Doubts over growth now biggest threat to recovery
It is not surprising that austerity fatigue is setting in after €24 billion in fiscal adjustments since the summer of 2008. Yet restoring the State’s creditworthiness remains central to our recovery.
As long as a heightened risk of default hangs over us – especially a default that would involve the loss of international funding support – the risk remains that the crisis could enter a vicious new phase.
The resulting fear of Greek-style chaos acts as a weight on recovery. National and international policymakers must show determination to reinforce the progress already made in restoring the State’s solvency.
The bursting of the property-cum-credit bubble put in motion a set of vicious feedback loops between the banking, fiscal and real sectors of the economy. This created a difficult economic management problem, as actions in one area aggravated the problems in another.
Partly due to a series of setbacks in 2010 – larger than anticipated bank losses, the escalation of the Greek crisis, disappointing growth, and suggestions from euro zone leaders that future official-sector support would involve default on private bondholders – policymakers proved unable to stabilise the situation without outside support.
Initially, creditworthiness actually deteriorated on entering the programme, with secondary market bond yields rising steadily through the first half of 2011. However, the situation has improved significantly since.
Key contributors have been the Government’s demonstration of capacity to meet the programme targets and improvements in the design of the official supports. Notable for the latter has been the reduction in interest rates to more realistic levels and the substantial removal of the threat of forced default in the event that a new programme is needed.
Earlier in the crisis, the most damaging source of uncertainty was the size of the bank losses that would ultimately be borne by the State. That uncertainty has fallen due to resolute action in stress testing and recapitalising the banks. However, after downward revisions of growth forecasts, doubt over growth prospects is now the main drag on creditworthiness.
This sets up a new vicious cycle: weaker growth undermines creditworthiness, which in turn undermines confidence and growth. A robust resolution of the crisis requires determined action by both national and euro zone policymakers.
At a national level, policymakers must commit to the fiscal adjustments necessary to retain official support. This will be more credible if all adjustment margins (including pay, tax and social welfare rates) are available. The Government must also attach its political reputation to avoiding a default – ideally supported by a broad societal consensus. But these efforts need to be reinforced by a range of improved euro zone-level policies.
First, the reliability of official support for countries meeting their programme conditions could be strengthened.
Second, the conditions for official support could be made more flexible, so that countries are not forced to pursue ever harsher adjustments when growth disappoints.
Third, lengthening the maturity on sovereign debt related to the State-owned Irish Bank Resolution Corporation (IBRC), would ease medium-term funding requirements and, depending on the interest rate, the burden of that debt.
Fourth, effective implementation of the ECB’s new bond-buying programme – with no ECB seniority – would help ensure that Ireland can sustain a good equilibrium of low interest rates, more sustainable debt and low probability of default as it makes a full re-entry to the bond market.
Finally, more growth-oriented fiscal policies by stronger euro zone governments and the ECB would help underpin an export-led recovery.
Ireland is on a path out of the crisis – albeit a treacherous one. At this stage, any direct absorption of past Irish banking losses by other euro zone countries looks unlikely.
But with a common European interest in a demonstration by Ireland that a successful return to robust creditworthiness is possible, now is the time to reinforce a “well-performing adjustment programme”.
John McHale is professor of economics at the NUI Galway and chairman of the Irish Fiscal Advisory Council