There are good grounds to believe that austerity will end, and that it will work
Opinion: 2015 could see a return to modestly expansionist budgets
Brendan Howlin and Michael Noonan: there have been gains in credibility won by our delivery of what was promised.
Today we face into another difficult budget. Announced adjustments totalling close to €2.5 billion come on top of a cumulative figure of €28 billion since the crisis erupted in 2008. People want to know: is the crisis-resolution strategy working? And will the need for new expenditure cuts and tax hikes ever end?
Over the course of 2010 the creditworthiness of the Irish State was rapidly eroded, in part due to new revelations on the size of banking losses. Without outside assistance, a potentially catastrophic default would have occurred, forcing a much more draconian adjustment. Rather than default, the then Government embarked on a strategy of adjustment with conditional EU/IMF financing.
This strategy, sometimes referred to as “catalytic finance”, has been continued by the present Government. The idea behind it is that the demonstration of a capacity to take necessary measures together with official support can restore the State’s market borrowing capacity. The Government has also been able to leverage demonstrated achievements to improve the terms of the original agreement.
Is it working?
People want to know if this painful crisis-resolution strategy is working. It is sometimes argued that the fact that slows growth means that it is not working. But this is not the right basis on which to judge it. All realistic commentators recognise that the direct short-run impact is negative for the real economy. It is important to remember, however, that the austerity measures are not the only thing holding us back. The continuing overhang from the bubble period and the weak international environment are also major headwinds. Encouragingly, there have been recent - if still tentative - signs that the growth and employment outlook is improving.
The immediate test for judging the success of the adjustment strategy is whether it succeeds in bringing control over unsustainable public finances and restores the borrowing capacity of the State. Success here is also essential to laying a foundation for future growth in incomes and employment, and to allowing a reasonable phasing of the budgetary adjustment over time. A forced “cold turkey” approach would have done devastating damage to social protections and public services.
Without adjustment, and even with benign assumptions on growth and interest rates, simulations undertaken by the Fiscal Council indicate that the deficit would be close to 20 per cent today and debt on an explosive upward path. Of course we would never have reached this point on a “no-adjustment” path, as a costly default would inevitably have been forced along the way.
It is easy to forget how precarious our position was as recently as the middle of 2011. At the time, bond yields were implying a perceived probability of default in the vicinity of 90 per cent. The interaction of a demonstrated capacity to bring the deficit down and (improved) conditional support has brought about a dramatic reduction in perceived default risk, with Ireland’s market borrowing capacity now on the verge of being restored. While the final chapters of Ireland’s crisis-resolution effort have yet to be written - and much could still go wrong - it appears as of now that Ireland is an emerging success story of catalytic finance.
Will it end?
People are also naturally asking when the need for ever more austerity measures will end. Concern is heightened by the existence of tougher new European and national fiscal rules, including one that forces the debt to GDP ratio on a path towards 60 percent.