Ireland has correct fiscal policy for facing coronavirus crisis

Prudent approach to spending in good times has created room for manoeuvre

Minister for Finance Paschal Donohoe. The Government announced €3.2 billion of potential fiscal supports last week, mostly aimed at supporting those unable to work. Photograph: Gareth Chaney/Collins

Minister for Finance Paschal Donohoe. The Government announced €3.2 billion of potential fiscal supports last week, mostly aimed at supporting those unable to work. Photograph: Gareth Chaney/Collins

 

The coronavirus pandemic is already having a severe impact on people’s lives in Ireland and across the world. This will intensify in the coming days and weeks. While the human impact is central, the economic effects will be strong and widespread. A cool-headed and balanced response will help to achieve the best outcomes for everyone and should minimise the long-term impact.

The Government’s balance sheet should play a central role in supporting the economy in the short term and avoiding long-term damage. Additional support from the European Union should help. The health system will be in the front line and will require the necessary resources. More widely, additional spending and fiscal support on a large scale is likely to be required to ensure that workers and firms are able to weather the storm as activity runs at a very slow pace and businesses are disrupted.

The Government announced €3.2 billion of potential fiscal supports last week, mostly aimed at supporting those unable to work. This amounts to about 1½ per cent of national income and is nearly as high as the sums allocated over five years in the case of a disorderly Brexit. This amount may yet need to increase, with larger packages already announced in a number of other countries.

Deficit

This changes the immediate fiscal outlook completely. While at budget time Ireland looked set to run surpluses in the coming years, the budget balance will switch sharply back into deficit. Tax revenues will fall sharply, especially income taxes, social contributions and VAT. Added to the additional spending measures, the budget deficit will likely the exceed the 3 per cent deficit ceiling, perhaps by a significant margin if the downturn is more severe and larger fiscal measures are required.

This is the right fiscal policy in these exceptional circumstances. While such outcomes in normal times might raise alarm, the best response to the public-health emergency and the economic downturn is to ensure the health system has adequate resources and to support people’s incomes, the continuity of businesses and economic activity. This will help to ensure that the economy emerges in the best shape and is able to support jobs and the public finances when health conditions allow.

Most of the deterioration in the fiscal position would be expected to reverse as the economy recovers and when spending measures are no longer needed. With the right policy measures, this episode should be what economists would view as a textbook “temporary shock”. This is exactly the situation for timely, targeted and temporary policy measures. Allowing the budget balance to deteriorate temporarily should not lead to lasting damage to the public finances.

Prudent debt management since the crisis and supportive monetary conditions provide a favourable backdrop. The State’s cost of borrowing was still essentially zero at the most recent debt auction on Thursday of last week. Measures by central banks will likely continue to ensure that governments can borrow at low rates in these challenging times and the rainy-day fund has €1.5 billion in resources available.

The Irish and EU fiscal rules make provision for “exceptional circumstances”. This has been used previously in countries facing severe terrorist threats or for countries that were dealing with large inflows of migrants. It clearly applies to the current pandemic. It allows the flexibility required in meeting the 3 per cent deficit ceiling and the medium-term objective.

Long-lasting effects

Looking further ahead, many of the economic effects should reverse as the public-health situation improves in Ireland and globally. It can be hoped that many activities will return to more normal levels within a reasonable time frame. Nevertheless, some of the effects may be long-lasting. Ireland will likely see its debt ratio significantly higher than planned.

This will make the task of the next government more challenging. Hard choices still need to be made for the years ahead to meet the aspirations for better healthcare and solutions to the housing crisis. The “fiscal space” available to support better public services on a sustainable basis – without raising taxes or reducing spending in other areas – was already more limited than many assumed. The unresolved issues around Brexit and the reliance on volatile corporate tax receipts will continue to argue for caution.

While the human and economic costs of the coronavirus pandemic are likely to be high, the State has the fiscal capacity to support its citizens during these exceptional circumstances. Situations such as this underline the benefits of fiscal efforts undertaken since the crisis and the advantages of a prudent approach to spending in good times to create room for manoeuvre when it’s needed most.

Sebastian Barnes is a head of division at the OECD Economics Department and a member of the Irish Fiscal Advisory Council

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