction to Macroeconomics

• Data on Irish Economy Today & Yesterday

• Irish Macroeconomic History

• Origins of the Celtic Tiger

Picture of today’s macroeconomy

• GDP growth: ~0.0%

• Price inflation: 4%

• Unemployment: 6.1%

• Low Consumer Confidence

• Housing Boom Over

• Fiscal Austerity Measures to come into place on Oct 14.

Introduction to Macroeconomics

• Macroeconomics is the study of the overall structure and performance of national economies.

• Instead of trying to analyze the behavior of individual households or producers, we analyze the behavior of average households and producers.

“Real” Sector

Markets for:

• Goods and Services

• Labor Services

• Land, Structures, Capital Goods

Actors:

• Households (consumers)

• Producers

• Government

Financial Markets

Markets for:

•Claims on money in the future

•Allocation of current savings

Savings

Investment Capital

SIGNALS

MONEY

Basic Questions

• What determines the rate of growth of the Irish economy?

• What determines the rate of inflation?

• Why are there periods of high and persistent unemployment?

Basic Questions

• Why are there fluctuations in economic activity?

• What role can and should government play in promoting full employment, stable prices, and economic growth?

Measures of Economic Performance

• The basic performance measure for an economy is the measurement of its ability to “produce” goods and services.

Gross Domestic Product

• Gross Domestic Product (GDP) is a measure of the output of an economy in a given time period.

• GDP is the total value of all final goods and services produced in the economy during a given time period.

Gross Domestic Product

• GDP measures the total goods and services available to the various potential consumers: - households, firms, and government.

• In principle GDP equals income (GDI): - the value of all payments by producers to factors of production: - labour, land, and capital.

1960 1970 1980 1990 2000Year

5000

10000

15000

20000

25000

30000

Real GDP Per Capita

Irish Real GDP per Capita, 1950-2005. Source: Penn World Tables v. 6.2, CSO.ie, and author's calculations. Penn Data available here, CSO data available here.

How is GDP measured?

• It includes only the value of goods produced this period and not the value of all goods bought and sold this period.

• GDP includes only the value of final goods and services produced. Intermediate products sold to other producers and embodied in goods sold to final consumers are not included in the GDP calculation.

What does GDP not include?

• Value of non-market production; e.g., home produced goods, volunteer work, value of “public” goods.

• Non-market costs; e.g., pollution costs.

• Value of transactions in existing assets; e.g., sale of a used car or house.

Price Changes and GDP

• GDP uses market values as units of measurement.

• When comparing GDP from different time periods, we will be comparing numbers based on different measurement systems if prices have changed.

The price problem - Example

• Computers count for 10 GDP units in 1999 but for only 8 in 2000.

• Apples count for 3 GDP units in 1998 and for 4 in

Solution: - Price Index

• We need units common to both years.

• Could choose either 1999 or 2000 prices as units of measurement.

• Choosing 1999 as the base, we would then re-value 2000 at 1999 prices.

• This would yield a 2000 GDP of $335 ($10×20 + $3×45).

The GDP Deflator

• The GDP deflator shows how the cost of different bundles of goods would vary holding prices constant.

• The GDP deflator holds base period prices fixed while the CPI holds base period quantities fixed.

0

10

20

30

40

1997 1997 1999 2000 2001 2002 2003 2004 2005 2006

GNI at constant 2005 prices per capita

€000

Measuring Inflation – Consumer Perspective• Can be measured in different ways.

• Standard measurement in to compute the cost of an “average” bundle of goods and services consumed by households. This is frequently referred to as the “headline” rate.

• In Ireland, this “headline” rate is the Consumer Price Index or CPI.

What is the CPI?

• The standard bundle is based on survey of consumer buying habits.

Prices and Inflation

• Inflation is a problem in a monetized economy. If inflation is too high, people will be unwilling to hold money.

•

0

7.5

15.0

22.5

30.0

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

CPI Annual % Price Index Changes

AVERAGE (%)

Measuring Growth

• One way to measure growth is growth in total output.

• Better yet, in terms of individual well-being, growth can be measured in per worker or per capita terms.

g =

Yt+1 ! Yt

Yt

Unemployment

• Two reasons for concern with unemployment:

1. Unemployment represents waste. There are resources which could produce output not employed.

2. Unemployment is a distribution problem. The “burden” is not shared equally across the working population.

Measuring UE

• u = Unemployment Rate = U/N

• U = number unemployed actively seeking work

• N =Total Labour Force = U+N

Effects of Cycles

• In recessions, unemployment rate increases and price inflation tends to moderate.

• In expansions, unemployment falls as GDP grows.

• As the economy nears a peak, price inflation tends to accelerate.

Break

Today

• Introduction to Macroeconomics

• Data on Irish Economy Today & Yesterday

• Irish Macroeconomic History

• Origins of the Celtic Tiger

Break

Today

• Introduction to Macroeconomics

• Data on Irish Economy Today & Yesterday

• Irish Macroeconomic History

• Origins of the Celtic Tiger

When a national government makes decisions on taxation and

spending with a view to influencing the level of production and

employment, this is called "fiscal policy."

Definition of Fiscal Policy

Actual growth rateInflation gap

Unemployment gap

Growth rate of potential GDP

% change GDP

Time

Idea of Fiscal Policy

• Demand Pull inflation: actual growth rate > potential growth rate

• Unemployment gap: actual growth rate< potential growth rate

• Objective of stabilisation policy: keep actual GDP close to its potential level

• Should always be Counter Cyclical

• What is likely to happen if it is Procyclical?

