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The Fiscal Watchdog

Irish Fiscal Advisory Council is intent on austerity but it lacks teeth so will we as a nation take the bitter medicine?

This week the Irish Fiscal Advisory Council (IFAC), which is chaired by NUI Galway economics professor John McHale, called on the Government to impose even more stringent austerity. But would the IFAC's severe prescription end up killing the patient?

After the failings of the Celtic Tiger years, when the governments routinely ignored the on-the-one-hand/on-the-other-hand warnings from the Department of Finance that the Irish economy was over-heating, one of the conditions of the November 2010 EU/IMF bailout was that the government establish a fiscal advisory council to monitor and assess its budgetary performance. In addition, the assessments of the IFAC would be published.

The IFAC was duly set up in July of last year with Professor McHale as its chairman. The other members of the council are OECD senior economist Sebastian Barnes, former IMF deputy director Donal Donovan, TCD economist Alan Barrett and Roisin O'Sullivan, an Irish-born associate professor of economics at Smith College, Massachusetts.

This is very much a roll call of the great and the good of the Irish economics profession, with not an iconoclast or maverick among them.

What guarantees, if any, do we have that it will prove any more effective in reining in future spendthrift governments than the Department of Finance mandarins were in the past? Where were most mainstream economists, including Professor McHale, when the Irish economy was going over a cliff during the middle of the last decade?

Since its establishment 14 months ago, the IFAC has published regular fiscal assessments in which it analyses the Government's current fiscal stance and suggests possible improvements.

This week it published its latest assessment in which it called upon the Government to impose a further €1.9bn of "additional adjustments", tax increases and public spending cuts to you and me, in the three years to 2015.

With the Government already committed to a further €8.6bn of tax increases and spending cuts in its next three Budgets, one rather suspects that the IFAC's advice was not greeted with a cead mile failte in Merrion Street.

The hard budgetary line urged by the IFAC in its latest fiscal assessment is consistent with its previous pronouncements. In its first assessment, which was published in October 2011, it recommended an additional €4bn of fiscal tightening over the following four Budgets.

It maintained this hard line in its second assessment, which was published last April, when it called for a €2.8bn fiscal tightening over the next three Budgets.

For the Government, the main consolation in the latest fiscal assessment is that the IFAC now seems to be proposing a slightly less rigorous stance, recommending a tightening of "only" €1.9bn.

Unfortunately, what the IFAC gives with one hand it seems determined to take back with the other.

In its assessments, the IFAC has been openly sceptical about the economic growth forecasts upon which the Government is relying to generate about half the expected growth in tax revenue out to 2015.

In the most recent assessment it observed that:

"In recent years, the forecast levels of GDP and GNP have generally been lowered by the Department of Finance (and other agencies) in each successive forecast. This factor is more apparent for nominal GNP than it is for nominal GDP. Thus, forecasters have consistently over-anticipated the timing and extent of a possible turnaround in the economy.

"The uncertainties surrounding the growth outlook for the Irish economy that were highlighted in the council's previous report remain."

While the IFAC's scepticism about the economic growth forecasts being used by the Department of Finance are surely well justified, the suitability of the medicine it wishes to prescribe -- even more austerity -- must be open to doubt.

Although most of us didn't realise it at the time, the recession began in August 2007 when the credit crunch first struck and terrified banks stopped lending to one another.

For the Irish banks, which relied upon interbank funding to fund over half of their loan books, the seizing up of the interbank market quickly proved catastrophic.

Unable to roll over loans from overseas banks, the Irish banks in turn stopped lending which, with almost two-thirds of lending already tied up in bricks and mortar, had a disastrous effect on the property market.

Bursting the property bubble blew a €10bn hole in the public finances, leading inexorably to the November 2010 bailout and ultimately the creation to the IFAC.

Given its previous fiscal failures, the IFAC is not unnaturally anxious to ensure that the Government reduces the budget deficit to the 3pc of GDP target agreed with the EU/ECB/ IMF troika as quickly as possible.

Unfortunately, with a return to economic growth seemingly slipping ever further over the horizon -- despite six hairshirt Budgets since October 2008 and with at least three more to come -- is the austerity being recommended by the IFAC making an already bad situation even worse?

Will an intensification of austerity, by further depressing the economy and tax revenues, make a return to fiscal balance less rather than more likely?

Doubts about the main intellectual premise underpinning its operations aren't the only problems confronting the IFAC.

At present its role is purely advisory. While its original mandate envisaged that it would monitor and assess the compliance of the Irish Government with the terms of an as-yet-to-be-passed Fiscal Responsibility Bill, the necessary legislation has yet to be enacted.

Don't be too surprised if this, and possibly future, governments take their own sweet time in putting the IFAC's operations on a statutory footing, drastically limiting their own room for manoeuvre in the process. Stand by for all sorts of excuses, including the political equivalent of "the dog ate my homework" before that eventually happens.

Such political sloth is only one of the potential obstacles that the IFAC will have to overcome.

An even bigger difficulty will almost certainly prove to be that, because its mission is to stop something from happening, it will by definition be impossible to determine whether or not it is doing its job well. However, if it fails and a future spendthrift government bankrupts the country once again, its failure will immediately be apparent to all.

OF course in an ideal world there should be no need for a body such as the IFAC. If we possessed a cadre of economically literate senior bureaucrats and responsible politicians the budget crises of the 1980s and the noughties would never have happened. But they did.

What, if at root, our problems are primarily cultural rather than fiscal or administrative? If this is in fact the case then how effective can a body such as the IFAC, which has effectively been grafted on to an alien culture at the insistence of our creditors, really be? What is there to prevent the IFAC gradually becoming yet another ineffective talking shop?

Will we, once the present crisis has passed, relapse into our traditional bad habits with the next generation repeating the traditional boom-and-bust cycle that beggared their parents and grand-parents?

Professor McHale must be hoping that the operation of the IFAC ensures that future Irish governments will learn from the lessons of the past so that they don't repeat the disastrous mistakes made by their predecessors.

Irish Independent