Expansionary Fiscal Contraction?

An Irish Perspective Frank Barry

Trinity College Dublin

Hypothesis as originally formulated by Giavazzi and Pagano derived from analysis of two episodes of fiscal contraction in the 1980s: ◦ Ireland (c. 1987) and Denmark (c. 1982)

Wealth and expectational effects of well-designed

consolidation programmes might very much reduce and possibly even outweigh the traditional Keynesian multiplier effects of fiscal policy on demand and activity.. In addition, fiscal consolidation might improve long-term financing conditions by way of.. lower risk premia on government paper. ◦ ECB President Jean-Claude Trichet, Dublin, May 2004

Also referred to as "the German view of fiscal policy"

Vast majority of Irish economists were (and are) not convinced

Why? ◦ Concurrent "Lawson boom" in the UK ◦ Influx of FDI in lead up to the Single European

Market ◦ Successful 1986 devaluation against DM (to re-

establish previous rate against sterling) ◦ 1986/87 wage deal ("social partnership")

Undoubtedly market sentiment is more volatile today

But market sentiment matters less if you are in a troika programme

"Good boom": 1987-2000

"Bad boom": 2001-2007

The problems of the latter were all property related ◦ Banks overexposed ◦ Households overindebted ◦ Government overreliant on tax revenues from property

transactions

Ireland: the Celtic Tiger era

Annual sectoral GDP growth (%): 1986-2000 and 2001-2007; Tradable (i.e. manufacturing) and Non-tradable

(i.e. construction and services) sectors

Major GDP crash Real GDP growth rate:

Deflation more pronounced in Irish case Unemployment levels similar; substantial emigration

Parallels with Latvia over the downturn

Ireland began its fiscal adjustment in 2008; earlier than Greece (2010), Spain (2010) or Portugal (2009)

Expenditure cuts relative to tax increases in ratio of 2 to 1

Fiscal adjustment frontloaded ◦ 2/3 of the adjustment (equivalent to 15% of 2011 GDP)

undertaken from 2008 to end-2011, the remainder due by 2015

Export sector has been highly buoyant, due largely to the nature of the goods produced by the MNCs that the economy hosts

But growth has been around zero for years, with export growth counterbalanced by weak domestic economy

Domestic demand growth during 2005-2011, in % of GDP

Why?

Most ascribe it to: ◦ Massive debt overhang (households and corporates as

well as public), combined with ◦ Fiscal austerity

This is not at all to suggest that the fiscal retrenchment is unnecessary, or self defeating

the primary deficit has about halved since 2009