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.
Under reasonable central growth projections, budgetary projections extended out to the end of the decade indicate that the most difficult phase should be complete by 2015. These projections assume full compliance with all fiscal rules. After 2015, the projections indicate that it should be feasible to have modest expansions in money terms instead of the contractionary budgets that we have become accustomed.While the scope for expenditure increases is still likely to be limited, it should be at least possible for public expenditure increases to keep track with inflation.
Of course, huge uncertainty surrounds any such longer-term term projections. Growth could disappoint; new banking losses could emerge and fall on the State; the euro zone crisis could flare up again. But the path out of the crisis is slowly becoming visible.
The Government has announced its intention to pursue a smaller nominal adjustment of €2.5 billion in Budget 2014 than the €3.1 billion originally planned. The main reason is that the promissory note deal allows the budget deficit targets as a share of GDP to be achieved with fewer measures.
The Fiscal Council has argued that the preferred policy was to stick with the original plan. There are two main reasons. First, given the uncertainties surrounding growth, there remain significant doubts relating to the ability to meet the key 3 per cent deficit target for 2015 required for exit from the European Excessive Deficit Procedure (EDP). The existing buffer is eroded by the choice to do less than planned. It is true that growth disappointments could be accommodated by doing more than the €2 billion planned for Budget 2015. But such a reversal to a tougher budgetary policy would be a blow to confidence.
Second, there have been gains in credibility hard-won through our success in delivering on what was promised. While I don’t want to exaggerate the loss from a relatively modest scaling back of what was planned, it is inevitable that there has been some sacrifice in credibility at a time when Ireland is seeking to restore full bond market access and negotiate a back-up official credit line.
On the other hand, the €600 million reduction should boost growth in 2014 by about 0.2 per cent and lower the unemployment rate by about 0.1 per cent. It is also undeniable that people need whatever break they can get after six years of painful austerity measures.
But neither can we forget that any extra borrowing next year will have to be repaid with interest. Even so, future growth could help with the later heavy lifting, and it should be easier to forego future tax reductions and expenditure increases than to bear hikes and cuts now.
The choice of the adjustment figure for Budget 2014 has therefore been a difficult balancing act. The more important point is that the broader crisis-resolution strategy remains in place and is working.