The Labour Market and the New Budgetary Framework

Thomas ConefreyIrish Fiscal Advisory Council

DPER Labour Market Policy Symposium19 May 2015

Overview• Context• What’s the link between labour market and

fiscal rules?• Ireland’s new fiscal framework• The structural balance • Potential output measurement challenges• Improving labour market inputs• Long-term issues

Current context• Ireland exited official assistance programme at

the end of 2013.• Expected to exit the corrective arm of the SGP in

2016.• From 2016, Ireland’s budgetary policy subject to

the requirements of the preventive arm.

New Fiscal Framework

• Preventive arm assessed under 2 pillars:1. For countries not at their MTO a minimum improvement in

the structural balance of at least 0.5pp of GDP is required.2. Expenditure benchmark complementary to structural

balance rule. EB designed to ensure public expenditure grows at a rate below economy’s long-run potential growth rate.

• Rules given effect in Irish law through the Fiscal Responsibility Act (2012) and Ministries and Secretaries Amendment Act (2013).

European/National fiscal rules

National

European

Corrective Armof SGP

Preventive Armof SGP

3% Deficit Rule

1/20th Debt Rule

MTO / Adjustment path to MTO

Expenditure benchmark

National Budgetary

Rule

National Expenditure

Ceilings

National Budgetary Rule Consistent with Preventive

Arm of SGP

National Expenditure Ceilings Consistent with Expenditure Benchmark

Potential output and structural balance now centre stage

• Appropriate target for fiscal policy is structural balance.

• Structural balance is an indicator of the surplus/deficit in the government accounts adjusting for the cyclical position of the economy.

• However...estimating the cyclical position of the economy is difficult!

• Much focus to date on EC harmonised method.

Harmonised method

• Production function approach used:• Y* =

• Of interest here is how labour (L) determined.• Labour input in harmonised method

determined by:• L = Popw * LFPR * (1 – NAWRU) ) * Trend Hours Worked

• Key inputs: projections for LFPR and NAWRU

Unemployment Rate and NAWRU

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

20132015

20172019

0.02.04.06.08.0

10.012.014.016.018.0

actual NAWRU

per c

ent

MIGRATION, UNEMPLOYMENT AND NAWRU ESTIMATES

19651967

19691971

19731975

19771979

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

20130

2

4

6

8

10

12

14

16

18

-5

-4

-3

-2

-1

0

1

2

3

4

NAWRU*Actual UnemploymentMigration (inverse) as % of total labour force (RHS)

%

% o

f tot

al la

bour

forc

e

Sources: AMECO; Eurostat and IFAC internal calulations.* EU Commission estimates as of Winter 2014 forecasts.

Labour Force Participation • Forecasts extended

using simple AR model

• Data for full period then filtered using HP filter

19811985

19891993

19972001

20052009

20132017

50.052.054.056.058.060.062.064.066.068.070.0

actualsmoothed

per c

ent

Procyclicality

19811983

19851987

19891991

19931995

19971999

20012003

20052007

20092011

20132015

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Actual Output PF Potential Growth NAWRU

Other approaches• Statistical filters:

– No economic content, largely arbitrary specification of parameters

• Multivariate filters:– IMF conditioning relationships e.g. Philips curve, along assumptions about

various “balances” e.g. Current account, credit, NAWRU (!)

• Cyclical indicators:– OBR: weighted average of survey indicators of recruitment difficulties and

capacity utilisation; principal component analysis

• Cost functions– ESRI HERMES/COSMO: high elasticity of labour supply in Ireland, fall in

potential output partly reflects erosion of the capital stock

A way forward?

• Approaches discussed up to now could be greatly improved by better estimates of key underlying parameters:– “Equilibrium” rate of unemployment– Labour force participation

• Could a microdata approach help?• Some key questions:

– How might current composition of unemployed impact equilibrium unemployment rate?

– Mismatch in labour market– Labour force participation

Unemployment as % of Total Labour Force by Duration

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132014

0

2

4

6

8

10

12

14

16

All1yr+2yr+4yr+%

Long-term unemployment by previous sector of employment

0 5 10 15 20 25 30

Agriculture, forestry and fishing (A)

Industry (B to E)

Construction (F)

Wholesale and retail trade, repair of motor vehicles…

Transportation and storage (H)

Accommodation and food service activities (I)

Information and communication (J)

Professional, scientific and technical activities (M)

Administrative and support service activities (N)

None

Public administration and defence, compulsory social…

Education (P)

Human health and social work activities (Q)

Other NACE activities (R to U)

Mismatch?

TotalIndustry (except construction)

ConstructionWholesale and retail trade; repair of motor vehicles and motorcycles

Transportation and storageAccommodation and food service activities

Information and communicationFinancial and insurance activities

Real estate activitiesProfessional, scientific and technical activitiesAdministrative and support service activities

Public administration and defence; compulsory social securityEducation

Human health and social work activitiesArts, entertainment and recreation; other service activities

0 0.5 1 1.5 2 2.5 3

2014Q22009Q1

Employment rate + productivity?

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132014

30.0

40.0

50.0

60.0

70.0

80.0

90.0

Total Males Females% o

f 15-

16 p

opul

ation

Longer-term issues• Population ageing likely to create significant

challenges in the medium term.• Implications for labour market, public finances,

health, pensions etc. • Preliminary work on building long-term

demographic model.• Use CSO life tables along with assumptions on

fertility, mortality, migration, participation to project population by single year of age.

Dependency Ratios

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 20200.0%5.0%

10.0%15.0%20.0%25.0%30.0%35.0%40.0%45.0%50.0%

Old age dependency ratio (70+) Youth dependency ratio (0-14)Total dependency ratio

% o

f wor

king

age

pop

ulati

on

Population structure

0-45-9

10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-84

85+

-10.0 -5.0 0.0 5.0 10.0

Age and Gender Distribution 2010 Females

Males

%

Age

Coho

rt

0-45-9

10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-84

85+

-10.0 -5.0 0.0 5.0 10.0

Age and Gender Distribution 2020

FemalesMales

%

Age

Coho

rt

Conclusions• Concepts of potential output and structural balance

important underpinnings of Irelands new fiscal framework.

• Much scope for improving measurement and estimation of key labour market inputs.

• A microdata perspective could help complement existing approaches.

• Long-term demographic change an important area for further analysis.