Policymaking: Before, During and After the Crisis

Michael O’Sullivan writes in today’s Irish Times about the importance of establishing a new policymaking institutional structure in the wake of the crisis: you can read his article here.   In his contribution, he identifies the pro-cyclical nature of fiscal policy as one of the main problems:

“The second related issue is the topsy-turvy nature of Irish economic policymaking. In an economy that is expanding too quickly, the normal approach is to try to slow it down; and when it is contracting, the typical response is to support or even stimulate it. In the early years of this decade, our politicians and policymaking “elite” responded to a very “hot” economy by lashing on more fuel. Now they respond to one of the sharpest contractions ever in a developed economy by squeezing harder on the brakes.”

It is certainly vital that the political system in the post-crisis era finds institutional mechanisms that can guard against procyclicality.  It would have been helpful in responding to the current crisis if the fiscal situation had permitted some level of counter-cyclical fiscal intervention.  However, the scale of the structural fiscal deficit (determined by the skewed nature of the pre-crisis tax system) means that the general nature of the government’s fiscal adjustment strategy is conditionally optimal  – it cannot un-do the past.  (Of course, there is still plenty to debate in terms of the precise design and timing of the fiscal adjustment.)