The Labour Market and the New Budgetary Framework Thomas Conefrey Irish Fiscal Advisory Council DPER Labour Market Policy Symposium 19 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 Expected to exit the corrective arm of the SGP in 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 Arm of SGP Preventive Arm of SGP 3% Deficit Rule 1/20 th 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

M IGRATION, U NEMPLOYMENT AND NAWRU E STIMATES

Labour Force Participation Forecasts extended using simple AR model Data for full period then filtered using HP filter

Procyclicality

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

Long-term unemployment by previous sector of employment

Mismatch?

Employment rate + productivity?

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

Population structure

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.