I propose to take Questions Nos. 165 to 167, inclusive, together.
The Department of Finance has developed a number of alternative statistical models to assist in its assessment of the medium term growth potential of Ireland’s economy and its cyclical position over the short term. These results, along with other economic indicators (including the modified current account, labour market developments and credit developments) are considered by the Department when assessing the cyclical position of the economy. The development of the Department of Finance’s own approach is seen as providing more intuitive estimates of the cyclical position than the Commission’s harmonised methodology, thereby helping to better inform fiscal policy-making.
This work was undertaken as a response to the under performance of the Commission’s harmonised methodology in estimating Ireland’s output gap. The harmonised methodology has often produced counter-intuitive results for Ireland’s cyclical position. This is largely due to the “one-size fits all” nature of the approach which fails to accurately account for the specific characteristics of the Irish economy. The Irish Fiscal Advisory Council (IFAC) has welcomed the use of the Department’s alternative approach.
Assessment of the Medium Term Objective (MTO), the cornerstone of the preventive arm of the Stability and Growth Pact (SGP), requires an estimate of the structural budget balance. This is the cyclically adjusted general government balance less one-offs or temporary measures. An estimate of Ireland’s output gap is necessary to calculate the cyclical component of the budgetary balance. This is used in turn to derive the structural balance. As a result, using estimates of the output gap based on the Commission’s methodology can lead to counter-intuitive estimates for the structural balance.
Considering this, an alternative Department of Finance structural balance was included in Table 1 of the Stability Programme Update (SPU) 2019, alongside an estimate of the structural balance based on the Commission’s approach (referred to respectively in Table 1 as the 'DOF' and ‘SGP’ approaches ). This methodology makes use of the Department’s alternative assessment of the cyclical position of the economy and therefore produces estimates for the structural balance that are more representative of the underlying performance of the economy.
The Department will continue to use the harmonised approach to estimate the level of potential output as it is the legally binding reference method used by the Commission for assessment of Member States’ compliance with the SGP. Moreover, when issues with the methodology manifest themselves the Department will continue to engage with the Commission bilaterally and through the Output Gap Working Group to devise solutions that help to improve the plausibility of potential output estimates.