Irish Fiscal Policy: Not Out of the Woods Yet

Gillian Tett’s Financial Times column today praising the Irish government’s approach to fiscal adjustment relative to that of Greece, Spain or Portugal is welcome. Without doubt, the government has taken a brave approach to fiscal adjustment and the public reaction to it has been one of remarkable tolerance. However, I think we need to be careful about overdosing on external and self-praise and concluding that we’re somehow out of the woods on the fiscal front.

I was a guest on RTE’s Late Debate program last night and heard Fianna Fail TD Frank Fahey declare that the UK had greater fiscal problems than Ireland. This judgment was perhaps based on the fact the UK is also running a large budget deficit. However, it is worth factoring in that the UK has provided discretionary stimulus of about 2 percent of GDP and has allowed its automatic stabilisers to fully function, while we have had to go in the opposite direction by applying fiscal contractionary measures and cutting back on automatic stabilisers by reducing unemployment benefits. The comparable size of the two deficits hides the underlying reality that, without denying the tough road ahead for the UK, our path towards fiscal stability is a tougher one.

Beyond the deficit, there is little doubt that financial markets are also concerned about the potential costs of the banking situation due to recapping Anglo and INBS (and perhaps more for the two big banks at some point), losses from NAMA and the sovereign’s commitments under the guarantee.

In relation to the latter, I noted on the radio show (near the end) that the fact that the NTMA has €27 billion in its coffers is also regularly cited as a reason not to be too worried but that one needed to remember that the Irish banks covered by the guarantee have maturing loans prior its expiry that exceed this figure and that this represents a risk factor. Deputy Fahey immediately declared that it was irresponsible of me to suggest we should be reneging on bank senior debt and that he couldn’t understand why academics like me have been going around recommending this.

In relation to this, I’d note (a) That’s pretty clearly not what I said (b) That hasn’t been my position over the last year and there’s tons of public record to illustrate that. However, even if one supported a guarantee for senior debt, that doesn’t mean you have to ignore the risks associated with such guarantees, which are very real.

The fact remains that, for all the talk about international praise for our approach, the market judgment on our fiscal situation as of last week was one that questioned its sustainability. That Irish bond spreads have fallen as much as they have since Sunday’s announcement is an indication of how reliant we are now on EU support.

It may be that the ECB’s secondary bond market interventions are enough to keep our primary bond market open but then again they may not (we don’t know much about these interventions yet). If not, then the possibility of having to call on the emergency fund at some point is very real. And if that comes to pass, the adjustment program that would be put in place will undoubtedly be very tough.

An important unknown is whether such a package should involve the Irish government backing off on the full scale of its support for the banking sector, for instance by focusing its support on the two main banks and depositors in other banks and letting other institutions fail. Over the past year, the argument against letting institutions fail has often revolved around the potential repercussions for our ability to borrow in the sovereign bond market, but a program like this will be only implemented if we have already been shut out of this market.

The other argument against letting institutions fail relates to financial stability but this could play either way. Yes, the failure of one institution could undermine confidence in the rest. However, if the government only has a finite amount of EU\IMF money to play with and finite time horizon to sort itself out, then a credible commitment to back the part of the banking sector that matters may work better than an incredible attempt to maintain a blanket support.

Quite possibly, I’ll be castigated for not wearing the Green Jersey by even contemplating this scenario and discussing the options that may be open to us at that point. But since ubiquitous Green-jersey-thought was a major part of what got us in to this mess in the first place (with the notable exception of Morgan Kelly and a few others) I won’t worry too much about that.

33 thoughts on “Irish Fiscal Policy: Not Out of the Woods Yet”

  1. The Greek bail-out should prevent a de jure default on Greek sovereign debt held by private investors. If debt has to be restructured it will be the Eurozone, the IMF and the ECB who will have to deal with it, not private investors.

    So what happens if there is a run on Anglo for instance? How do we prevent a de jure default on the guarantee? I am guessing Anglo would receive an injection in the form of Government bonds and the ECB would buy them on the secondary market. This would be quicker and simpler than calling on the emergency fund. It would, of course, adversely affect our fiscal position. Thereafter, the problem is rolling over the bonds falling due later in the year.

  2. Actually, am I wrong that de jure default on private creditors will be avoided (thereby contagion in the banking system) as a result of the Greek bail-out?

  3. One reason IMO why our government has been more pro-active than governments in other countries is that the costs to us of losing fiscal sovereignty are unusually high, given our reliance on low corporate tax rates. I wonder if this helps explain the relatively acquiescent response of the population also (?).

