Demographic Change and Projections for the Public Finances over the Medium Term. Thomas Conefrey NERI Economics Seminar, 13 January 2016

Transcription

1 Demographic Change and Projections for the Public Finances over the Medium Term Thomas Conefrey NERI Economics Seminar, 13 January

2 IFAC: SOME BACKGROUND MANDATE OF THE COUNCIL: ASSESSMENT OF FORECASTS 9 th Fiscal Assessment Report FISCAL STANCE INDEPENDENT ECONOMIC ANALYSIS ENDORSEMENT OF MACROECONOMIC FORECASTS Five-member Council Six-member Secretariat COMPLIANCE WITH RULES 2

3 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

4 European/Domestic fiscal rules European Domestic Corrective Arm of SGP Preventive Arm of SGP Domestic Budgetary Rule Consistent with Preventive Arm of SGP 3% Deficit Rule 1/20 th Debt Rule MTO / Adjustment path to MTO Expenditure benchmark Domestic Expenditure Ceilings Domestic Expenditure Ceilings Consistent with Expenditure Benchmark Domestic Budgetary Rule 4

5 Complementary domestic and European elements Domestic ownership adds legitimacy to the European rules Effectiveness of Domestic Framework Effectiveness of European Framework Monitoring, peer pressure and possible sanctions of the European framework enhances the effectiveness of the domestic framework 5

6 STRONG RECOVERY AND CENTRAL GROWTH FORECASTS % Change Y-Y Real GDP Real GNP Employment REAL GDP, REAL GNP AND EMPLOYMENT GROWTH (% CHANGE Y-Y) Sources: Department of Finance (Budget 2016); CSO. 6

7 Increasing contribution of domestic demand to recovery CUMULATIVE CONTRIBUTION TO REAL GDP GROWTH SINCE TROUGH % Growth Since Trough in Q Residual Net Exports Domestic Demand Real GDP Source: CSO. 7

8 Evidence of rebalancing 35% % OF NOMINAL GDP 30% 25% 20% 15% 10% 5% Investment Net Exports 0% Source: CSO. 8

9 Current account near balance excluding re-domiciled PLCs % GDP Current Account Balance Adjusted for Re-domiciled PLCs

10 National Income and Consumption per Head Macro indicators per head, real Consumption GDP GNP 40, Sources: CSO and Department of finance forecasts. 10

11 Sharper downturn + recovery than trading partners 110 REAL GDP PER CAPITA Index: 2007 = IE UK 75 US EA Sources: CSO; IMF and internal calculations. 11

12 Employment Rate 80 Employment rate, % of population 75 %of population Ireland United Kingdom Source: CSO and Eurostat (latest) 12

13 Growth Benefitting the Public Finances T AXES AND PRSI RELATIVE TO C UMULATIVE PROFILE Income Taxes VAT Excise Duties Corporation Tax Capital Taxes Stamp Duties "Other" PRSI million Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Note: These overruns are relative to Budget profile. SPU anticipated taxes and PRSI coming in 13

14 Exchequer Tax Revenue billion ANNUALISED EXCHEQUER TAX RECEIPTS 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 Source: Department of Finance. 14

15 EXCESSIVE DEFICIT CLOSED IN GENERAL GOVERNMENT BALANCE (% GDP) 2 % of GDP Primary Balance Interest General Government Balance EDP Ceiling Source: CSO; Budget

16 BUT SIGNIFICANT RISKS AROUND CENTRAL FORECASTS 8 6 REAL GDP FAN CHART BASED ON BUDGET 2016 PROJECTIONS (TO 2016) % Change Y-Y % 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 sample. 16

17 CRISIS LEGACY OF HIGH DEBT AND ASSOCIATED RISKS 160 GENERAL GOVERNMENT DEBT 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. 17

18 Short Term Outlook 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, opportunity to re-focus on medium term. 18

19 Why are Medium-Term Budgetary Plans Important? Budgetary process has focussed attention excessively on 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

20 Deviations from Expenditure Plans 30% GROSS CURRENT EXPENDITURE, % DEVIATION FROM FORECAST 25% Yr1 % Deviation Yr2 % Deviation 20% % deviation 15% 10% 5% Yr3 %Deviation Real GDP growth 0% -5% -10% * Budget Year Source: Department of Finance Note: * denotes the Supplementary budget in 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 This adjustment is made for comparison purposes. 20

21 CONTINUOUS REVISIONS TO MULTI-YEAR EXPENDITURE CEILINGS CHANGES TO CURRENT EXPENDITURE CEILINGS 52 Budget billion Budget 2013 Budget 2015 Budget Budget Budget Year Source: Department of Finance. 21

22 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 Scenario takes into account estimated demographic changes and assumptions on the cost of providing public services based on Budget 2016 macro projections. 22

23 Budget 2016 Projections imply Steep Fall in Primary Spending 45 Government Revenue and Primary Expenditure, % of GDP % 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

24 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. 24

25 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

26 Overview of the Cohort Component Method Survival Rates (CSO 2015) Survival Rates for Under 1 year old (CSO, 2015) Survived Population Launch Year Population (CSO 2015) Child-bearing Population (Females, 15 54) Survived Births Projected Population Projected Migration Budget 2016, Dept. Finance. Fertility Rates (EUROPOP, 2013) 26

27 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. 27

28 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 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 28

29 Historical Patterns C ONTRIBUTIONS TO CHANGE IN N ET MIGRATION Immigrants Emigrants Net Migration Title Source: CSO Historical Data Note: Gross flows were not available earlier than

30 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 30

31 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% '000 Annual Population change growth in '000 % growth (rhs) 31

32 Dependency Ratios Dependency Ratios Very Old age dependency ratio (80+) Old age dependency ratio (65+) % of working age population 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% Youth dependency ratio (0-14) Total dependency ratio Share of People % Year 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 32

33 Population Pyramids Females 2065 Age % -1.00% 0.00% 1.00% 2.00% Share of Population Age % -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% Share of Population Age 97 Males % -1.50% -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% Share of Population 33

34 Medium-Term Expenditure Scenario Baseline demographic projections used to construct expenditure scenario. Macroeconomic assumptions from Budget 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 Debt interest: average interest rate from Budget 2016 applied to difference between Exchequer balance projections. 34

35 Capital Expenditure 7.0% Departmental Capital Expenditure, % of GDP 6.0% growth in spending 5.0% 4.0% 3.0% 2.0% 1.0% Capital spending, % of GDP Average % f 2017f 2018f 2019f 2020f 2021f Source: Budget 2016, Budget and Economic Statistics (Department of Finance). 35

36 Comparison of Expenditure Scenarios COMPARISON OF PRIMARY EXPENDITURE UNDER ALTERNATIVE SCENARIOS 32% 30% 28% % of GDP 26% 24% 22% 20% 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. 36

37 Budget Projections imply Steep Fall in Primary Spending 45 Government Revenue and Primary Expenditure, % of GDP % 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

38 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. 38