Ireland left with nowhere to go, damned if it does, damned if it doesn’t

If Ireland tightens fiscal policy to reduce the deficit, output growth will be even weaker in the short-term, pushing the deficit back up again. And if it cuts taxes or increases spending to boost economic activity, the deficit will also increase. It is damned if it acts, and damned if it doesn’t. Unfortunately, the only way out may be recourse to the IMF.

The news that Irish government bond yields yesterday reached their highest level – and their highest spread over German bond yields – since the start of European Monetary Union illustrates the problems that await any country that really allows its public finances to get out of control.

The Irish government is now being simultaneously criticised for not cutting its budget deficit quickly enough and for not supporting economic growth sufficiently, so allowing revenues to be weak, public spending higher and the deficit wider.

Consequently, it has nowhere to go. If it tightens fiscal policy to reduce the deficit, output growth will be even weaker in the short-term, pushing the deficit back up again. And if it cuts taxes or increases spending to boost economic activity, the deficit will also increase. It is damned if it acts, and damned if it doesn’t. Unfortunately, the only way out may be recourse to the IMF.

Is there a lesson here for the UK? George Osborne would say there is. Don’t allow your fiscal position to get into such a mess in the first place. Hence the need for tax increases and spending cuts to eliminate the UK budget deficit over the next four years.

Certainly there are parallels between Irish and UK positions. According to the OECD, Ireland’s debt in 2010 will be 82.9 per cent of GDP; the UK’s 82.3 per cent (though the UK’s debt has a much longer maturity, so less has be re-financed every year). And government borrowing in Ireland will be 11.7 per cent, compared to 11.5 per cent in the UK.

But it is not that simple (it never is in economics). One difference is that Ireland has cut its deficit from 14.3 per cent in 2009 and remains in recession (the OECD forecasts a drop of 0.7 per cent in real GDP in 2010, though this looks optimistic now). The UK did not cut its deficit this year and the OECD thinks its economy will grow by 1.3 per cent. Another is that while bond yields in Ireland are now over 7 per cent, in the UK they have been below 4.25 per cent throughout the last two years.

Conducting fiscal policy in the period after a deep recession is like walking on a narrow ridge of land with steep drops on either side. Attempt to cut the deficit too quickly and growth will be weak; revenues will disappoint, the deficit will not improve and bond yields will increase, adding to the downward pressure on growth. Fail to cut the deficit and bond yields will go up anyway, again resulting in weaker growth.

For the Irish government, the ridge has become so narrow that it has lost its balance, and it may now only be a matter of which side it chooses to fall off. But the UK is still at a point where the ridge is wide enough to allow some room for manoeuvre.

Critics of Osborne’s deficit reduction plan argue that he has taken us close to the edge marked ‘return to recession’ and they are backed up, to some extent, by the controversial forecasts for job losses released by the CIPD yesterday. The Treasury points to the Office for Budget Responsibility’s forecasts of more modest job losses in the short-term and healthy employment growth from 2012.

The FT’s alphaville blog reports on another survey that has received less attention, explaining how construction, which drove Q2 growth. Alphaville notes “the surge in construction output added 0.6 and 0.2 percentage points respectively to second and third quarter GDP”, asking “what does that mean for the Q4 reading?”

The Opposition prefers a plan that involves a slower pace of deficit reduction, which would steer the economy away from the risk of recession. But, counter the Treasury, this would instead risk taking the economy too close to the other side of the ridge, the one marked ‘fiscal position out of control and bond yields rising’.

In fact, there is little to suggest this is the case. There is no evidence of investors losing faith in the UK bond market at any time under the last Labour Government and talk of the country being on ‘the brink of bankruptcy’ is, frankly, ludicrous. UK bonds would not have held onto their AAA rating earlier this year if that was even a faint possibility. They would have been immediately downgraded several notches on the rating scale.

But the Opposition’s policy is not going to be implemented, so we will never know for sure what would have happened if it had been. Osborne’s plan is the one that is in place and only time will tell who is right about it.

In the meantime, it is little consolation to know that while the outlook may be grim in the UK, the Irish situation shows how much worse it could be.

