The publication of the Autumn QEC certainly has created a stir this morning. Having been an advocate of front-loading the adjustment – albeit with nuance – the ESRI have now expressed doubts about the four-year time frame.
I am bit puzzled by the shift in their position. Based on the Institute’s evolving view of the economy, I would have thought the case for back-loading was actually stronger a year ago. While already stressed, international credit markets were then more favourable to the “peripherals” than they became after the Greek crisis. In addition, the ESRI were then forecasting what was effectively a V-shaped recovery. This suggested room to avoid an excessively pro-cyclical adjustment. (A basic principle here is that there is more scope to smooth temporary growth shocks than persistent shocks.)
Now that credit markets have turned extremely unfavourable and the underlying output path looks closer to the dreaded L-shape, I actually see less room for manoeuvre. (It is interesting that the ESRI are now focusing on their low-growth scenario from their Recovery Scenarios update, which itself might be viewed as in line with a modest V-shaped alternative, with average real growth of 3.2 percent between 2011 and 2015.) Moreover, the need to establish credibility around a focal adjustment path has if anything increased – the most obvious being the 4-year path already agreed with the European Commission and the major political parties.
From media reports, it appears that outside observers consulted by the ESRI are increasingly concerned by the poor outlook for growth. But the main reason for the worsened outlook is the drag caused by Ireland’s balance-sheet recession. While a contractionary fiscal policy will slow growth even further, I can’t see how extending the adjustment period is the best route to convincing investors that we can steer our way through this without default.