Every Irish Budget since 2008 has been Contractionary

The Irish Budget gets much media attention and the process itself is now more transparent than in the past, although the net impact on demand in the economy is generally small and certainly far less important than developments in employment and wages. Indeed, given the scale of mortgage debt in the economy and the prevalence of variable mortgage rates ( declining as a share of the market now but still dominant in terms of outstanding debt) monetary policy has had a far bigger impact, particularly in recent years, and it is surprising that the actions of the ECB and our own Central Bank does not receive more scrutiny from the Oireachtas.

The stance of fiscal policy ( i.e. is the Budget adding to demand in the economy or reducing it) does get attention from the economic community and a standard criticism of fiscal policy in Ireland is that it is pro-cyclical , meaning that the Government tends to boost demand in an already strong economy by  cutting taxes and/or raising expenditute. What is therefore surprising is that an examination of the evidence shows that every Irish budget since 2008 can be said to have been contractionary, at least as delivered by the Minister ( the outcomes are often quite different)

The change in the actual budget is not a good measure of the fiscal stance as the General Government balance is itself  impacted by the economy; tax receipts will  rise in a boom, for example, and fall in a recession, with the reverse operating in terms of government transfers such as unemployment benefit.

These forces act as ‘automatic stabilisers’  in that a downturn will increase a government deficit, thus offsetting, at least in part. the decline in private sector spending , a process which the current Minister of Finance has suggested Ireland would allow in the wake of a significant weakening in activity following Brexit (should it happen). A better measure of the fiscal stance, therefore, is to adjust for the economic cycle, an inexact science to say the least but one that is published in the Budget every year by the Department of Finance. A final tweak is to adjust for interest payments on the debt, which are not at the discretion of the  Government ( and are falling rapidly in Ireland’s case ) to arrive at the structural primary balance, which is the preferred measure of the fiscal stance by many economists, including those at the IMF. For example, the 2019  Irish Budget projected a primary surplus of 1.4% of GDP  or 0.8% when adjusted for the economic cycle.

Using that metric, we can see that the 2008 Budget was the last that could be called expansionary , with a planned structural primary surplus of 0.7% of GDP against an expected 2007 surplus of 1.6%. The following budgets saw massive spending and tax cuts, of course but it is surprising and contrary to the perceived narrative that this contractionary process is still at work. For exampe the 2016 Budget saw a projected shift in the adjusted primary balance from zero to a surplus of 0.5% of GDP. In 2017, the projected surplus rose again, from 0.5% to 1.1%, followed in 2018 by a projected 1.3% from an estimated outturn of 0.9%. In 2019 the change in stance was marginal, it has to be said, but nonetheless the projected adjusted primary surplus still rose, to 0.8% from 0.7%, with much larget surpluses projected over the coming years.

These may never materialise , of course, and as noted the implied stance at the delivery of any budget can look very different at the end of the year in question. Moreover, the  above takes no account of what the budgetary position might have been had the suthorities not made the discretionary choices they did, and again it is a common charge in Ireland that  governments have tended to spend  most of  any tax windfalls. One can  therefore debate whether  fiscal policy could and should have been tighter but it is the case that in terms of the actual policy stance as  delivered by the Minister it is over a decade since we have seen an expansionary budget.

 

European Commission latest to convert to Fiscal Expansionism

The widely accepted view on the Great Depression is that it was exacerbated by a series of policy errors- trade protectionism, tight monetary policy and contractionary fiscal policy. Consequently, given the lessons learned,  the Great Recession in 2008-9 prompted a substantial policy reaction across the globe, with a massive easing in monetary policy accompanied by counter cyclical fiscal policy. Oddly, though, policy makers then decided that debt reduction should take priority, and fiscal policy generally became contractionary even when the global recovery began to falter and lose momentum, with monetary policy seen as ‘the only game in town’. That emphasis on the  perceived dangers of high and rising  sovereign debt resulted in new and stricter fiscal rules in the Euro Area (EA), emphasising the need for a steady and persistent reduction in budget deficits.

Policy doubts eventually began to emerge, including from the IMF, with evidence questioning whether ‘austerity’ actually reduced debt levels and claiming that the  negative multiplier effects of contractionary fiscal policy were steeper than previously believed. Doubts also grew about the effectiveness (and  possible adverse consequences ) of loose monetary policy particularly after the adoption of negative interest rates and large scale QE. The ECB has also changed its tone of late, accepting the need for monetary policy to be complemented by some expansionary fiscal policy in the EA, albeit while still respecting the existing fiscal rules.

Academic debates  on fiscal policy have also intensified, with the case being made that budgetary policy can be more effective at or around the zero rate lower bound, but  events have transpired to take fiscal policy centre stage in the real world. The UK government has already announced , post the Brexit vote, that it has abandoned its previous pledge to balance the budget by 2020, and is expected to announce a more expansionary fiscal path later this month. In the US,  markets now expect fiscal policy to be far more expansionary under the incoming Trump Administration, although it remains to be seen how much of the campaign rhetoric will translate into policy action.

Closer to home, the European Commission has just announced , for the first time, a recommendation on the overall fiscal stance in the EA, and is advocating that it should be expansionary in the coming year, amounting to 0.5% of GDP , equivalent to a €50bn budgetary injection. On existing  national plans , the  overall  EA fiscal stance is expected to be neutral in 2017, after being modestly expansionary in 2016, and the Commission believe that a number of countries have the fiscal space available to raise spending and/or cut taxation, although it cannot force any action. The group comprises Germany, Estonia. Malta, Latvia, Luxembourg and the Netherlands. In practice, the Federal Republic is the only member with the size to affect the EA as a whole, and while calls for Germany to adopt a more expansionist policy in the interests of the wider zone have been made before, it is novel and perhaps surprising to see Brussels join in that chorus.