Austerity in coming years less harsh due to debt deal
The ability of the pillar Irish banks to use Irish sovereign debt (or Irish government guarantees) to avail of cheap euro system funding would also have been severely impaired under this alternative scenario, since the credibility of the ECB in preserving payment discipline across the euro system would require it to tighten eligibility criteria and collateral rules in relation to Irish sovereign instruments.
For these reasons, any decision to renege on the promissory notes could only have been in the context of a wider decision to seek sovereign debt restructuring, which would be a radical break from the current economic strategy. (The wider debate on sovereign debt sustainability will doubtless continue to run.)
What are the implications for Ireland’s fiscal strategy? The analytical framework that underpins the fiscal treaty would indicate that the target primary (non-interest) structural surplus Ireland needs to achieve in the medium term is lower. In turn, this more attainable target means that the scale of required austerity in the coming years is appreciably less than was required before this week’s deal.
However, there remains a considerable fiscal gap to be closed before this target is achieved. Accordingly, while it may be politically tempting to slow down the pace of fiscal adjustment in order to deliver a short-term dividend from the deal in terms of easier budgets in 2014 and 2015, this would be a risky strategy for several reasons.
First, the international growth pessimism debate speculates that the next few years will reveal that the medium-term output growth trend (at home and overseas) may be lower than projected, which implies a tougher fiscal future.
Second, even if not envisaged under central scenarios, the playing out of our household debt crisis may ultimately require extra capital injections into the Irish pillar banks, which would negatively alter Ireland’s fiscal profile.
Third, there are multiple scenarios by which the international sovereign debt crisis reignites, leading to higher funding costs. All told, these downside fiscal risks would be easier to handle if the fiscal deficit is closed more quickly.
Furthermore, given that substantial adjustment is still required, delaying the spending cuts and increases in revenue prolongs fiscal uncertainty. This adjustment overhang delays private-sector recovery, since households and businesses cannot make firm plans if the individual elements in the required fiscal adjustment remain unspecified. It also runs the risk of fiscal fatigue on the part of politicians and the electorate, since implementing spending cuts and revenue hikes is progressively more difficult as the date of the next general election draws closer.
This Government faces many severe economic challenges (fiscal adjustment, public sector reform, household debt restructuring), while the full recognition of the special nature of Ireland’s bank-related debts requires further major steps at the European level. At the same time, this remarkable (if limited) deal should not be under valued. It is a major achievement for the Government and the policy officials who designed and delivered it.
Philip R Lane is Whately professor of political economy at Trinity College Dublin