    Those potential costs are still very high, which is why IMO the government is playing a very risky game if it extends the bank guarantees in their current form past September.

  4. Whilst listening to the debate last night it was clearly obvious that Frank Fahey did not listen to what you were saying (or did not understand). I have noticed that using the term ‘we cannot renege on senior debt’ is a new replacement to distract attention from ‘we had to provide a blanket guarantee’. The public will sympathise more with politicians saying ‘debts have to be paid’ than ‘we had to bail out the banks’.

  5. @ Kevin O’Rourke

    Another reason for our ‘pro-active’ government is simply that we entered recession first.

    Seasonally adjusted, the real economy peaked as early as Q1 2007.

  6. @Rory: OK, pro-active is perhaps the wrong word since it has a normative connotation, and as Karl says the policy was pro-cyclical which helps explain the depth of our depression.

    Perhaps the relative size of our structural deficit going into the crisis, and the rapidity with which it was exposed, is another reason why adjustment happened relatively rapidly here.

  7. I keep hearing this “but the Brits are worse” argument.

    I still don’t know how that helps us out of our fiscal and debt hole though.

    Moreover, as a nation we are far more indebted – at this stage to ignore private debt is a big mistake.

  8. @ Aidan R:
    I thought Fahey wasn’t just “not listening”. It seemed to me that he waited until the end of the programme to make an attack on Karl, that his sole purpose was to suggest that economists were not worth listening to, that what he said was clearly irrelevant to anything Karl might have had to say and that he was allowed to get away with the attack by a presenter who should have known better. What he did was in line with what other government representatives have done. I don’t know how a respectable contributor to a debate can best respond to such an attack; my own response would probably have been to inform Fahey that he was a contemptible person who, if any respectable club had the misfortune to have him as a member, should be horsewhipped on the steps thereof.

    bjg

  9. @Kevin O’Rourke
    Another reason is that we had far more to do than other countries.

    The adjustment thus far has been far far more than any other country yet we still have the largest deficit. If we hadn’t acted the deficit would now be at dizzyingly high levels.

  10. This, and previous, governments are responsible for the borrowing they authorized. They had willing accomplices (trades union, special interest groups, etc.). So anything that any government minister, party hack or advisor asserts about the current debt predicament is most likely a deliberate falshood. Legislators have forgone the protection of their citizens for the protection of private financial institutions.

    If you expect ‘salvation’ from the direction of ‘gov’ – you are a complete fool. Just hope (or maybe pray) that the citizens of this country are not driven to resolve the matter themselves. There are plenty of historical (and successful) precedents for this type of action.

    B Peter

  11. There have been some figures and graphs put up recently showing the refinancing needs of the irish government over the next few years.

    Assuming that the guarantee will be extended, does anyone have figures and graphs for the total refinancing needs of the state and the banks over the next few years.

    Does the NTMA have any influence over bank debt issuance?

  12. >> Tett: The previous, hated, British colonial rule has left the country with a well embedded legal and political infrastructure.

    A not-so-subtle wag of the colonial finger.

    By that logic the Scandinavians would be still be barbarous savages — having never been civilised by red coats and bayonets !

  13. I find all the “oh the Irish govt is doing so well with the cutbacks” a bit much. After some u-turns and general reneging it may turn out that the amount of actual cutting is nowhere near what is needed for the current “banks uber alles” policies (see An Bord Snip Nua)

    @rory o farrell – can you pay Danegeld with NAMA bonds?

  14. @Kevin O’Rourke – another reason might be that it is not that long ago (late 80s) that we made a significant fiscal adjustment, which laid the foundations of the Celtic Tiger. (When is the last time the Greeks did that – data from the Commission shows that since 1991 they have run deficits of 6.7% of GDP on average.)

  15. I too listened to the Late Debate. Frank Fahey’s comments were entirely off point: KW was not saying anything about the appropriateness or otherwise of the guarantee, but rather making a different point as to the potential effect of the existence of the guarantee on borrowing requirements. It seems from reading today’s Irish Times that Frank Fahey was simply parroting lines from a presentation given to the FF party by Alan Ahearne, e.g. the bonds are owned by pension funds, insurance companies, credit unions.

    http://www.irishtimes.com/newspaper/ireland/2010/0512/1224270210964.html

  16. Karl,

    A realistic appraisal I think. I’m particularly interested in your comment,

    “…..Fianna Fail TD Frank Fahey declare that the UK had greater fiscal problems than Ireland. This judgment was perhaps based on the fact the UK is also running a large budget deficit. However, it is worth factoring in that the UK has provided discretionary stimulus of about 2 percent of GDP and has allowed its automatic stabilisers to fully function, while we have had to go in the opposite direction by applying fiscal contractionary measures and cutting back on automatic stabilisers by reducing unemployment benefits. The comparable size of the two deficits hides the underlying reality that, without denying the tough road ahead for the UK, our path towards fiscal stability is a tougher one.”

