There's nothing 'mini' about this budget
ECONOMICS:Given that the cuts package will be spread over nine months, it will equate to 3.5% of GDP, writes JIM O'LEARY
SO, WE’RE to have a supplementary budget on April 7th. The purpose of the exercise is to ensure that this year’s budget deficit does not exceed 9.5 per cent of GDP. The official assessment of what is required to so do is a set of adjustments to existing spending and revenue-raising plans amounting to €4.5 billion. This implies a package two-and-a-half times bigger than that unveiled a few weeks ago and one-and-a-half times bigger than the one announced in the October budget.
Given that the package will be spread over nine months, it will equate to 3.5 per cent of GDP. Now we know why Government Ministers have been reluctant to describe it a mini-budget. There’s nothing mini about it: in the world of budgetary correction, this is about as big as it gets.
The background to the decision is the worrying trend in the public finances year to date. The February exchequer returns suggested that tax receipts are on track to undershoot by €5 billion and the effect of this on the budget deficit is compounded by the fact that expenditure is tracking above target.
Given that the principle of sound public finances is central to Government economic policy, ignoring such a sharp deterioration is not really an option, even if the alacrity of the response is remarkable. The protection of the Government’s credibility demanded something significant: either the deficit target had to be changed or fresh measures implemented in a bid to sustain the existing target.
The case for sticking with the original deficit target has been well rehearsed. One argument is that doing otherwise would increase the risk of a financing crisis. In this respect it may be that the prospect of a double-digit deficit as a percentage of GDP is seen as holding particular perils.
Another argument is that abandoning the 9.5 per cent target would display an overly cavalier attitude to euro zone budget rules. After all, that target was first published under the auspices of that rulebook just two months ago, and the Government’s overall fiscal consolidation programme, of which the 2009 target is part, has already come in for strong criticism from Brussels.
A related argument (the most compelling), is that sticking with an EU-approved programme offers the best prospect of securing EU assistance in sorting out our fiscal problem. As I argued last week, such assistance is likely to prove necessary.
Of course, sticking with the existing target is not without its perils. There is the risk that a package of measures as large as the Government is planning to implement will have a correspondingly large deflationary effect. The counter argument here is that resolute corrective action by Government will dispel the impression that the public finances are out of control, boost consumer and business confidence, and offset any negative effect on activity.
We might hope that this will be the case, but in current circumstances we cannot be confident about it. In this regard, attempts to draw parallels between where we are now and where we were during the successful fiscal consolidation of the late 1980s seem misplaced. The adjustments that took place then were much less severe than those now under way, followed a stimulatory currency devaluation, and took place against the backdrop of healthy economic growth in our trading partners.
There are also risks attaching to the composition of the upcoming adjustments. On the one hand, there is the danger of an escalation in civil unrest and political instability if the package is dominated by cuts in current spending. On the other hand, there is the risk of longer-term economic damage if heavy reliance is placed on cuts in capital spending and/or tax hikes.
Given the prevailing public mood and the popular response to earlier rounds of current expenditure cuts, one’s sense is that the balance of these risks is fairly heavily tilted in the latter direction.
A ticklish question that arises from all of this is: what is to happen if, notwithstanding the measures announced on April 7th, a significant breach of the deficit target is threatened again a couple of months later? Should the Government enact yet another set of emergency measures or adjust the deficit target?
The question points up the desirability of setting realistic budgetary targets and adopting a strategy that is reasonably robust in the face of the unexpected. The design and implementation of fresh adjustment packages every month or two and the more or less permanent state of emergency that this generates are not conducive to good policy design. Moreover, this pattern arguably strengthens the perception of control loss by Government and accelerates the loss of confidence among the public.
Finally, back to the risk of a financing crisis, a risk which I think is a good deal smaller than much commentary on the subject suggests. Still, the fact that it exists at all underlines how important the financing dimension of the Government’s fiscal strategy is. There are a number of initiatives worth exploring, including the joint issuance of euro zone bonds and the launch of a national recovery bond.
There is also a continuing need to stem the flow of false and misleading information about the State’s financial system. In this regard the wildly inaccurate claim that State-guaranteed bank liabilities amount to over 900 per cent of GDP continues to circulate and causes exaggerated concerns among potential international investors. The true ratio is just over 300 per cent.