Irish Economic Environment. Contact Details. Office Hours: by appointment KB3-46

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1 Irish Economic Environment Dr. Stephen Kinsella & Ms. Claire Hurst Department of Economics University of Limerick Contact Details Office Hours: by appointment KB

2 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

3 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.

4 Real Sector Markets for: Goods and Services Labor Services Land, Structures, Capital Goods Actors: Households (consumers) Producers Government MONEY Savings Investment Capital SIGNALS Financial Markets Markets for: Claims on money in the future Allocation of current savings 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?

5 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.

6 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.

7 Real GDP Per Capita Year Irish Real GDP per Capita, 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.

8 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.

9 The price problem - Example Computers count for 10 GDP units in 1999 but for only 8 in 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).

10 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. 40 GNI at constant 2005 prices per capita !000

11 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.

12 Prices and Inflation Inflation is a problem in a monetized economy. If inflation is too high, people will be unwilling to hold money CPI Annual % Price Index Changes AVERAGE (%)

13 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 = Y t+1 Y t Y t

14 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

15 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

16 Today Introduction to Macroeconomics Data on Irish Economy Today & Yesterday Irish Macroeconomic History Origins of the Celtic Tiger Break

17 Today Introduction to Macroeconomics Data on Irish Economy Today & Yesterday Irish Macroeconomic History Origins of the Celtic Tiger Definition of Fiscal Policy 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."

18 % change GDP Idea of Fiscal Policy Growth rate of potential G Inflation gap Actual growth rate Unemployment gap Time 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

19 Fiscal Policy: Lags 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?

20 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 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

21 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 General Election 1977 Abolition of rates at a time when the economy was growing at 7% real GNP in 1977

22 Justification? 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 Real GNP 2.7% between 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

23 Procyclical Fiscal Policy 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 Mini-budget 1981 Tax increases rather than expenditure cuts Budget deficit increased to 15% of GNP External debt doubled between April New Coalition Government: Increased taxation and reduced current expenditure Further deterioration in fiscal situation combined with rising unemployment (16.7%)

24 New Coalition Government: Increased taxation and reduced current expenditure Further deterioration in fiscal situation combined with rising unemployment (16.7%) White Paper Buillding on Reality 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

25 Components of the Turnaround Stabilisation of debt/gnp ratio Real wage moderation Cuts in expenditure Widening the tax base Tax amnesty Results Debt/GNP ratio fell to 106% by 1991 Rate of growth of GNP increased Unemployment fell (14.7%) Inflation (3.3%)

26 Fiscal Correction Social Partnership: Objective wage moderation Programme for National Recovery (PNR) The Programme for Economic and Social Progress (PESP) The Programme for Competitiveness and Work (PCW) Partnership 2000 (P2000) Programme for Prosperity and Fairness Caution... 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

27 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

28 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

29 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

30 After 2000, the real growth rate fell significantly. 4.6% in 2001, 1.25% in 2002 and 2.8% in 2003 f. 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 September 11 th terrorist attack in Quarterly Ec. Commentary 2008 GDP growth expected to stall, or fall slightly Consumption growth of 1% 15% decline in investment CPI expected to average 4% in 2008

31 Summary of Today s Lecture