The new government’s difficult navigation through the crisis took significant steps forward last week with the stress tests and strengthened lender of last resort commitment. While we can hope for some easing of the bailout terms, the next milestone is likely to be the upcoming “jobs budget”. For a new centre-right/centre-left coalition government, this will be an opportunity to demonstrate political capacity on the fiscal side. Unfortunately, market assessments of Ireland’s chances of avoiding default are less favourable than we might have hoped when the EU-IMF programme was agreed (see Colm McCarthy’s post and article below). With this inescapable reality in mind, it is worthwhile considering case for sending a strong signal on adjustment capacity by accelerating some of the planned deficit reduction.
I do not make this suggestion lightly. As Karl Whelan has emphasised, Ireland has already engaged is a truly massive discretionary adjustment (roughly €20 billion euro, or about 13 percent of GDP), involving huge sacrifice. I have also no doubt that the austerity measures have deepened the recession. Additional austerity is thus doubly unwelcome. However, a demonstration of adjustment capacity by a new government that is still being assessed by markets and official funders could be a well-timed “investment” at this stage. This could be combined with the planned improvement in the mix of policies designed to spur growth and employment, though realistically these measures would probably only the edge off any accelerated austerity. A “jobs and creditworthiness special budget” (it clearly needs a better name) would allow the new government to show it is taking control of the situation, rather than passively following a course laid down by its predecessor, and build the sense that the adjustment-with-assistance strategy provides a clear path to exiting the crisis.