    Is the implication that the fiscal road ahead is less rocky for Britain because it had a modest stimulus in 2009?

  17. @ MB

    “Is the implication that the fiscal road ahead is less rocky for Britain because it had a modest stimulus in 2009?”

    I’m not keen to get into the effectiveness of stimulus in Ireland versus UK etc. My point was intended only to be a fairly simple one. Consider two countries with the same large fiscal deficit. However, Country A has introduced a set of fiscal stimulus measures that everyone knows are temporary while Country B has already cut significantly to get to this same figure.

    The first thing Country A does to restore fiscal balance is turn off the temporary stimulus, which everyone expects. Only after that’s done do you have to start making the hard decisions about unpopular tax increases and spending cuts to close a structural budget balance.

    Country B, however, has no temporary stimulus to turn off and has already implemented a rake of unpopular decisions already, with much of the more easily implemented lower-hanging fruit already done. Country B has a tougher road ahead.

  18. No I think Karl’s point was that the British deficit is after a once-off stimulus whereas our is after we have already begun retrenching, in other words they could afford to increase borrowing to fund a stimulus and still only end up with a deficit as bad as ours.

  19. Karl

    I undersand your point; a less rocky road because the stimulus can be ‘turned off’ and spending reduced/taxes reduced subsequently.

    I will respect your wish not to be dragged into a debate on the merits or otherwise of fiscal stimulus. But simply point out that I think there is an error in identifying fiscal tightening with deficit reductions; that is, cuts do not equal savings.

    If they did, Ireland’s situation, where the deterioration in government finances plus the fiscal tightening measures exceeds the total decline in GDP, would be inexplicable.

  20. In Keynesian terms the stimulus is the deficit; therefore, as a percentage of GDP, the Irish stimulus is greater than that of the U.K.

  21. @Karl

    I heard the radio item and was incensed. Fahey was doing a Bertie. “If you can’t keep your mouth shut go and top yourself”

    FF, and Fahey in particular, are just peddling mantras.

    Keep up the good work.

  22. The scary thing is the lack of understanding of all this by the politicians and maybe in the Dept of Finance itself. As for Frank Fahey, where to start…

  23. @MB
    If they did, Ireland’s situation, where the deterioration in government finances plus the fiscal tightening measures exceeds the total decline in GDP, would be inexplicable

    That is primarily because a very large proportion of Irish tax revenue was cyclical in nature and linked to a once in a century property bubble.q

  24. Well said all!

    Clearly the lack of understanding by GFF also throws a shadow over the next steps to be taken to reduce the stimulus of the deficit …… They seem to be using poor Alan A as a stalking horse suggesting that less effort may be necessary? He seems to be seriously adrift and may be carrying too much of a policy burden? I have heard/read nothing from him so I judge by the tenor of the remarks about his contribution.

    GFF are seriously bereft and seem intent on cutting links to those who might be able to help: economists of all shades. Democracies have so many checks and balances …..

    Incidentally, I believe GFF have made a good start. But taxes have to be next and in a depression these make things worse. I have little confidence. based on their spokesmen.

  25. DE

    I think we are talking at cross-purposes.The source of the tax revenues and its sustainability is immaterial to the discussion about the efficacy of fiscal tightening. If cuts work, they can be shown to work.

    If, as its supporters suggest, cuts = savings, then it would be possible to show where govt. finances would now be by adding those cuts and tax increases to the deterioration in government finances to date. The case for tightening rests on that proposition, that the government policy has saved the economy from a far worse fate.

    However, when that calculation is made we find the fiscal deterioration + fiscal tightening is greater than the cumulative fall in GDP. Even if we allow for a modest reduction in the efficacy of fiscal tightening (ie, about one-fifth of cuts lead to no savings) then we arrive at the situation where the decline in GDP = fiscal tightening + fiscal deterioration.

    In that case, the State is responsible for 100% of GDP, which is simply not credible.

Comments are closed.