The speed of the fiscal deterioration is truly alarming—all the more so given Ireland’s fiscal history. But, observing from a distance, I am still surprised that the wisdom of discretionary fiscal contraction is not subject to more public debate. (I realise I may be missing much of the actual debate.) Ireland is now in the throes of an extreme domestic demand-deficient recession. On its face, it is tragic to pursue a contractionary discretionary fiscal policy with such a demand collapse and no monetary policy instrument. Of course, the fear of a large increase in the risk premium on Irish debt and associated explosive debt dynamics could validate such a tragic choice. But is the fiscal caution being overdone given Ireland’s modest debt and ability to borrow in its own currency? The marginal value of stimulus should be high with the economy operating well below potential. Thus the fact that debt is being piled up at an alarming rate does not necessarily mean it is bad policy. I would be grateful for any thoughts on the extent of the risk of explosive debt dynamics and the likely size of fiscal multipliers in the current depressed environment.
The government has published a stability program update with new projections for the economy and for the budgetary situation. Projections are provided for the general government balance under current policies as well as under a multi-year adjustment plan.
The government now project declines in GDP of 4% in 2009 and 0.9% in 2010 and unemployment is projected to average 9.2% in 2009 and 10.5% in 2010. Without changes in policy, the general government balance is projected to be in deficit to the tune of 11%-12% of GDP every year out to 2013.
The govenment has decided to address the fiscal situation gradually over the next five years. The report states: “Restoring sustainability to the public finances can only realistically involve a period of adjustment of up to five years. Taking action over a shorter period of time, given the scale of the emerging position, would impose substantial economic and social costs and would not be sensible or appropriate.”
An adjustment of €2 billion is proposed for this year, still leaving a budget deficit of 9.5%. Subsequent adjustments of €4 billion in 2010 and 2011, €3.5 billion in 2012 and €3 billion in 2013 will gradually reduce the deficit over time to 2.5% in 2013.
No details are provided as to how these adjustments will be made. Worth noting, however, is that the adjustments total €16.5 billion. Given that the total bill for public sector pay and pensions is currently about €20 billion, it should be clear that despite the regular media focus on public sector pay cuts, restoring fiscal balance will require many other adjustments.
Two recent statements by Irish government ministers deserve to be quoted at length, since they illustrate very nicely two of the broader threats to the international economy going forward.
On Sunday, Willie O’Dea wrote the following passage, which will have seemed somewhat familiar to readers of this website:
We tried the fiscal stimulus approach in response to the oil shock in the late Seventies. The increased spending power given to the Irish consumer largely leaked out on increased imports and left us in an even worse position. There is absolutely no evidence to suggest that the same thing would not happen again…From Ireland’s point of view, the best sort of fiscal stimulus are those being put in place by our trading partners. Ultimately these will boost demand for our exports without costing us anything. What we need to do is to ensure that we are well positioned to avail of the opportunities that result from our trading partners’ actions.
This is precisely the problem that Martin Wolf, Dani Rodrik and others have been highlighting recently: governments worried about this leakage abroad may well combine fiscal stimuli with import restrictions (governments bigger than our own, that is). The obvious solution is to have a coordinated fiscal reflation, and in that light the fact that the G-20 is meeting in London in April is obviously positive. Unfortunately, the history of the 1930s suggests at least two reasons for caution here. The first is that leaders then also realised that cooperation was in principle desirable, and organised a World Economic Conference in London in 1933. That conference failed. The second reason for caution is that one reason why cooperation was so difficult to achieve was that leaders in different countries disagreed about what the economics of the situation required. Notably, the gold bloc centered around France continued in its orthodox gold standard beliefs until 1936. It is crucially important that the Germans today abandon their resistance to Keynesian solutions to the Keynesian crisis we find ourselves in (which may in fact be gradually happening, as the bad news in Germany continues to mount up); and that the ECB be as proactive as the Bank of England and Fed, and as open to the possibility of quantitative easing.
The second Irish ministerial statement that has historical resonances is that of Brian Lenihan quoted this morning. He apparently said:
It is a question for all of us in the EU as to the extent to which a competitive devaluation can be used as any kind of a weapon…The fall in sterling is causing us immense difficulties…They have in effect produced a devaluation of the pound through expansion of the money supply. That has put us under immense pressure
History shows that exchange rate misalignments have been one of the most common reasons why countries resort to wholesale protectionism. The French-led gold bloc of the 1930s found itself with a progressively more and more overvalued currency, as other countries abandoned gold and cut interest rates. Its response was to impose far more stringent import controls, in particular quantitative import controls, than comparable economies elsewhere. The question today is what an undervalued remnibi, or an overvalued Euro, or other similar misalignments, could imply for global trade policies going forward.
Within Europe, the current decline in sterling, if unchecked, will provide future scholars with a fascinating case study. Recall that one of the main arguments for EMU in the 1990s was that the Single Market would in the long run not survive fluctuating exchange rates between EU member states — this was Barry Eichengreen’s view, for example, expressed in the wake of Hoover’s decision to transfer a plant from France to Scotland. I was sceptical at the time and still am; the shared political commitment to the European acquis can’t be overestimated. But there is no doubt that Ireland is incredibly exposed, and that we urgently need the ECB to match whatever is being done in London and DC. Time for a helicopter drop of Keynesians over Franfurt?
Hat tip to my colleague Brendan Kennelly for this provocative paper by Brad DeLong on the “Chicago School” response to the current crisis. You can find a link to the paper here .
Alan Ahearne in his post on the recent National Competitiveness Council report draws attention to the high electricity costs in Ireland relative to our trading partners documented in the report. Malore in his/her comment on Alan’s post suggested some reasons for this. These and other reasons are further explored in the Sustainable Energy Ireland 2008 report Understanding Electricity and Gas Prices in Ireland.