Ireland’s Fiscal Strategy

This post was written by Philip Lane

This article is in today’s Sunday Business Post (link tomorrow) and released here with kind permission of its editor.

There has been an intensification in the debate over Ireland’s fiscal strategy over the last couple of weeks, with Minister Noonan’s recent appearance before the Joint Committee on Finance, Public Expenditure and Reforms, the political party think-in events during this past week and the preparations for the imminent new Oireachtas session.

It is important to realise that Ireland retains considerable fiscal autonomy under the EU/IMF programme, such that there are genuine and substantive issues to be decided by the government during the coming weeks. The programme sets down a set of minimum targets for the overall pace of fiscal adjustment but there is considerable latitude in determining the appropriate mix of spending and taxation measures. Moreover, the government is free to pursue more ambitious targets that exceed the lower bounds that are specified in the programme.

For 2012, the government is required to introduce fiscal consolidation measures of at least €3.6 billion (importantly, including the carryover impact of the tax changes introduced in 2011). In addition, it is required to deliver a general government deficit that is no larger than 8.6 percent of 2012 GDP. Indeed, at the time of the deal in November 2010, the assumptions concerning the projected growth of the economy and the projected interest rate on the government debt meant that fiscal consolidation of €3.6 billion would deliver the minimum target of a general government deficit of 8.6 percent of GDP in 2012.

A closer look at the makeup of the overall target balance of 8.6 percent of GDP shows that it consists of three components. According to the Department of Finance’s Stability Programme Update (April 2011), the target overall balance is the sum of a cyclical budget deficit of 0.5 percent of GDP, debt servicing costs of 4.7 percent of GDP and a structural primary (non-interest) balance of 3.4 percent of GDP. (This breakdown does not allow for temporary or one-off factors that can be quite considerable in any given year.)

In one direction, the sizeable reduction in the interest rate on European official funds that was agreed in July 2011 means that debt servicing costs in 2012 will be significantly reduced. On the face of it, this should mean that a €3.6 billion fiscal consolidation package should result in an overall deficit that is significantly lower than the 8.6 percent ceiling – for instance, the ESRI scenario analysis that was published during the week projects an overall deficit of 7.8 percent of GDP for 2012.

However, in the other direction, Michael Noonan has indicated that the government will downwardly revise its GDP forecast for 2012. A lower GDP make it more difficult to hit targets that are expressed as ratios to GDP; lower GDP also means a loss in tax revenues and an increase in welfare payments.

Here, there is an important distinction to be made. If the lower GDP forecast is classified as a temporary cyclical factor, then it means a widening in the cyclical component of the budget deficit but does not adversely affect the structural component that is the main concern in international policy and investor circles. A cyclical decline in the budget balance of itself does not call for additional austerity measures, since subsequent economic recovery will fix the cyclical component of the deficit.

Alternatively, if the lower GDP forecast is classified as a reduction in the long-term potential output level of the economy, then the implication is that the structural budget deficit has deteriorated, since cyclical recovery in the economy will not be enough to restore budget balance. If that is the case, then the government will need to plan for larger fiscal consolidation measures over the next number of years in order to achieve the sizeable improvement in the structural balance that is required for fiscal sustainability.

So far, I have concentrated on what is required to meet the minimum fiscal targets that are specified in the EU/IMF programme. However, the sharp and sustained deterioration in the international financial environment since the negotiation of the deal in November 2010 means that the government should strongly consider extra fiscal consolidation measures in order to move more quickly in closing the structural primary deficit.

Despite the large reduction in spread between Irish and German sovereign bond yields in recent weeks, the European sovereign bond market remains remarkably volatile. In addition, the inter-bank market has also declined over concerns about the exposures of European banks to sovereign risk and a weakening economy. For Ireland to attain the twin policy goals of restoring the government’s access to the bond market and weaning the Irish banking system from its dependence on central bank funding (since market funding costs for banks are closely tied to sovereign borrowing costs for myriad reasons), the shift in investor sentiment means that Ireland needs to set a lower trajectory for its public debt and demonstrate faster progress in reducing its reliance on deficit financing. Furthermore, even if it turns out that an extension of the current EU/IMF deal is required, the bargaining position of the government vis-à-vis its official counterparts will be stronger if it can demonstrate over-achievement in turning around the structural primary fiscal balance.

