Cantillon: Does Irish rebound fit elastic band theory of recession?

Central Bank’s chief economist Gabriel Fagan thinks that it plays a role

At the launch of the Central Bank's latest quarterly commentary, chief economist Gabriel Fagan expounded on what's loosely known at the "elastic band theory of recession", or in some circles the "rubber band effect", and whether it could be applied to Ireland.

Essentially, it contends that the strength of recovery is directly proportional to the depth of the recession, or in Fagan’s words “when you have an economy that falls very sharply, there tends to be, at some point, a sharp pick-up”.

He suggested the theory might explain at least part of Ireland’s current rebound, with pent-up demand, postponed consumption and deferred investment now unwinding in the form of 6 per cent growth.

However, he cautioned that it would be misleading to put too much store in the theory, noting that the same logic suggests Greece should be expanding at a faster rate than Ireland, having fallen further initially.

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Economic history also tell us deeper recessions almost always take longer to recover than the shallow ones.

Nonetheless, Dr Fagan believes the current bumper growth rates have an elastic quality and are therefore unsustainable. He suggests the best we can hope for in the medium term is about 3-4 per cent.

So if it’s not pent-up demand, what is behind the economic turnaround?

In its report, the Central Bank suggests it's a "coming together" of several factors. The current spurt of jobs-rich growth , it said, was underpinning a resurgence in domestic demand and a healthy stream of tax revenue for the exchequer.

It also referenced soft energy prices, a pick-up in growth in export countries such as the US and the UK, an unprecedented €1.1 trillion ECB stimulus, cheap money internationally and the restoration of bank balance sheets.

Fagan also points to the rehabilitation of the public finances, describing the unprecedented correction as the “outstanding achievement” of the current economic era.

He said the fiscal deficit had been reduced from a peak of over 13 per cent of GDP to a likely 2 per cent this year, while the debt ratio had come down from 120 per cent of GDP to about 100 per cent.