Demographic Change and Projections for the Public Finances over the - - PowerPoint PPT Presentation

Demographic Change and Projections for the Public Finances over the Medium Term

Thomas Conefrey NERI Economics Seminar, 13 January 2016

1

IFAC: SOME BACKGROUND

MANDATE OF THE COUNCIL:

9th Fiscal Assessment Report

Five-member Council Six-member Secretariat

ASSESSMENT OF FORECASTS COMPLIANCE

WITH RULES

FISCAL STANCE ENDORSEMENT

OF MACROECONOMIC

FORECASTS

INDEPENDENT ECONOMIC ANALYSIS

2

Outline

• Review of recent macroeconomic and fiscal

performance (IFAC Fiscal Assessment Report, November 2015).

• Rationale for medium-term fiscal forecasts.
• Estimating medium-term demographic change

and implications for public spending.

• Assessment of medium-term budgetary

forecasts.

3

European/Domestic fiscal rules

Domestic European Corrective Arm

• f SGP

Preventive Arm

• f SGP

3% Deficit Rule 1/20th Debt Rule MTO / Adjustment path to MTO Expenditure benchmark Domestic Budgetary Rule Domestic Expenditure Ceilings Domestic Budgetary Rule Consistent with Preventive Arm of SGP Domestic Expenditure Ceilings Consistent with Expenditure Benchmark

4

Complementary domestic and European elements

Effectiveness

• f Domestic

Framework Effectiveness

• f European

Framework

Monitoring, peer pressure and possible sanctions of the European framework enhances the effectiveness of the domestic framework Domestic ownership adds legitimacy to the European rules

5

REAL GDP, REAL GNP AND EMPLOYMENT GROWTH (% CHANGE Y-Y)

STRONG RECOVERY AND CENTRAL GROWTH FORECASTS

• 10
• 8
• 6
• 4
• 2

2 4 6 8 10 12

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 % Change Y-Y Real GDP Real GNP Employment Sources: Department of Finance (Budget 2016); CSO. 6

Increasing contribution of domestic demand to recovery

Source: CSO. 9.4 8.8 18.2

• 10
• 5

5 10 15 20 2010 2011 2012 2013 2014 2015 % Growth Since Trough in Q2 2009

CUMULATIVE CONTRIBUTION TO REAL GDP GROWTH SINCE TROUGH

Residual Domestic Demand Net Exports Real GDP 7

Evidence of rebalancing

0% 5% 10% 15% 20% 25% 30% 35% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

% OF NOMINAL GDP

Investment Net Exports

Source: CSO.

8

Current account near balance excluding re-domiciled PLCs

• 0.4
• 0.6
• 1.0

0.5

• 0.1
• 3.3
• 4.9
• 6.1
• 5.8
• 4.1
• 0.8
• 1.2
• 1.5

3.1 3.6

• 5.1
• 3.9
• 4.5
• 5.7
• 0.2
• 8
• 6
• 4
• 2

2 4 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 % GDP Current Account Balance Adjusted for Re-domiciled PLCs 9

National Income and Consumption per Head

10 15 20 25 30 35 40 45 50 55 € ,000

Macro indicators per head, real

Consumption GDP GNP Sources: CSO and Department of finance forecasts.

10

Sharper downturn + recovery than trading partners

60 65 70 75 80 85 90 95 100 105 110 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Index: 2007 = 100

REAL GDP PER CAPITA

IE UK US EA

Sources: CSO; IMF and internal calculations.

11

Employment Rate

40 45 50 55 60 65 70 75 80 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 (latest) %of 15-64 population

Employment rate, % of 15-64 population

Ireland United Kingdom

Source: CSO and Eurostat.