Importantly, the weak state of domestic demand and high level of household debt mean that the pace of fiscal adjustment should not be accelerated too much. But the €3.6 billion figure for 2012 was determined as a minimum target in November 2010 when the perception of the downside domestic risks facing the Irish economy were considerably more pessimistic than is the case today. One basic factor is that the level of 2010 nominal GDP turned out to be considerably higher than was feared at the time of the deal. In addition, the EU/IMF programme

allowed for the possibility of much greater bank losses than is now envisaged, such that the banking system has an improved capacity to absorb the adverse short-term impact of an accelerated austerity package. Moreover, the EU/IMF programme assumed that the sovereign bond market would re-open to Ireland in 2013 so long as the debt/GDP ratio could be stabilised even at a high ratio around 125 percent of GDP. Rather, the “fundable” peak level of public debt has clearly declined throughout the course of 2011.

Taken together, these factors call for a measured improvement in the pace of reducing the structural primary deficit (even if cyclical factors mean a slower rate of improvement in the overall primary deficit). Accordingly, the fiscal debate in the coming weeks should focus on determining the appropriate degree of extra consolidation in 2012 and in the subsequent years. In this way, the government can demonstrate its leadership by moving the domestic policy debate beyond the narrow framework of just meeting the minimum targets in the EU/IMF programme.

This debate can best be conducted in the context of the multi-year fiscal plan that is due to be announced during October. In addition to providing an opportunity to re-calibrate the overall level of fiscal consolidation, a credible multi-year plan can help reduce the considerable uncertainty that is holding up consumption and investment plans. For these reasons, the next few weeks should be more pivotal for Ireland’s economic prospects than the traditional December budget announcement.

25 Responses to “Ireland’s Fiscal Strategy”

  1. Joseph Ryan Says:

    @Philip Lane

    For Ireland to attain the twin policy goals of restoring the government’s access to the bond market and weaning the Irish banking system from its dependence on central bank funding …..

    While not disagreeing with you concerning the need to do more on the deficit, the twin policy goals you outline above need to be questioned.

    The Irish government does need to get back to the ‘market’ but it should not be a concern of Ireland or the government if the banks have to continue to rely on ECB/ICB funding. The banks are supposedly well capitalised. It is not the fault of Ireland if the EZ interbank system is completely broken and will remain broken for years to come. Until a robust EZ wide FDIC is put in place, the EZ interbank system will remain on the verge of, if not fall off a cliff. The fact that the ECB has chosen to protect commercial creditors as distinct from retail creditors (depositors), has caused huge damage to EZ banking confidence.

    It is long since time to seperate bank funding from State funding and to seperate bank policy from its erroneous coupling with State policy.

  2. Al Says:

    Off topic, but eoghan harris has a disgraceful swipe at Karl whelan in the sindo.

  3. Brian Woods Snr Says:

    Again I encounter a set of proposals which are based on a deeply flawed, useless and totally misleading virtual model.

    I really wish ALL economists would take a course of instruction which explains the real world of nature - the one in which in which our actual economy is embedded, not their Disneyland version in an electronic spreadsheet.

    Please ask a microbiologist to explain the growth curve followed by bacteria growing in a closed container with fixed levels of nutrient. Please look up the plots of human population growth (and energy use) since 1800. Notice anything interesting? As I mentioned in another post, Malthus will be proven correct - he just did not observe that fossil-fuel, steam-driven technology bus parked around the corner.

    Try this for size. The Gov dictates that all energy imports are capped at to-day’s level. And that in the future, the total amount of all energy imports will be subject to an annual, compounding, decrement of, say 3%. They will allow a gently cyclization above and below the 3%, but -3% is the trend. Think that might be acceptable? Think that might be ‘good’ economics?

    Contemporary fiscal policies (deficits are normal) is simply assuming that your future income will cover the difference between income and spending. It may, (nay, even will, if your model is daft enough), but in a closed container (our planet) and fixed levels of nutrient it behaves like those bacteria. Stop here, and look up this growth curve now! -

    With a bit of fishing around you will find the corresponding population and energy consumption plots.

    “Accordingly, the (political Economy) debate in the coming weeks should focus on determining the impact of both the likely decrease in the supply of energy and the increase in prices in 2012 and in the subsequent years.”

    There are models available for fossil fuel (energy) discovery, production and depletion, which pass the Sniff test. Economic models, on the other hand, have the distinct odour of a gangrenous limb.

    Brian Snr.

  4. grumpy Says:

  5. Mike Hall Says:

    It’s no surprise to anyone who understands economics that growth is way below the fantasy forecasts of the austerity program. Sadly that’s very few of Ireland’s (or other) economists.

