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.
20 Responses to “Ireland left with nowhere to go, damned if it does, damned if it doesn’t”
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.
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…
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
Anon E Mouse
William – Or Canada…
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