Wednesday, 14 November 2012

Budgets the cyclical and Structural parts

The budget has two basic parts to it.

The cyclical and structural parts. Both are estimates.

the largest is the cyclical. In good times there is more taxation , less social security etc.

The smallest but most significant is the structural part of the budget. It is this part that plainly either boosts the economy or takes away from it.

Treasury has naturally written on this.

The key part to remember is that changes in the structural part of the budget will effect the cyclical part of the budget.
Done the right way it combines with it. As the economy gets stronger and stronger you need to boost the structural surplus. This means the cyclical surplus will also be large.

What they have done in Europe is the complete opposite.

One little point is the effect of the structural part of the budget will be determined by whether it was deliberate or not.

If, as in Europe or even here, the structural deficit increased because tax  revenues have changed and are considerably less then the effect on GDP will be negligible or even nought. If a Government spends money on infrastructure for example then the impact will be considerable.
The best way to see what way fiscal policy is going is to look whether it is adding or detracting from GDP.
If the structural deficit has increased but the budget is detracting from GDP then you know the structural deficit isn't worth looking at.

Greece is a good example to look at when looking at these two parts of a budget.

I said earlier they are only estimates. Ireland is the best example of what can happen with estimates. Before the GFC hit them Ireland's budget was in surplus and the structural deficit was around 0.5%. In essence it was balanced. (It should have been in surplus.)

After the GFC hit the country that small deficit suddenly rose substantially to  around 6% of GDP.
This was all due to tax revenues or lack thereof.
Yet fiscal policy was detracting from GDP!

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