Michael Taft: Patrick Honohan, the Government of the Central Bank, was on News at One today. He stated:
‘€3 billion next year will not do it [move us towards the Maastricht Guidelines by 2014]. The economy has drifted so weak that this will not do it. The balance between moving forward with fiscal correction and allowing the economy to grow is, to some extent, a false dichotomy . . It is not a question of growth versus fiscal correction, its fiscal correction leading to growth.’
This is wrong.
Just as the debate is now, finally, entertaining the common-sense and economically verifiable proposition that austerity measures depress future growth which, in turn, undermines deficit reduction (because they depress tax revenue and maintain high unemployment costs) the Central Bank Governor is trying to pull the debate back. He is wrong.
In a paper widely unread, with analysis largely unreported on, the ESRI put forward two models of growth and the subsequent impact on the deficit.
• In their High-Growth model they projected an annual average growth rate of 4.6 percent between 2011 and 2015. This would result, according to their model, in an annual deficit of -1.8 percent by 2015.
• In their Low-Growth model they projected an annual growth rate of 3.2 percent in that same period. Their projected annual deficit by 2015? - 4.1 percent. We miss the Maastricht target by a significant amount.
See a pattern? Higher growth leads to lower deficits. The ESRI reinforces this in their analysis of the structural deficit:
• Under their High Growth model, the structural deficit is projected to be -1.8 percent.
• Under their Low Growth model, the structural deficit is projected to rise to – 4.1 percent.
Here is the key point that has been made numerous times on this blog: economic growth is, itself, fiscally corrective. It is lower growth that engenders higher deficits.
The Governor wants more fiscal adjustment in the 2011 budget (either spending cuts or tax increases or a combination of both). The ESRI projected that a €3 billion package would knock approximately 1 percent off GDP growth. More fiscal contraction will cut GDP growth further.
If under the ESRI’s Low Growth model we miss the Maastricht target by a wide margin, how does cutting that growth even further assist us towards the goal? It won’t. It will embed more deflation in the economy going forward. This, in turn, will depress growth further. This will result in ever higher levels of debt.
The Governor is simply wrong. But if the Government listens to him (as it appears they are) it is the Irish economy that will suffer – through more spending cuts, higher unemployment, lower incomes and poorer public services.