Without a clear deal on medium-term liquidity support from the European Central Bank, last Thursday's government decision to inject yet more borrowed money into the Irish banks could only be another leap of faith.

The Government appears to have expected something more from our European 'partners', but was left at the altar by the ECB, which is not to deny that the stress tests are a considerable advance on the unconvincing efforts that went before. The difficulty is that neither the Government nor its guaranteed banks are creditworthy, and support from one to the other cannot improve the joint creditworthiness of the pair.

The Irish State is insolvent and headed for sovereign default. This is not my opinion, it is the opinion of the credit markets to which the Government must return within, at most, about two years. Friday's market close saw five-year Irish government bonds offering a yield of 10.8 per cent per annum. To be perfectly clear about this, if you believe that Ireland will exit the crisis smoothly on current policies, you can buy a government bond redeemable for €100 in April 2016, paying a tidy €4.60 each year, for no more than €77. This is a stunning bargain for the believers. The ECB, according to its limp press release on Thursday night, is confident that current policies will deliver. If this view was shared by the market to which the ECB expects Ireland to return next year, these bonds would be trading well above €100. There is no getting away from this cold reality.

The crisis which struck in Autumn 2008 consisted of a ballooning budget deficit and a banking system struggling to borrow in the interbank market. The government chose to help the banks through extending a broad guarantee on liabilities in the mistaken belief that their loan losses were minor. Two-and-a-half years later neither the Government nor the banks can borrow at all and the measure of any policy announcement is whether it brings closer the day when they can. Thursday's bank stress tests look certain to fail on this score, and cannot be greeted as a resolution of the banking and sovereign debt crisis.

There is no unilateral policy available to the Irish Government which will achieve resolution of the solvency problem without a compromise with creditors, and the sole provider of liquidity to the Irish economy, the European Central Bank, has chosen to veto any such compromise. The fact that a decisive resolution has been vetoed by our European 'partners' does not unfortunately imply that some soft option is available that requires no more than political testosterone, and it would be churlish to dismiss last week's measures. But what has been achieved is a small step towards an exit still barely visible.

The extent of the loan losses at the Irish banks has now been quantified at a level almost without precedent in a developed country, a point which Central Bank Governor Patrick Honohan was right to emphasise in his remarks on Thursday. Just how this came about will be explained in the Nyberg report into the debacle, due to be released shortly. Score-settling is not a waste of time: it is an inescapable ingredient in developing a politically coherent response to the disaster. Nyberg's report is thus of great political importance and should help to allocate responsibility for the mess the new Government faces, an essential step in focussing attention on the limited range of feasible policy options.

Any market-credible exit strategy from the Irish debt crisis requires a restoration of solvency and a return of both State and banks to normal funding on sustainable terms. Thursday's measures, in the inescapable verdict of the market, make a very limited contribution to the attainment of this objective. In the hostile environment created by past Irish policy failures and dysfunctional European institutions, government needs to focus on the limited range of options within its control, none of which offers a one-shot escape route.

The Government has engaged in a complicated renegotiation with the IMF and EU which will play out over the next several years. The pace of deficit reduction is a purely domestic policy choice and it is now time to refocus on this critical question. No less than €18bn will be added to the State's debt mountain in 2011, in addition to whatever goes into the banks. The Irish Government will spend (at least) €18bn more than its revenue this year, with further huge sums adding to the debt in future years. Regrettably the new Government's programme envisages that the State will still be borrowing around €5bn per annum by 2015, a milestone which Fine Gael wished to register a year earlier, Labour a year later. The compromise, to split the difference, should now be reviewed and cannot be ducked until December's Budget.

Ireland has lost the capacity to borrow and has been forced into rescue by official lenders. Any country in this desperate position should be making every effort to get the deficit down as quickly as possible.

The decision by the coalition partners for a relaxed programme of deficit reduction is a cop-out on, critically, the one dimension of macroeconomic policy entirely within our own control.

There is no shortage of wishful thinkers offering snake-oil solutions, including unilateral default or leaving the euro. There are no useful unilateral options available to my knowledge but the surging debt mountain is controllable.

A relaxed timetable for deficit reduction means the eventual debt will be higher, and the debt service costs costlier, for the debatable benefit of postponing adjustments which cannot be avoided. Government revenue must increase, and government spending must fall, in any plausible scenario, which means higher taxes and further spending cuts. Higher taxes are coming, everyone knows it, and no useful purpose is served by pretending otherwise. The 2011 levels of current and capital spending cannot be sustained even with large further tax increases. The soft option of borrowing indefinitely is not available unless the IMF/EU, the only lenders, decide that Ireland should be financed into further insolvency.

If there is a clear lesson from Ireland's last fiscal crisis in the Eighties, it is that little was gained by delaying the budgetary correction. The Government acknowledged, early in 1980, that the budget deficit was out of control and that something had to be done. Successive governments prevaricated for the best part of a decade and it was only in 1988 that a decisive reduction in borrowing was achieved. This wasted decade looks set to be repeated if the Government persists in current plans to defer the inevitable.

Planned government expenditure for 2011 is about 40 per cent higher than government revenue. Corrective measures overseen by the last government have reduced spending under many headings, notably the capital programme, public service pay and social welfare rates. But these necessary measures have been offset by bigger numbers claiming social welfare and the interest bill clocks up inexorably. The result is that total current spending by government has not in fact fallen. The cuts have been neutralised by the surge in interest and social welfare costs.

Meanwhile government revenue has fallen rapidly under virtually all headings, despite steep increases in personal tax rates. Current Irish levels of public spending are being sustained, not by our own resources, nor by markets willing to lend to the Irish Government, but by emergency loans from the IMF and EU.

Meanwhile the incessant lobbying for more spending on the favoured schemes of interest groups, including utterly implausible peddlers of job creation stunts, continues to prey on job-desperate politicians.

A faster reduction in borrowing will strengthen the Government's bargaining position in its renegotiations with the IMF/EU, but is in Ireland's interests anyway. The sluggish deficit reduction of the Eighties achieved nothing, and we can at least deal with the present fiscal crisis a little better than we did with the last one.

Errors are excusable but repeated errors are unforgivable. Edmund Burke put it better than I can: "Far from ignoring the actions that have caused our present difficulties, we should take a strict review of them in order to correct our errors if they be corrigible; or at least to avoid a dull uniformity in mischief, and the unpitied calamity of being repeatedly caught in the same snare."

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