ECONOMICS:External commentators were even more relaxed on Ireland's economic performance over the last decade than their domestic counterparts

RESEARCH SUGGESTS an independent body composed of fiscal “experts” can support a government’s capacity to adhere to a responsible budgetary policy. Such institutions, commonly known as fiscal councils, have become popular. At last count there were 27 of them in the EU, including one in Britain, which was set up about a year ago. The International Monetary Fund (IMF) now recommends them as a matter of course.

By making aspects of fiscal policy independent of government and placing them outside the political arena, fiscal councils, it is argued, can help to inform the general public and elected representatives, enhance confidence and transparency and, ultimately, facilitate a better policy outcome.

Ireland is committed under the IMF-EU programme to establishing an independent Budget Advisory Council with an announcement due by the end of this month.

The Department of Finance set out its thinking in a document published last April. Broadly, the core function of the council will be to assess the Government’s fiscal projections and the proposed fiscal stance, including compliance with new fiscal rules which will, to a large extent, dictate fiscal policy for the foreseeable future.

The council will report publicly and routinely on these matters to Government and the Oireachtas. It will be independent, comprising five people with relevant expertise and experience, including significance overseas representation.

However, its role over the next decade or so is likely to be constrained as Irish fiscal policy will be under the microscope as never before, with the the IMF, EU and European Central Bank on the one side and, on the other, the markets watching with a jaundiced eye.

Still, IMF programmes typically provide for a fiscal council, so we are going to get one.

While the IMF-EU programme runs to 2015, that will not be the end of the story. At that point, the budget deficit should be below 3 per cent, but the debt ratio will still be above 100 per cent of GDP and EU rules will require us to reduce this to 60 per cent over time.

Many years of budget surpluses will be required before this is achieved, which is why the external scrutiny will continue – and the scope for a fiscal council will remain constrained for an extended period.

The more interesting question is whether a fiscal council would have made much difference had it been in existence over the past decade. I suspect it would not.

First, let us deal with the question of forecasting which in some countries, eg Britain, is devolved to the fiscal council. This does not seem to be intended here. I agree with this. It would be both unnecessary duplication and a waste of resources to set up yet another forecasting agency.

The widespread view that the Department of Finance has a poor forecasting track record is seldom challenged, but is another myth. In fact, the department’s record in forecasting GDP is better than that of any other major forecaster (the Organisation for Economic Co-operation and Development, Economic and Social Research Institute, IMF, European Commission and Central Bank). This puts it in the middle of the pack internationally, and there is no reason to suppose a fiscal council would do any better.

Ever since the Regling/Watson report on the banks, it has become popular to refer to fiscal policy as being pro-cyclical – eg to be expansionary in the good times and contractionary when things are bad, as is currently the case. In fact, Regling was circumspect in the language he used, and this is another abuse of reality.

It is only with the benefit of hindsight that policy has been deemed to be pro-cyclical, with the IMF, for example, doing a complete U-turn on its assessment of the stance of policy.

Numerous commentators criticised aspects of policy (excessive growth in spending, notably around election time, delay in removing tax concessions for property, reliance on temporary transactions taxes). However, with the exception of the ESRI, there were few objections to the overall stance of policy per se. How could there be when Ireland, unlike Greece, Spain or Portugal, was well within the terms of the Stability and Growth Pact, with budget surpluses, a falling debt ratio and no expectation of trouble from the banks.

(Note that the absolute amount of debt actually rose modestly, reflecting the fact that governments seldom repay debt, something that has been lost sight of in the recent debate, but rising GDP caused the ratio to fall.)

Nowhere was this relaxed stance more evident than in the external commentary on fiscal policy. The views and recommendations of the IMF, OECD and EU are summarised in the Wright report on the Department of Finance. Generally speaking, these were far from critical, and often laudatory.

For example, an EU warning in 2001 had transmogrified by 2004 into a view that Ireland was on a sustainable fiscal path, while in 2006 and 2007 Ireland was commended as a good example of fiscal policies conducted in compliance with the pact.

Commissioner Almunia, in Dublin last week, sought to portray the 2001 warning as reflective of the commission’s position. Klaus Regling, who was director general of the Directorate-General for Economic and Financial Affairs (DG ECFIN) at the relevant time, struck a more appropriate note when he admitted they got it wrong.

The IMF, for its part, commended the Irish authorities for the economy’s outstanding economic performance and its exemplary track record of sound economic policies every year from 2001 to 2007.

It should be clear, therefore, that external commentators were even more relaxed than their domestic counterparts. It is a bit ironic, therefore, that the new fiscal council is to include significant external representation.

Traditionally, the ECB does not comment much on individual countries, though, as we know to our cost, this has changed recently with Irish fiscal policy criticised by a number of governing council members, rather unfairly.

Speaking at the Central Bank in May 2004, ECB president Jean Claude Trichet was lavish in his praise and focused on the “astonishing experience” of Ireland, which had recovered from poor economic and fiscal conditions in the mid-1980s to impressive economic activity and a sound fiscal position in no more than a decade. This is a more accurate reflection of the ECB view at the time.

While the fiscal effort put in by Ireland is considerable, it has now paled by comparison with other countries. The data in the accompanying table show the reductions in budget deficits between their peak in 2009 and the projection for 2012 in the recent Commission Spring Forecasts – the Irish figures exclude transactions related to the recapitalisation of the banks.

Unfortunately, Ireland in now bottom of the class, with a reduction in the deficit that is no better than the EU27 average. It is forecast to have a deficit in 2012 that is second only to Greece.

I have argued that the new fiscal council will not be unduly burdened. If it has some time on its hands, it might like to consider whether it would not be more prudent to aim for a budget deficit that is closer to 5 per cent – ie similar to Spain and Portugal – than the 9 per cent currently on the cards. The medicine is unpalatable, but the doctor has decreed that the bottle must be finished. All that is in question is the size of the dosage.