Tough austerity strategy was better than defaulting
IN his recently published memoir 'Stress Test', Timothy Geithner – President Obama's first Treasury Secretary – recalls a conference call prior to the president-elect taking office.
Obama wanted to plan for the key accomplishments in his first term. "Your accomplishment is going to be preventing a second Great Depression", Geithner responded. As an astute politician, Obama knew that avoiding disaster would not be enough.
Here in Ireland, the recent election results have underlined the difficult politics of disaster avoidance. After six years of painful measures to balance the Government's books, austerity fatigue is understandably widespread. But any fair assessments have to acknowledge what would have been the likely outcomes had different policies been pursued.
Once Ireland's property bubble collapsed, it was clear that the outcome would be bad, no matter what policies were followed. The Irish economic crisis entered a second more serious phase with a slow-motion run on the banking system and the State itself in late 2010. It was then a choice between two evils.
The stark choice faced by policy makers was to adjust unsustainable policies or to default on state debt. Their choice of adjustment was based on a number of assumptions. The economic and social costs of debt default were likely to be heavy. Austerity was effectively a given no matter which course was followed.
Default at a time when Ireland was running a large primary deficit (i.e. excluding interest) would likely have required harsher measures in a tighter timeframe, even if some official financing support could still have been secured. The irony is that the often supposed alternative to austerity is likely to have led to greater austerity.
On the adjustment side, a key question was whether the fiscal adjustments would be directly self-defeating – that is, would these slow the economy so much the public finances would actually deteriorate? For any adjustment strategy to work, it was also obvious that there needed to be a strengthening of European-level support.
While recent years have been very difficult, the adjustment strategy has worked better than might reasonably have been expected, given the prospects in 2010. The primary deficit has fallen from a peak of over 9pc of GDP (nearly €15bn) in 2009 to an expected balance this year. Ireland's 10-year borrowing costs have dropped from over 14pc in mid-2011 to less than 3pc.
Perhaps most encouragingly, employment growth has surpassed expectations in what has been a tentative overall recovery.
These achievements belie a still fragile situation, however. After a financial crisis, international evidence shows that domestic demand tends to be weak and prone to setbacks. Recent strong employment growth has faltered a bit in the first quarter of this year. Although there are signs of an international recovery, growth in the eurozone remains anaemic, with risks of a low-inflation – or even deflation – trap yet to be resolved. The German Constitutional Court's questioning of the ECB's critically important bond-buying "OMT" programme underlines the risk of policy setbacks.
As set out recently by the Department of Finance, the basic fiscal plan for the coming years has two broad phases. The first phase is to meet the requirement of a deficit below 3pc of GDP in 2015 to secure an exit from the EU's Excessive Deficit Procedure (EDP). After 2015, the requirements of Ireland's new national Budgetary Rule are to balance the structural deficit (i.e. the deficit with cyclical factors stripped out). This is currently projected for 2018.
Much debate is likely in the coming months on the wisdom of easing back on previously announced plans for €2 billion in additional adjustments in Budget 2015. This debate will be fuelled by the relatively strong Exchequer returns in the early part of this year, as well as weariness in the face of yet another year of corrections.
But with the public debt at more than 120pc of GDP, risks to debt sustainability are still present. There is also considerable uncertainty about nominal growth prospects for this year and next and, therefore, the level of adjustments needed to meet the 3pc target.
Hard-won credibility is also put at risk when previously announced plans are not implemented – all the more so in the framing of the first post-troika Budget. If the next downturn were to hit sooner than expected, investors might not be so convinced of the State's creditworthiness, particularly if the most recent adjustment commitments had been set aside.
One positive legacy of the crisis is a greatly strengthened fiscal framework. Combining complementary national and European elements, the new framework should help to smooth future boom-bust cycles of the kind that have done so much damage in the past.
It should also help guide debt down from its current unsafe level and help ensure borrowing capacity during the time that debt levels remain unavoidably high.
Rather than being viewed as something imposed on Ireland, or even an act of shared sovereignty to make monetary union work, it should be seen as a framework that is in the national interest to the extent it underpins sustainable growth in incomes and employment.
The policy choices faced by the Irish State in the past six years have presented no easy options. The default option would likely have been even more painful and the political implications just as stark.
As President Obama intuitively understood, politicians tend to get little credit for disasters avoided. Complex counterfactuals cut little political ice. While the economic recovery in the US has been slower than had been hoped, history may well record the prevention of a second Great Depression as his greatest accomplishment.
John McHale is Professor of Economics at NUIG and Chairman of the Irish Fiscal Advisory Council. The Council will release its next Fiscal Assessment Report on June 17.