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20 Responses to “Ireland left with nowhere to go, damned if it does, damned if it doesn’t”

  1. Ma

    RT @leftfootfwd: Ireland left with nowhere to go, damned if it does, damned if it doesn't: http://bit.ly/bC11rk writes @ippr's Tony Dolphin

  2. FrancisDoherty

    RT @leftfootfwd: Ireland left with nowhere to go, damned if it does, damned if it doesn't: http://bit.ly/bC11rk writes @ippr's Tony Dolphin

  3. Shamik Das

    Ireland left with nowhere to go, damned if it does, damned if it doesn't: http://bit.ly/bC11rk writes @ippr's Tony Dolphin on @leftfootfwd

  4. M Dyson

    RT @leftfootfwd: Ireland left with nowhere to go, damned if it does, damned if it doesn't: http://bit.ly/bC11rk writes @ippr's Tony Dolphin

  5. william

    Ireland has nowhere to go? Yes it has.It could go and consult the architect of the UK’s economic collapse, the man that saved the world,the man with so much time on his hands he does not show up for the day job,the man that abolished the economic cycle,the man that was never elected, the man who has confined us to ten years in the wilderness…

  6. scandalousbill

    William, It is hard to argue with a person in a continuous rant as evidenced by your parroting of every right wing pundit under the “Sun”, among others. There never was one sole architect of the global recession. The Irish experience pertains more to the ptifall of implementing austerity measures within the contractions brought on by global economic collapse than issues fostered by government spending.

  7. Anon E Mouse

    Scandalousbill – You cannot STILL be banging on about that last useless PM – the one who never got elected, Gordon Brown – in anything other than sheer annoyance surely?

    Aside from costing Labour the election, selling the gold at a historically low price, lying about an end to “Boom and Bust”, raiding the pensions, lying about British Jobs for British workers, 10p tax and bullying even of Labour MP’s – and on and on… are you seriously suggesting that a public servant should take full pay and only turn up for his job once in 6 months?

    No wonder Labour is so out of touch if you think that is acceptable behaviour…

  8. william

    scandalousbill,’the Irish experience’included negligible control of their banks,a dollop of corruption,and an economy artificially fuelled by tax breaks and EU subsidy.The party ended.The UK had a disastrous reform of banking regulation,no corruption,and an economy artificially fuelled by an over expansion of the public sector.Fact.The global recession did for Ireland and the UK, but not Australia, Norway, Chile and so on.You can call sound economics a rant, if you like

  9. Anon E Mouse

    William – Or Canada…

  10. Tim Moore

    RT @leftfootfwd: Ireland left with nowhere to go, damned if it does, damned if it doesn't: http://bit.ly/bC11rk writes @ippr's Tony Dolphin

  11. David Nash

    poor Ireland – my colleague Tony Dolphin with the latest on the celtic tiger's economic woes http://bit.ly/9iuu0b

  12. scandalousbill

    Anon and William,

    Pardon me for interceding on your little Tea Party whinge. So, Brown was a real baddie, more than that, a prime candidate for the anti-Christ. So What?
    Cameron and the coalition are the modern day messiah and his disciples? (Incidentally, I am not a fan of new labour, Brown or Blair.)

    Australia, Norway, Chile, Canada and so all dodged the bullet of Global Recession. So did Borneo. Again, so what?

    To compare the UK economy with Canada is as error prone as comparing the UK economy with Greece. Canada is a resource based, export oriented economy, the UK is not. The revenues generated Tar Sands oil production in an inflated energy market did far more to bolster the Canadian economy than any policy initiated by Stephen Harper. Although I will concede that the fact that Harper, in order to avoid his governments defeat in the house of commons and an opposition motion of non confidence, suspended the Canadian Parliament, is indeed an item of interest for Cameron and his cronies should the wheels come off the coalition cart.
    If you wish to look for comparable economies, perhaps Germany is a more apt example. The primary dynamic of their recovery is based upon the performance of their manufacturing sector. This dynamic is absent from the UK, and its erosion began under Thatcher. Further, many analysts point out that the bubble in the construction sector, which played a very significant part in the recent UK GDP figures, is going to be short lived. I do not feel that anything put forward by the Coalition, or buy their 35 Business buddies, provides any meaningful strategy for correction.

