The proposed fiscal compact will not solve the euro crisis but it is an indispensable bridge to a set of policies that can resolve the crisis, former adviser to the Department of Finance Dr Alan Aherne has told an Oireachtas committee.
Strengthening fiscal discipline at member state level will pave the way for more aggressive counter-cyclical policies at euro area level, the Galway university economist told the Joint Committee on European Affairs.
“An appropriate macroeconomic stance at federal level is critical, because along with fiscal consolidation and competitiveness improvements at home, the crisis countries in the euro area need favourable external conditions to resolve their problems.”
He said that a recent paper written by him and a colleague for the Bruegal think tank had suggested raising tax revenues at European level – such as by way of taxing the financial services industry – to help borrow money for European smart energy initiatives. This could be an efficient way of supporting the euro area economy. “But such policies are unrealistic unless fiscal discipline at the national level is nailed down.”
Fiscal consolidation at the rate envisaged by the compact is probably necessary at any event given the position of Ireland’s economy, he said.
Macroeconomist Prof Karl Whelan of University College Dublin said he was a sceptic regarding legally binding macroeconomic rules.
He said it should be remembered that macroeconomists were often one step behind in figuring out how things work. “Frontier macroeconomic thinking” can subsequently appear overly rigid and outdated. The adherence of international policy makers to the gold standard rule in the 1930s was a good example of this, Prof Whelan said.
“What is noteworthy about the new EU fiscal compact, however, is that it does not correspond to mainstream thinking among economists as to how an ideal fiscal policy framework should operate.”
The idea of a balanced budget might appear self-evident to the famous Swabian housewife, but an economy was not a single household and the golden rule covering allowed structural deficits was a poor one, the committee was told.
Structural deficits were a theoretical phenomenon and establishing legally binding rules about impossible to measure quantities was sure to create trouble sooner or later. He thought the rules would lead to more austerity across Europe than was required.
Prof Whelan said he nevertheless thought it was in Ireland’s interest to sign the treaty as Ireland’s debt ratio was so high, the state was set for a long era of tight fiscal policy. Also, signing the treaty was needed to secure access to European Stability Mechanism funds.
John McHale of the Irish Fiscal Advisory Council said the real innovation in the treaty related to the enforcement measures involved. Other key aspects of the treaty were in substance already contained in the revised Stability and Growth Pact, which came into force in December.
He said it was almost impossible to see how mutual insurance mechanisms for the countries in the euro area could be introduced without a credible commitment to greater shared fiscal discipline.
“Although it would be better if the linkages were explicit, it must also be recognised that the treaty is likely to play an important facilitating role in the development of mutual insurance arrangements that are critical to the resolution of the euro crisis.”
Economist Tom McDonnell, representing the Tasc think tank, said it was important to remember that there was no consensus among economists about how to manage budgetary policy, particularly over the short term.
“At best the fiscal compact is incomplete and these are various other jigsaw pieces needed at euro area level to resolve the crisis,” he said. “At worst it will damage recovery in the Irish and other European economies.”