12

Growth Benefitting the Public Finances

• 500

500 1000 1500 2000 2500 3000 3500 4000 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15

€ million

TAXES AND PRSI RELATIVE TO CUMULATIVE PROFILE

Income Taxes VAT Excise Duties Corporation Tax Capital Taxes Stamp Duties "Other" PRSI

Note: These overruns are relative to Budget profile. SPU anticipated taxes and PRSI coming in

13

Exchequer Tax Revenue

• 5

10 15 20 25 30 35 40 45 50 Jan-95 Nov-95 Sep-96 Jul-97 May-98 Mar-99 Jan-00 Nov-00 Sep-01 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Sep-11 Jul-12 May-13 Mar-14 Jan-15 Nov-15 € billion

ANNUALISED EXCHEQUER TAX RECEIPTS 1995-2015

Source: Department of Finance.

14

EXCESSIVE DEFICIT CLOSED IN 2015

0.3

• 7.0
• 11.5
• 11.0
• 8.4
• 7.9
• 5.7
• 3.9
• 2.1
• 1.2
• 14
• 12
• 10
• 8
• 6
• 4
• 2

2 4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

% of GDP

Primary Balance Interest General Government Balance EDP Ceiling

Source: CSO; Budget 2016.

GENERAL GOVERNMENT BALANCE (% GDP)

15

REAL GDP FAN CHART BASED ON BUDGET 2016 PROJECTIONS (TO 2016)

BUT SIGNIFICANT RISKS AROUND CENTRAL FORECASTS

• 6
• 4
• 2

2 4 6 8 2008 2009 2010 2011 2012 2013 2014 2015 2016 % Change Y-Y

80% likelihood range 60% likelihood range 40% likelihood range 20% likelihood range Official Outturns / Central Forecasts

Sources: CSO; Department of Finance; internal IFAC calculations. Note: Distributions or 'fans' around historical growth estimates are based on previous revisions to real GDP data. Both forecast errors and revisions are based on 1999-05 sample.

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CRISIS LEGACY OF HIGH DEBT AND ASSOCIATED RISKS

76.0 84.2 62.5 69.3

20 40 60 80 100 120 140 160 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Gross Debt (% GDP) Gross Debt (% Hybrid) Net Debt (% GDP) Net Debt (% Hybrid)

Sources: Department of Finance; internal IFAC calculations. Note: Changes in EDP debt instrument assets for forecast years are assumed to be in line with Budget 2016 projected changes in cash balances.

GENERAL GOVERNMENT DEBT

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Outlook

Short Term

• Policy vigilance and economic growth have helped to improve

the public finances

– But significant risks surround the forecasts. – Importance of prudence to ensure sustainable growth.

Medium Term

• Key weakness remains the absence of realistic medium-term

projections for the public finances.

• Projections for expenditure, tax revenue, deficit and debt based

largely on technical assumptions.

• With period of crisis management and repair coming to an end,
• pportunity to re-focus on medium term.

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Why are Medium-Term Budgetary Plans Important?

• Budgetary process has focussed attention excessively
• n one-year ahead.
• This has contributed to pattern of procyclicality in Irish

fiscal policy.

• Medium-term fiscal plans are required in order to:

– Provide a medium-term anchor for the public finances and avoid the risk that incoming cyclical revenues are spent. – Increase the predictability of the budgetary planning process. – Provide a link between resource allocation and Government policy and priorities.

• Key theme of recent Fiscal Assessment Reports

19

Deviations from Expenditure Plans

• 10%
• 5%

0% 5% 10% 15% 20% 25% 30% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2009* 2010 2011 2012 2013 2014 2015

% deviation

GROSS CURRENT EXPENDITURE, % DEVIATION FROM FORECAST

Yr1 % Deviation Yr2 % Deviation Yr3 %Deviation Real GDP growth Budget Year Source: Department of Finance Note: * denotes the Supplementary budget in 2009. Bars show the forecast error for 1 year ahead, 2 years ahead and 3 years ahead. Latest figures for 2016 to 2018 (used in calculation the latest deviation from Budget 2015 years 2 and 3) are adjusted by €1 billion to reflect the change in the treatment of the HSE from 2015. This adjustment is made for comparison purposes.

