Expansionary Fiscal Contraction? An Irish Perspective

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Presentation by Franc Barry, Professor of International Business and Economic Development, Trinity College Dublin (Ireland) at the Bank of Latvia conference "Economic Adjustment under Sovereign Debt Crisis: Can Experience of the Baltics Be Applied to Others?"

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Expansionary Fiscal Contraction? An Irish Perspective

  1. 1. Expansionary Fiscal Contraction?An Irish Perspective Frank Barry Trinity College Dublin
  2. 2.  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)
  3. 3. Also referred to as "the Germanview of fiscal policy" 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
  4. 4.  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")
  5. 5.  Undoubtedly market sentiment is more volatile today But market sentiment matters less if you are in a troika programme
  6. 6. Ireland: the Celtic Tiger era "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
  7. 7. Annual sectoral GDP growth (%): 1986-2000 and 2001-2007; Tradable (i.e. manufacturing) and Non-tradable (i.e. construction and services) sectors
  8. 8. Parallels with Latvia over thedownturn Major GDP crash  Real GDP growth rate: Deflation more pronounced in Irish case Unemployment levels similar; substantial emigration
  9. 9.  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
  10. 10.  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
  11. 11. Domestic demand growth during 2005-2011, in % of GDP
  12. 12.  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

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