  13. Anon E Mouse

    Scandalousbill – Actually I’m camparing the deficit reduction by the Canadians and as for bleating on about Thatcher – that was a long long time ago AND Labour in 13 years did nothing about it.

    Just the fact Ireland is in the Euro means the comparison is stupid and (once again) a baseless groundless excuse to winge on about the government with no factual basis in that very complaint.

    If this is the level of opposition by the left then the Tories can look forwards to a long time in power.

  14. Mike Guillaume

    “Unfortunately, the only way out may be recourse to the IMF.”
    Is this really the only alternative -and one putting a left foot forward?
    I disagree.
    Even before the Greek -or, more broadly, the PIIGS- crisis, I was not the only one to have doubts about the euro and its supposed virtues.
    This crisis, which is actually neither a Greek tragedy nor an Irish blues but purely and simply THE eurozone crisis, shows, as Paul Krugman wrote it in the New York Times earlier this year (February 14): “The real story behind Europe’s troubles lies not in the deficit but in the policy elites who pushed the Continent into adopting a single currency before it was ready.” (see views and debate about, for and against the euro summed up on http://www.mikeconomics.net).
    As I put it a few weeks later (read on http://www.libdemvoice.org/opinion-another-greek-tragedy-time-for-europhiles-to-admit-the-dream-is-over-18240.html), it’s time for Europhiles to admit the dream is over… and the euro is a mess, on both sides of the English and St. George’s Channels and the Irish Sea.
    If not all has to be blamed on the euro in the Irish crisis -property bubbles and other short-termist and credit sicknesses have been at play for years- it is blatant that being part of the eurozone -and a zone now entirely dominated by German views- makes it worse. Much worse.
    The only least worst alternative is not the IMF, but leaving the eurozone. And, why not and with no disrespect intented to our Irish friends, pegging the new currency to the British pound.
    If the eurozone crisis goes deeper (Greece, Spain, Portugal, Italy are not healed yet), the alternative will anyway come “naturally” and it will be the break-up of the eurozone, or this left with a devalued euro and Germany getting back to its mark.

  15. Anon E Mouse

    Mike Guillaume – The problem is the Irish are now too deeply stuck in the Eurozone. Whilst I agree that Germany calls the shots – which is entirely understandable – just wait until Turkey is accepted into the EU if you want to see a devalued Euro.

    You ain’t seen nothing yet I feel…

  16. Mike Guillaume

    To Anon E Mouse: Turkey -who the heck considers it a European country?- in the EU willl not mean a devalued euro, just the end of the EU.

  17. Michael Burke

    “Consequently, it has nowhere to go. If it tightens fiscal policy to reduce the deficit, output growth will be even weaker in the short-term, pushing the deficit back up again. And if it cuts taxes or increases spending to boost economic activity, the deficit will also increase.”

    Logically both of those statemnents cannot be true. Either increased goverment spending merely adds to the deficit (on a net basis, after taking account of all multipliers and the sensitivity of government finances).

    Or it doesn’t. If it doesn’t, then how did €14.6bn in fiscal tightening lead to a wider deficit? This tightening is about 9% of GDP, same ballpark as Osborne’s.

    I’m willing to bet that the deficit will be wider here next year than it is now, and wider again the year after, justlike Ireland. Whereas the deficit hee is falling now, courtesy of increased spendign in 2009.

  18. Mike Guillaume

    Sure Samuel Brittan may be more on the right foot, but he has often looked forward anyway. His column dated November 4 in the Financial Times -“The futile attempt to save the eurozone”- (read on http://www.ft.com/cms/s/0/def42cae-e84b-11df-8995-00144feab49a.html#axzz14OWNbezW) goes straight to the point… and is heavily based on Christopher Smallwood’s analysis (“Why the euro needs to break up”. Read on: http://findarticles.com/p/news-articles/analyst-wire/mi_8077/is_20100712/christopher-smallwood-economist-capital-economics/ai_n54421867/). Smallwood is a social democrat turned eurosceptic (a bit like me, by the way) and rightly refers to the euro as “a corset”, for Greece then, and now for Ireland and others.
    Why should Ireland wait until the next domino?

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