    Moreover, as Ireland’s export sector can largely be separated from its domestic economy in terms of effects, it is GNP that should be being discussed. GNP is tanking, unemployment is continuing to rise & will do, the austerity is applied. For a more sanguine (& realistic) analysis, read Bill Mitchell: (the title mentions Britain, but the piece has much to say about Ireland)

    “Britain is tracking Ireland down the drain”

    Another piece of general interest on the global crisis/recession is this on Credit Acceleration by Steve Keen, another economist who, predicting the crash, deals with reality rather than fiction:

    Michael Hudson is always worth a read. A piece on the historical context of the hopenomics theo-liberal paradigm that is the present mess for all except the wealthy elites & their apologists:

  6. Ceterisparibus Says:

    If that article is accurate it would appear that the late Brian played a lousy game of poker. Trichet could not afford to let the Irish banks collapse at that time, just as now he is afraid to let any bank fail. When you examine it, the deal they entered into was the worst possible outcome with onerous interest rates and a MOU that has been described as a surrender document.
    The Greeks are playing a better game…even today Papandreou is hanging in and blaming the EU for not implementing the second bailout quickly enough.
    Liathrodi or just desperation?

  7. Ceterisparibus Says:

    Should we fly the EU flags at half-mast?
    “Greece clearly needs help escaping from its financial quagmire, according to German European Union Energy Commissioner Günther Oettinger. In fact, the EU should consider using some “unconventional” methods to increase motivation among Greek officials for solving the country’s problems, he told daily Bild on Friday.

    “There has been the suggestion too of flying the flags of deficit sinners at half mast in front of EU buildings,” the member of Chancellor Angela Merkel’s conservative Christian Democrats told the paper. “It would just be a symbol, but would still be a big deterrent.”
    Another tactic for pulling the debt-stricken country out of crisis could be replacing “the obviously ineffective administrators” there, he added. Because Greek officials have failed at collecting outstanding taxes and selling state-owned assets as planned, Oettinger alleged, experts from other EU nations should be sent in to do their jobs instead. “They could operate without concern for resistance and end the inefficiency,” he told Bild.

    After all: “Those who demand solidarity from the other countries must also be prepared to give up partial responsibility for a certain time.”
    From Der Spiegal

  8. hoganmahew Says:

    It’s comforting to see that we are not the only ones with idiot politicians. It’s a good thing we don’t have these dummkopf running Ireland. Oh, wait…

  9. Philip ii Says:

    Ceteris paribus
    Am i the only one who has a shudder down my spine when I hear about german administrators willing to operate “without concern for resistance”…? I thought th Dirlwsngef brigade had been disbanded
    The last time Germany replaced “obviously ineffective administrators” in Greece it was with this approach
    There’s a reason the EU exists…

  10. Philip ii Says:

    That’s Dirlwagner…

  11. Joseph Ryan Says:


    “There has been the suggestion too of flying the flags of deficit sinners at half mast in front of EU buildings,” the member of Chancellor Angela Merkel’s conservative Christian Democrats told the paper. “It would just be a symbol, but would still be a big deterrent.”

    Fronted by a sign ‘unnutzen esser’, no doubt. It looks like Europe is heading back to a very dark place.

  12. Ceterisparibus Says:

    I’m still trying to figure out how flying the flag at half-mast would deter anyone or anything. Perhaps it would be better if the Germans decreed that all defect sinners wear sackcloth.

  13. Philip ii Says:

    Joseph ryan
    Yes, the germans have a lomg history of badges,. maybe they could make the debtor nation populations wear Black inverted triangles, denoting them as “work shy”… It’s been done before. And look how well that turned out

  14. Gavin Kostick Says:

    @ All

    Bit of a Sunday muse. I don’t think national humiliation is the way to go for a thriving, coherent Europe.

    I was at the site of the ancient Olympics at Olympia. The story was that if you won a number of events you got a statue put up for you in your home city-state. If, however, you were caught cheating you had to pay for statues of yourself to be put up, with your name and words to the effect of ‘is a big fat cheat’, on it.

    So rather than flags at half mast, how about banks that require support from the tax payer have to take out TV and radio ads., scripted for them, apologising for the imposition and setting out their strategy for paying the money back.

    It sounds unlikely, but now I look at it General Motors took out an ad apologising to the general public, and the big three were famously piloried for arriving in Washington for their bailout in private corporate jets - which they later sold.

  15. Ceterisparibus Says:

    Should be “deficit sinners”
    Maybe we should repent.

  16. desmond brennan Says:

    There are gross inefficiencies in many areas of public expenditure. However concretely identifying them, and seeing through changes will cost money.

    I vote we
    1) Do more austerity FY 2012 than planned
    2) Use that saved cash for one off funding of even more fiscal austerity

    This is as global outlook is poor…and we need to eliminate deficit (not expect a revenue upswing)

  17. Ceterisparibus Says:

    These German Ministers are getting belligerent …
    “German Economy Minister Philipp Roesler, leader of Chancellor Angela Merkel’s junior coalition partner, said an orderly bankruptcy of Greece should not be a taboo and that sanctions should be considered for repeat fiscal offenders.

