Fiscal Council proposals not credible - would make a bad situation worse

The proposals from the Irish Fiscal Advisory Council to Government are simply not credible. In reality they would make a bad situation worse.

The Advisory Council has advised Government that its target for the General Government deficit target, currently set at 2.8 per cent of GDP, to be reached in 2015 should be reduced further to 1 per cent by that date. In practice, according to the Advisory Council, this would require Government to reduce its borrowing in 2012 by €4.4bn rather than by €3.6bn which was the target until now.

They argue for this further hardening of Ireland’s response despite the fact that they acknowledge the changes agreed by European leaders in July 2011 should result in interest savings of approximately €1 billion per year from 2012 to 2014. Furthermore, they acknowledge the funding requirement to the State as a result of banking recapitalisation is now likely to be approximately €3.5 billion lower than was envisaged last March.

A short review of what was originally proposed is most enlightening. The overall adjustments in Budget 2012 were to be €3.6 billion. In practice this meant there would be an adjustment to the Irish economy of approximately €4 billion in reduced economic activity in Ireland in 2012. The size of this effect is driven by both the direct reduction in government and consumer spending from the Budget’s decisions and the indirect effect on the economy of the knock-on effect of these decisions (the multiplier effect). Put simply, a reduction in an area of government spending means there is less money circulating in the economy and less money passing from company to company and consumer to consumer - i.e. there will be less economic activity. Additional taxation has a similar effect.

Taking this multiplier effect into account means that in 2012 for the Irish economy to stand still (achieve 0% GDP growth) it would have to replace through new economic activity (growth) the total effect of the Budget’s adjustments which would be approximately €4 billion or 2.5% of GDP.

Furthermore, for the economy to achieve the growth targets most recently set out by the Department of Finance (2.5% GDP growth) the economy would have to replace the effect of Budget 2012 and generate a further €3.9 billion in additional economic activity in 2012. Overall, this implies that Ireland would have to experience an underlying growth rate of 5% in 2012 - equivalent to the growth levels experiences in boom times.

Is this credible? Social Justice Ireland doesn’t think so. Now the Fiscal Advisory Council proposes an even steeper adjustment making the challenge even more difficult. In reality following this advice would make a bad situation worse.