IMF sees the downside to €4bn Budget cuts
Published 14/10/2010 | 05:00
A €4bn adjustment in next year's Budget would probably knock €2bn off economic growth, research by the International Fund (IMF) suggests.
Although the research does not deal specifically with Ireland, it found a consistent pattern across 170 historical episodes that a 1pc of GDP adjustment produced a 0.5pc fall in growth.
The example of Ireland in 1987 -- and Denmark in 1983 -- where budget correction was followed by growth, appear to be exceptions. They may even be the only two of their kind.
"We don't really know the reason," Daniel Leigh, one of the IMF researchers said yesterday.
"There are suggestions Ireland was helped by the 'Lawson boom' policies of Chancellor Nigel Lawson and by a devaluation of the Irish pound."
Mr Leigh was in Dublin giving briefings on implications of the research* to analysts.
"I think you have to assume that, if there is a fiscal correction it will affect growth in the short-term."
The research suggests that members of the eurozone suffer a bigger than average impact from fiscal correction. This could be because the ECB is not able to respond in the way a national central bank could, by cutting interest rates.
"The response of central banks may also explain why spending cuts seem to do less damage than tax rises. If the tax rises are on things like VAT and push up prices, the central bank may cut interest rates by less than with spending cuts, because of fear of inflation," Mr Leigh said.
One surprise finding is that large adjustments do not cause proportionately greater damage than small ones.
"It appears to be a 50c GDP loss for every euro adjustment," Mr Leigh said.
*Will it Hurt? Chapter Three, IMF World Economic Outlook October 2010.