    “To stabilize the euro, there can no longer be any taboos. That includes, if necessary, an orderly bankruptcy of Greece if the necessary instruments are available,” he wrote in an article for Die Welt daily.”

  18. Philip ii Says:

    Interesting use of words… Bankruptcy OF not BY….mistranslation or slip of the mind?

  19. PR Guy Says:

    @Philip ii

    Probably a Freudian slip

  20. Gavin Kostick Says:

    As I type the howls of ferocious big beasts can be heard rampaging across the European landscape, tearing lumps out of each other, calling either for austerity now (Stark), or stimulus now (Darling), with the occasional, self -devouring hybrid “growth-friendly fiscal consolidation” (G7 Statement).

    One wonders how many times the state has to front-load the cuts before it doesn’t count as front-loading anymore?

    In this very unstable context, no, I don’t agree with the proposition that the government should increase the consolidation in this budget.

    Growth in Ireland has been forecast for a year now, and has not yet arrived. Austerity is damaging growth, and growth (with an apologetic nod to Brian Woods Snr), is what the country needs, and indeed, a big chunk of what the markets are after.

    More prosaically, it’s a tricky three cornered hat between growth (preferably employment increasing growth), closing the deficit and keeping the total debt managable. As the estimated total debt is lowering a bit, I would go along with a Lagarde-esque balance.

    For what it’s worth, I reckon the ECB are so desperate for an ‘austerity works’ story, that hitting the button will do them fine.

    On target this year, and get those structural funds from the July agreement moving.

    Oh yes, and put in place the mechanism for the estimated (SBP) 63bn to flow from the banking sector to the state.

    “Government urged to cut welfare, public sector pay”

    “Former chancellor warns euro zone teetering on brink” & “G7 vows to restore stability to world markets”

    Also, splendid quote from Stark, just before he ran for the window:

    The ECB remains opposed to such an initiative [burden sharing with UG Anglo-bondholders] and Mr Stark says Ireland is “not autonomous to take this decision”. The question is a “non-issue” for the bank.

    Any offers as to exactly what that means?

  21. Ceterisparibus Says:

    You are in receivership and the receiver calls the shots.

  22. michael burke Says:

    The ESRI set the hare running- the notion that government finances are on an improving trend. They are not. All that’s happening is that forecasts are compiled that the finances will improve at a later date, which is not substanitally different from the position in mid-2008 and every year since.

    So, as Philip says Minister Noonan indicates growth foecasts will be cut for 2012.

    The April 2011 SPU demonstrates this point starkly by comparing the updated forecasts for growth, the deficit and the debt versus those made just 5 months earlier in the November Budget for 2011 (Table 5), noting the difference between the two:

    2010 2011 2012 2013 2014

    Real GDP -1.3 -0.9 -0.7 0 +0.2

    GG deficit -0.5 -0.6 -1.3 -1.4 -1.9

    GGG debt 2 12 14 15 16
    (% GDP)

    Only in terms of GDP growth in 2014 is the forecast ‘better’- and even then the cumulative level of GDP will be 2.7% lower than previously forecast. All forecasts for the deficit and the debt level are worse, some markedly so.

    This is after the imposition of yet further ‘austerity’ measures in the 2011 Budget itself. None of the forecasts of a stabilisation of the debt level owe anything to the positive effects of austerity to date. Instead the projected improvement owes everything to the lower interest rates and assumptions that there will be a lower bank bailout cost.

    It seems strange to advocate an intensification of a policy which has contributed nothing to fiscal consolidation and, on the face of it, appears to have had the oppostite effect.

  23. Irish Left Review · Depleting the Economy and the Alternative Says:

    [...] Lane’s thoughtful article in the Sunday Business Post helps clarify the debate. For while he argues for further fiscal contraction, this should not [...]

  24. Brian Woods Snr Says:

    @ MB: “It seems strange to advocate an intensification of a policy which has contributed nothing to fiscal consolidation and, on the face of it, appears to have had the oppostite effect.”

    Not if your Reference Frame (preserve the financial system, even if it means ensuring that those folk who prop up the financial system are appropriately hobbled) is set in Military Grade Concrete (aka: BAU Ideology).

    It would be irrational for ‘them’ to advocate and support anything other than that policy ‘they’ KNOW (with religious certitude) is the RIGHT policy.

    Successful Failure is de rigeur. After all, “They ARE worth it” 8)

    @GK: Thanks for the nod! “Every little helps!” :-)

    Brian Snr.

  25. Gavin Kostick Says:

    @ Brian Snr

    A little quiet question at the end of a vanishing thread.

    What do you make of George Monbiot - for example in this paper here. Is this the way to go?

Leave a Reply