20

44 45 46 47 48 49 50 51 52 53 54 2013 2014 2015 2016 2017 2018

€ billion Budget Year

Source: Department of Finance. Budget 2012

CONTINUOUS REVISIONS TO MULTI-YEAR EXPENDITURE CEILINGS

CHANGES TO CURRENT EXPENDITURE CEILINGS

Budget 2013 Budget 2014 Budget 2015 Budget 2016 21

Medium-Term Fiscal Plan in Budget 2016

• Budget 2016 medium-term fiscal projections include:

– €0.4 billion per annum for demographic pressures – Cost of Lansdowne Road Agreement until 2018

• Tax forecasts allow for indexation but assume no change in

policy, despite stated commitments to reduce taxes.

• Medium-term plans imply over-compliance with fiscal rules

although stated policy is for minimum compliance.

• Develop an alternative medium-term expenditure scenario for

2015-2021

• Scenario takes into account estimated demographic changes and

assumptions on the cost of providing public services based on Budget 2016 macro projections.

22

Budget 2016 Projections imply Steep Fall in Primary Spending

20 25 30 35 40 45 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 % of GDP

Government Revenue and Primary Expenditure, % of GDP

Primary expenditure/GDP Revenue/GDP Note: Chart shows Exchequer revenue and primary expenditure as a share of GDP. Source: Budget 2016 and internal IFAC calculations.

23

Methodology: Steps

• 1. Produce baseline demographic projections using

Cohort Component Method.

• 2. Demographic scenario with projections of

population by age used as input into long-term fiscal model.

• 3. Volume of public expenditure linked to

demographics, price indexed to relevant deflators.

• 4. Compare resulting scenario to Budget 2016

projections and estimates of fiscal space.

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Medium-Term Demographic Projections

• First step in producing alternative expenditure scenario is to

develop baseline population projections.

• Cohort Component Method used to build basic demographic

model.

• Most frequently used methodology for projections.
• UK Office for National Statistics, AWG, CSO, Smith (2013).
• Provides projections not only of total population but also of

demographic composition and individual components of growth by age and gender

• The cohort component equation describes population at time

t+1 as today’s population varied with changes in births, deaths, and net migration:

25

Overview of the Cohort Component Method

Launch Year Population (CSO 2015) Survived Population Projected Migration Budget 2016, Dept. Finance. Survival Rates (CSO 2015) Child-bearing Population (Females, 15 – 54) Survived Births Projected Population Survival Rates for Under 1 year old (CSO, 2015) Fertility Rates (EUROPOP, 2013)

26

Steps

• 1. Calculate the number of people in the base

population that survive to the next age interval.

• 2. Project migration flows for each year and add

them to the survived population.

• 3. Project the number of births occurring during

the projection interval.

• 4. Add the number of births to the rest of the

population to get a projection of the total population by gender and age for each projection 1 year interval.

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Assumptions

• Projections for the population structure involve assumptions about

mortality, migration, and fertility. For our basic projections we assume :

1. Mortality: estimated by applying the survival rates from recently released CSO Irish Life Tables (CSO, 2015). 2. Fertility: ASFR used to calculate births. Fertility assumptions in line with EC AWG (2015) and imply slight decrease in fertility rate to 1.98 by 2065. Immigrants face same age-specific fertility rate (CSO, 2013). 3. Migration: most difficult component to estimate. Number of options for migration projections:

• Use CSO (2013) judgemental projections
• Model migration (ESRI)
• Use Department of Finance projections

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Historical Patterns

• 150
• 100
• 50

50 100 150 200

1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Title

CONTRIBUTIONS TO CHANGE IN NET MIGRATION

Immigrants Emigrants Net Migration

Source: CSO Historical Data Note: Gross flows were not available earlier than 1987

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Migration Questions

• Rates or flows?
• Components of migration (i.e., immigration vs emigration) or net migration?
• ESRI models specifically emigration and assumes a level for immigration
• In the spirit of Harris-Todaro migration model , having the UK as Ireland’s main

trading partner and wage and employment differentials as the drivers of the model

