Oliver Mangan, Chief Economist at AIB discusses how expanding fiscal policy is the right call for Irish economy. 

fiscal

Expanding fiscal policy is the right call

There is considerable debate as to what should be the appropriate stance of Irish fiscal policy, now that the imbalances in the public finances have been largely corrected writes Oliver Mangan Chief Economist at AIB

The Government debt level remains high but the debt ratios are falling rapidly, with gross government debt declining from 120% to 97% of GDP in the past two years. Meanwhile, the budget deficit looks set to fall to around 2% of GDP this year and 1% in 2016. It stood at 8% of GDP as recently as 2012. This is some progress.

 

The ESRI made clear that it favoured a broadly neutral budget for 2016 and called the Government’s intention to run a modestly expansionary fiscal policy disappointing. It argues that the strongly growing Irish economy does not need a fiscal stimulus and warns against repeating the mistakes of the past. There has been a similar warning from the Central Bank.

 

There is also concern at the recent news that there will be a significant overrun in government spending this year. This will prevent an even bigger fall in the budget deficit in 2015 and raises the level of spending in 2016. The Irish Fiscal Advisory Council (IFAC) has also raised concerns that fiscal policy may be becoming too expansionary, especially with the large spending overruns this year.

 

The IFAC has pointed to the need to continue to strengthen the public finances given Ireland’s high debt level, which leaves it vulnerable if there is an adverse shock, especially given the current uncertain outlook for the global economy. While not advocating a strong pro-cyclical fiscal stance, we feel that it is important to take account of where fiscal policy and the economy are actually at presently.

 

Ireland has come through a prolonged, severe austerity programme that decimated the public capital programme, put public services under severe pressure, and left many workers with very high taxes on income. Meanwhile, although growth may be strong, economic conditions are still far from normal.

 

Much of the strong growth is due to exports and an associated large rise in business investment. However, both unemployment and emigration remain high, suggesting that there is still significant spare capacity within the economy. Inflation is at zero, while there is an enormous balance of payments surplus. Credit continues to contract at a very sharp pace with the economy still deleveraging.

 

Construction activity, most notably home building, remains in the doldrums, resulting in a housing crisis, as well as a growing public infrastructure deficit. Overall, the economy is far from overheating, as happened in the previous decade. It is also worth noting that the Government is hamstrung to a considerable extent by new fiscal rules aimed at achieving a balanced budget in structural terms.

 

There are also new expenditure rules which limit the pace of growth in government spending. We do not view fiscal policy as being too expansionary in either 2015 or 2016. Total gross government spending on current services is projected to rise by less than 1% next year, similar to the increase in 2015, even allowing for the spending overruns.

 

Meanwhile, Exchequer- financed public capital spending will fall slightly next year. It is running at less than 40% of its level in 2008. Indeed, public investment in Ireland is lower than in any other EU country at 1.5% of GDP, half the level seen in the rest of the EU and the US.

 

Meanwhile, even after the modest tax cuts in the 2015 and 2016 budgets, a marginal tax rate of some 50% applies to income earned above €33,800. As a result of all these factors, we favour a fiscal policy that is mildly expansionary, while keeping the budget deficit and government debt ratio on a firm downward path, and also adhering to the EU’s fiscal rules.

 

Source: Irish Examiner October 20th 2015

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