If you must hurry then do so slowly May 22, 2019

Raul Eamets
Chairman of the Fiscal Council

This spring the Fiscal Council completed five years of work in its role as the assessor of state economic and fiscal forecasts and guardian of the national budget rules. The make-up of the new government coalition also became clear this spring, and one of its first jobs will be to set the national fiscal policy targets for the next four years. I may make here some observations on the Estonian economy and fiscal policy from the experience so far of the Fiscal Council.

Turning points in the economy are hard to identify. When we look backwards there are always many wise heads who are able to identify exactly what cyclical phase the economy was in at any given moment. As a rough generalisation we could say that the tendency is to overestimate the growth in the economy during bad times and to underestimate it during good times. In 2013-2016 forecasters were convinced that Estonia would achieve the rate of growth that it was capable of, one that was faster than earlier, but the achievement of this kept being postponed. Then in the past two years, growth has proven faster than expected. As it is highly probable that the peak of the current economic cycle has been passed, care is needed with upcoming forecasts not to overestimate future growth in the economy. The good times won’t last forever.

Later revised estimates of economic growth may be quite different from initial estimates. Current information indicates that growth in 2013-2016 was notably faster than the initial estimates of Statistics Estonia showed at the end of each year. On average the real growth in the economy in these years has been revised upwards from initial estimates by more than one percentage point to 2.6% rather than 1.4%. This means that consideration and care are needed if the initial figures for growth in the economy do not coincide well with other economic indicators or general signs for the state of the economy. A good indicator of the general state of the economy is tax receipts for example. Care is also needed with any sort of quarterly estimate of economic growth. One-off large transactions can have a major impact in one quarter, because the Estonian economy is so very small in size.

Given the past background, the analytical capacity of our statistical office is not a negligible factor either. I know from personal experience that the turnover of staff in Statistics Estonia is very high. Having worked a lot in social sciences with statistics, I believe I can say that in the past 10 years all the staff have changed, with one single exception. I have not succeeded in confirming this absolutely, as the list of staff by structural unit is not available from their website. Perhaps this is a sign in itself. Part of the problem is probably low wages, because for years the wages at Statistics Estonia were among the lowest in the public sector.

Tax receipts as a whole have been better than expected. It is apparent from forecasts from 2013-2018 that those made in autumn were more optimistic about tax revenues for the next year than those made in spring, and that actual tax revenues were overall even better than forecast. There is of course nothing wrong in this, as it is better to be conservative rather than optimistic in spring when the budget strategy is drawn up. The good tax revenues in 2013-2015 was a consequence of the favourable structure of GDP growth, even though GDP growth as a whole was underestimated at the time, and also of tax collection measures being made more efficient. Such favourable factors cannot be counted on always and every year though. The growth in tax revenues has been better aligned with that in the economy in recent years, and has no longer exceeded it. It follows that slowdown of economic growth is a reason to expect that tax revenues will be lower too.

It is hard to assess the position of the economic cycle in Estonia in real time. This is not a problem that is specific to Estonia, but one that can be found in the economies of many states. We are always smarter when we are looking backwards than we are when estimating the present state. Comparing the forecasts of the Ministry for the output gap for 2013-2018 with estimates based on current knowledge shows that the correction each year has been upwards.* In general this has meant that the negative output gap has been replaced by a positive output gap. The change in sign is significant, as it gives a different signal to policy makers about what fiscal policy could be appropriate for the state of the economy. If the economy is wrongly assessed to be currently doing worse, we may start to stimulate it at a time when it really does not need it. This is what happened in 2017 for example. Many people will surely still remember the government programme for additional investment, which was intended to stimulate the economy. The actual rate of growth in 2017 turned out though to be one of the fastest of the preceding decade. For this reason we think it is important when estimating the cyclical position of the economy to look at the output gap together with a broader set of economic indicators. Alongside tax revenues for example are developments in the construction market, consumer and corporate sentiment, and more besides.

Another complicated topic is the structural balance of the budget, which is directly dependent on the estimate of the economic cycle. The budget balance rule in Estonia is based on a measure of structural balance that considers the cyclical position of the economy and one-off revenue and expenditure measures. As already noted, estimates of the position of the economic cycle have been very variable. It is apparent from 2013-2017 that the current estimate by the Ministry for the structural position of the budget is without exception weaker than the estimate given immediately at the end of the year. The main reason for this is the retrospective correction of the figures for GDP, which changes our understanding of the output gap in a given fiscal year. However, an accurate assessment given at the end of the year is very important for various reasons. Firstly because it is used by the Fiscal Council to give its opinion on whether the budget rules have been followed, secondly because it is a crucial input in setting the budgetary targets for subsequent years. Overestimating the strength of the structural fiscal position carries the danger of spending more than is reasonable given the state of the economy.

The Fiscal Council hopes very much that our macroeconomic statistics will become more accurate and that GDP will need to be revised less in the future, as this would improve our understanding of the current position of the economic cycle, and the structural balance of the budget. The Fiscal Council will look to contribute as much as it can to achieving more accurate state economic and fiscal forecasts.

Secondly we hope that our politicians will act as statesman and will not rush first of all to fulfil unrealistic election promises, but will look to do so with responsibility and with consideration of the current outlook for economic development. Good luck to them with that!

* The output gap measures the difference between the actual level of the economy and its long-term sustainable level, and by doing so it reflects the position of the economic cycle. The output gap is positive when the economy is heating up, and negative when it is cooling.

Published: 09.04.2019
Published in: Postimees

The data used for the article can be found here.