• Long Run Emigration Equation
• Where, em, is emigration in ‘000s, UR is the unemployment rates in Ireland and

the UK, and RATW is an index of the real after-tax wage in Ireland and UK

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Baseline Demographic Scenario

• 1.5%
• 1.0%
• 0.5%

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%

• 60
• 40
• 20

20 40 60 80 100 120 140 160 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049

'000

Annual Population change

growth in '000 % growth (rhs)

31

Dependency Ratios

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% % of working age population Year

Dependency Ratios

Very Old age dependency ratio (80+) Old age dependency ratio (65+) Youth dependency ratio (0-14) Total dependency ratio Share of People 65+

Note: The dependency ratio is an age-population ratio of those typically not in the labor force (the dependent part) and those typically in the labor force (the productive part). It shows the pressure on the productive part of the population. For the estimation of the “Total Dependency Ratio” we took into account the share of the population over 65 and under 14 divided by the rest of the population. Source: CSO, EUROSTAT, Author’s own Estimations

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Population Pyramids

• 2.00%
• 1.00%

0.00% 1.00% 2.00% 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97

Share of Population Age

2014

• 2.00% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97

Share of Population Age

2035

• 2.00% -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00%

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97

Share of Population Age

2065

Females 2065 Males 2065

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Medium-Term Expenditure Scenario

• Baseline demographic projections used to construct expenditure scenario.
• Macroeconomic assumptions from Budget 2016.
• Government expenditure split into five components: Health, Education,

Social Payments, Capital Expenditure, National Debt Interest.

• Pay: LRA until 2018, thereafter public sector pay grows in line with non-ag

wages and expected service demand.

• Non-pay: in health, education grow in line with expected demand linked to

demographics.

• Social Protection: split into four broad components: old age, child related

payments, unemployment and other.

• Capital expenditure: projections based on Infrastructure and Capital

Investment Plan 2016-2021.

• Debt interest: average interest rate from Budget 2016 applied to

difference between Exchequer balance projections.

34

Capital Expenditure

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016f 2017f 2018f 2019f 2020f 2021f growth in spending

Departmental Capital Expenditure, % of GDP

Capital spending, % of GDP Average 1983-2015

Source: Budget 2016, Budget and Economic Statistics (Department of Finance).

35

Comparison of Expenditure Scenarios

20% 22% 24% 26% 28% 30% 32% 2015 2016 2017 2018 2019 2020 2021 % of GDP Primary expenditure, % of GDP - Budget 2016 Primary expenditure, % of GDP - IFAC Scenario 1 Primary expenditure, % of GDP - IFAC Scenario 2

Note: Scenario 1 allows for demographic change with no indexation. Scenario 2 allows for demographic change plus indexation. Source: Internal IFAC calculations.

COMPARISON OF PRIMARY EXPENDITURE UNDER ALTERNATIVE SCENARIOS

36

Budget Projections imply Steep Fall in Primary Spending

20 25 30 35 40 45 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 % of GDP

Government Revenue and Primary Expenditure, % of GDP

Primary expenditure/GDP Revenue/GDP Primary expenditure/GDP, IFAC Scenario Note: Chart shows Exchequer revenue and primary expenditure as a share of GDP. Source: Budget 2016 and internal IFAC calculations.

37

Conclusion

• Significant progress made in resolving Ireland’s fiscal crisis.
• Encouraging central scenario for projected growth.
• But significant risks around that scenario in environment of

elevated uncertainty.

• Realistic medium-term fiscal plans needed to avoid repeat of past

mistakes.

• Need for comprehensive bottom-up medium-term expenditure

projections and comparison to likely fiscal space.

• Ongoing work:

– Impact of demographics on long-run growth. – Link demographics and macro scenario with the fiscal model. – Incorporate results of research on pensions, health projections from ESRI, IGEES.

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