Academic journal article National Institute Economic Review

The Irish Fiscal Crisis

Academic journal article National Institute Economic Review

The Irish Fiscal Crisis

Article excerpt

This paper considers the origins and characteristics of the current economic crisis in Ireland. In particular, it examines how fiscal policy contributed to the crisis rather than preventing it. The paper gives details of the major fiscal tightening that is under way. By 2014 the authorities will have implemented a package of ex ante cuts equivalent to one-fifth of GDP. The costs of this package, together with the more permanent effects of the recession on potential output, are discussed and the legacy effects of the crisis for government indebtedness are analysed.

Keywords: Fiscal policy; debt sustainability; Ireland

JEL Classifications: E62; H63; H68

1. Introduction

The Irish economy is facing extremely challenging times as a result of past policy mistakes that allowed a major property market bubble to develop (and burst) and also permitted the banking system to become overexposed to the property sector. The consequences have been a severe contraction in output and a major financial crisis. Due to the collapse in economic activity in Ireland over the period 2008 to 2010, and the associated rise in unemployment, output per head had fallen back to its 2000 level by the end of 2010 (Bergin et al., 2010). Because of a growing dependence of the public finances on transaction taxes on the property sector in recent years (Addison-Smyth and McQuinn, 2010), the severe economic shock had a catastrophic impact on the public finances. Government borrowing shot up to 14 per cent of GDP in 2009, having averaged a small surplus on the public finances over most of the period 2000-7.

This paper considers the origins and characteristics of the economic crisis in Section 2. The policy failures that contributed to the crisis are discussed in Section 3. Section 4 discusses the fiscal policy response. By 2014 the authorities will have implemented a package of ex ante cuts equivalent to one-fifth of GDP. The costs of this package, together with the more permanent costs of the recession on potential output are discussed in Section 4. Section 5 considers the legacy effects of the crisis for government indebtedness and the long-term sustainability of the debt burden. Conclusions are drawn in Section 6.

2. Double trouble: twin housing and credit bubbles

The Irish economy enjoyed an exceptional period of sustained growth from 1994 through to the early years of the past decade. This growth was driven by the expansion in world trade and a rapid increase in world market share for Irish exports as a result of the competitive nature of the Irish tradable sector. This produced rapid but sustainable growth in Irish output and living standards. By the late 1990s, as unemployment fell to historically low levels, the economy found itself approaching capacity output. Substantial immigration helped relieve labour market pressures (Barrett, Fitz Gerald and Nolan, 2002) but it was clear that growth could not continue at the same rate indefinitely. The natural mechanism to slow the economy was a real appreciation of the currency. In the absence of an independent exchange rate this had to take place through a loss of competitiveness as wage rates and other prices rose more rapidly than in the rest of the Euro Area. Managing this real appreciation through differential inflation was never going to be easy without overshooting. It would have been better, as argued by the EU Commission in 2001 and by Barry and Fitz Gerald (2001), if fiscal policy had been tightened to slow the process. However, the bursting of the dot.com bubble led to a slowdown in the world economy and hence the Irish economy. This slowdown was less severe than had been initially expected and it effectively provided some breathing space for the Irish economy.

2.1 Building bubble

Ireland's demographic structure meant that there was a rapid natural increase in the population in the 1990s. The largest cohort of the population in 2000 was aged 20-24. …

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