A bit more belt-tightening might be a good thing

 

ANALYSIS: We could go either way, but the fiscal watchdog believes the austerity measures are working and more would help

THE FISCAL position of the State is very fragile. If the economy does not grow this year and next, it is hard to see how the same fate as Greece can be avoided.

But two years is an eternity in times as difficult as these. Things could be markedly better and they could certainly be very much worse.

Yesterday’s second report by the new fiscal watchdog ponders different scenarios, illustrating just how big a range of potential outcomes there is, and how finely balanced the fiscal position is.

If economic growth were to exceed projections by 2.5 percentage points in the coming years, public debt would be back below 100 per cent of gross domestic product by mid-decade. That is not out-of-the-woods territory, but it is not far off it.

And, if anything, the simulation almost certainly understates the virtuous cycle that would take hold if growth were that strong.

Alternatively, if economic growth undershoots the Government’s projections by 2.5 percentage points up to 2015 – a perfectly plausible scenario – public debt would be 140 per cent of GDP. Again, the simulation takes no account of feedback effects. If growth undershoots to that extent, a vicious circle is likely to have begun well before 2015.

The five academic economists on the council urged the Government to do more to publicly analyse alternative scenarios, rather than just discussing its Plan A. Such exercises would enhance flexibility and boost credibility by letting it be known that thought-through back-up plans are ready to be rolled out if needed.

Yesterday’s report by the new council of wise men will fuel the debate between those who advocate doing more to bring the public finances under control and those who believe fiscal tightening is harming recovery.

The council rejected both of the more extreme positions.

At one extreme are the expansionary fiscal contractionists. They say that shock-and-awe austerity measures actually boost growth because consumers and investors believe that swallowing the medicine quickly will bring about rapid recovery.

When economic agents expect recovery in short order, it becomes self-fulfilling because they go out and spend, thereby generating recovery.

Yesterday’s report said that “the most authoritative international evidence does not tend to support hypothesis”.

Given how extreme the current period is internationally, one could go a lot further and say that there is really no readily comparable evidence base at all. The cases the expansionary fiscal contractionists cite – including Ireland in the late 1980s – took place against a radically different international backdrop and thus tell us little or nothing about the effects of big budgetary consolidations today.

At the other extreme in the debate are the fiscal stimulators who say things such as “no economy has ever cut its way out of recession” or “austerity is not working because it never works”.

This position is even easier to dismiss. Last year, the fastest-growing economies in the developed world were the Baltic trio of Estonia, Latvia and Lithuania.

They have undergone more severe fiscal adjustments than Ireland (or indeed Greece for that matter) and are now booming. Their successes show that those who say austerity cannot work are simply wrong.

Although the folk at the fiscal council did not raise specific examples, they reject the “self-defeating” argument of the fiscal stimulators.

They conclude that despite the growth-dampening effects of tightening (which they were at pains to acknowledge), the Government needs to be more ambitious on its deficit and debt-reduction efforts.

Doing so would boost credibility, give more leeway to meet targets, prevent debt rising as high as it looks like going and lessen the burden on future generations.

It makes a very strong case.