• Any examples of Procyclical fiscal policy in Ireland recently?

Fiscal Policy: Lags

• Recognition

• Policy lag

• Implementation

• How much of an injection?

• Political influence?

Fiscal Policy: Lags

• Discretionary: FP is used (conscious decision)

• Automatic stabilisers: operate through the tax and social welfare system. No conscious decision is made by government.

• Prior to 1987: depression (negative growth), high unemployment (18%), high inflation (16%), public finances in crisis (deficit of 15.1%) , balance of payments deficit (14.6% of GNP) and depreciating exchange rate. Mass emigration, rising poverty. “Basket Case” economy.

• 1994 to 2001: 7 years of spectacular growth (average 9%), low unemployment (3.6%), low inflation (1.4%), surpluses on fiscal budget (3.5%) and balance of payments (3.7%). The “Celtic Tiger”

Pre-1973

• Fiscal Policy not consciously used as an instrument of demand management

• Borrowing for capital purposes was accepted

1973 Oil Crisis

• Current budget deficit increased from 0.4% of GNP to 6.9% in 1975

• Exchequer Borrowing Requirement rose from 8.6% to 16% in 1975

• Abolition of rates

• at a time when the economy was growing at 7% real GNP in 1977

General Election 1977

• Need to reduce unemployment

• Fiscal deficit would only be temporary and would lead to increased private investment ‘private sector investment would rise on the back of the initial increase in government expenditure’

Justification?

• Real GNP 2.7% between 1979 -80

• CBD remained above 6% of GNP

• PSBR increased to 17.3% of GNP in 1980

• Unemployment increased to 7.3% in 1980 and annual inflation increased to 18.2%

• Living Standards fell

Open Economy

• Low multiplier

• High degree of leakage

Borrowing to cover day-to day expenditure

Capital investments inappropiate

Implications

• Ill-prepared for oil price shock of 1979

• Level of national debt rising

Procyclical Fiscal Policy

• Tax increases rather than expenditure cuts

• Budget deficit increased to 15% of GNP

• External debt doubled between April 1980-1981

New Coalition Government: 1982-86

• Increased taxation and reduced current expenditure

• Further deterioration in fiscal situation combined with rising unemployment (16.7%)

Mini-budget 1981

• Increased taxation and reduced current expenditure

• Further deterioration in fiscal situation combined with rising unemployment (16.7%)

• White Paper ‘Buillding on Reality 1985-87’

New Coalition Government: 1982-86

• Increase in taxation rather than reducing current expenditure

• Loss of confidence in the economy which led to a higher level of interest and a higher EBR and national debt

• Global Economic downturn

• Stabilisation of debt/GNP ratio

• Real wage moderation

• Cuts in expenditure

• Widening the tax base

• Tax amnesty

Components of the Turnaround

• Debt/GNP ratio fell to 106% by 1991

• Rate of growth of GNP increased

• Unemployment fell (14.7%)

• Inflation (3.3%)

Results

Social Partnership: Objective wage moderation

• Programme for National Recovery (PNR) 1987-90

• The Programme for Economic and Social Progress (PESP) 1991-93

• The Programme for Competitiveness and Work (PCW) 1994-96

• Partnership 2000 (P2000) 1997-00

• Programme for Prosperity and Fairness 2001-03

Fiscal Correction

• SOE is extremely susceptible to external ‘shocks’

• FP tends to have more impact on the BoP then on employment or prices

• Multiplier effect is very weak in a SOE because of a high MPM

Caution....

Procyclical Fiscal Policy

Open Economy

• Low multiplier

• High degree of leakage

Borrowing to cover day-to day expenditure

Capital investments inappropriate

Implications

• Ill-prepared for oil price shock of 1979

• Increase in taxation rather than reducing current expenditure

• Loss of confidence in the economy which led to a higher level of interest and a higher EBR and national debt

• Global Economic downturn

External Funding

• Large inflow of structural and cohesion funding for the EU had a beneficial effect on the economy

• Demand side effect

• Supply side effect

Euro/EMU/Maastricht criteria

• Economic criteria (interest rates, inflation rates, level of debt and exchange rates)

• Freer trade

Demographic Trends

• Size and composition of labour force can have a significant impact on the economic development

Education Profile and Cost of Labour Force

Industrial Investment and Incentives

Exchange Rate Policies

• Devaluations of 1986 and 1993

The External Economic Environment

Today

• Introduction to Macroeconomics

• Data on Irish Economy Today & Yesterday

• Irish Macroeconomic History

• Origins of the Celtic Tiger

The Footprints of the Celtic Tiger

• Growth Rates and Convergence

• Inflation

• Employment

• Unemployment

• Female Participation

• Migration

• After 2000, the real growth rate fell significantly.

• 4.6% in 2001, 1.25% in 2002 and 2.8% in 2003f.

• This is, in effect, recession as the economy is operating below potential.

• Slowdown is due, in part, to:

• 1. Downturn in the US and European economies.

• 2. Fall in equity markets due to unrealistic profit expectations and corporate accounting scandals.

• 3. Foot and mouth crisis in 2001.

• 4. September 11th terrorist attack in 2001.

• GDP growth expected to stall, or fall slightly

• Consumption growth of 1%

• 15% decline in investment

• CPI expected to average 4% in 2008

Quarterly Ec. Commentary 2008

Summary of Today’s Lecture