MANY POLICY lessons can and must be learned from Ireland’s banking and financial crisis to avoid future repetition of past mistakes. One such is the failure of the system of checks and balances to operate in two areas: for banks in managing financial risk, and for Government in managing the economy. Bank management and the financial regulator either ignored or failed to appreciate the systemic risk posed by concentrated loan exposures in the commercial property sector.
Government, and it would seem its Department of Finance advisers, foolishly relied on temporary revenues – raised from capital taxes and stamp duty during an unsustainable property boom – to finance permanent increases in public spending. The economic downturn and the property crash greatly depleted tax revenues, and left Ireland with the largest budget deficit in the euro zone in 2009.
Klaus Regling and Max Watson, in their report on the sources of the country’s banking crisis, have proposed a fiscal council as a worthwhile reform. The council would be composed of outside economic experts, and be independent of government. It would advise government on the budgetary situation and on the fiscal policies required to achieve fiscal sustainability. Minister for Finance Brian Lenihan has indicated his support for the proposal, which has also won some cross-party backing. As Regling and Watson have pointed out: “Fiscal policy, bank governance and financial supervision left the economy vulnerable to a deep crisis”.
The failures of the checks and balances were compounded by a parallel failure by outside economic agencies to highlight potential difficulties facing the Irish economy. The International Monetary Fund failed to sound the alarm, the OECD’s critical concerns were muted, and EU Council opinions of Ireland’s economic performance were favourable.
The Government has, from next spring, accepted external scrutiny by the European Commission of its draft budget measures before these are adopted by Cabinet. This oversight role is designed to achieve better co-ordination of economic policy by euro-zone members and to improve the euro zone’s governance regime. Certainly, a fiscal council would increase the accountability of government on budgetary matters and help raise public knowledge and awareness of the importance of fiscal policy. Mr Lenihan’s willingness to proceed quickly, and to establish a fiscal council before the next budget, is a very welcome development.