The budget, announced last October, was stimulatory, as was the budget for 2018: the Government is pumping more money into an economy at a time when it is growing very rapidly. This is unwise, adding to the boom in a way that may not be sustainable. It is also using up resources that we would need if things go wrong.
However, if the UK drops out of the EU without an agreement it could make what looked like an unwise approach to fiscal policy seem really prescient.
Last week the Central Bank published details of a very informative “no-deal” economic scenario for Ireland. While obviously not a forecast it brings together a wide range of evidence on the different ways the Irish economy would be affected. It estimates a fall in national income of around 4 per cent for a “no-deal” exit.
Unlike an exit with agreement, most of the bad news would hit simultaneously. In some cases the disruption in the early months could be even greater than it would be in the long term.
Such a shock to the economy would have a knock-on effect on the public finances. On the basis of economic modelling work out by the ESRI, this would result in a budget deficit of between one and two percentage points of GDP in 2019 and 2020.
If we are spared a major Brexit jolt the Government might actually run a very small surplus this year.
Outstanding debt
Ireland has a high level of outstanding debt, and a return to a significant deficit would obviously be a concern. However, the improvement achieved in the public finances since the crash means that we wouldn’t need to immediately plug the gap in the public finances that a fall in economic growth would bring; instead we could contemplate allowing the government borrowing requirement to rise in 2019 and 2020.
In overseeing an increase in unemployment-related welfare payments, and the big reduction in tax revenue, consequent on an economic slowdown, the Government would be providing some insulation for us all. While this would not offset most of the effects of a no-deal Brexit, it would make it slightly less bad.
But looser fiscal policy in 2019-20 would mean that fiscal policy in 2021-2023 would have to be tightened to return the public finances to a sustainable path.
This analysis shows the benefit to Ireland from having returned the public finances to a sound state. If necessary we could now operate a counter-cyclical fiscal policy, offsetting a serious economic shock. This option was not open to us during the crash because of the sheer magnitude of the hole in our public finances.
An unfavourable no-deal Brexit would justify the mild stimulus in Budget 2019, which, in all other circumstances, would be unwise.
However, a no-deal Brexit is only one possible outcome even if it does look more likely today than it did last October.
An orderly Brexit would leave our economy growing very rapidly this year. In turn this would mean that the current fiscal stance, embodied in the budget, is very inappropriate, a point made by the Irish Fiscal Advisory Council, the ESRI and the Central Bank.
Instead of fuelling the boom the Government should be running a surplus, saving for a future shock, such as an unfavourable post-transition Brexit.
The economy can only produce so many goods and services each year. If expansionary budgets push it beyond its capacity to deliver, the effect will be to raise prices.
House prices
While Irish wage rates are rising at a realistic rate, house price inflation in recent years has been far too high.
The supply response in the housing sector is beginning to crank up, but we have a long way to go. In the meantime the rapid growth in employment and population is adding to housing pressures.
To moderate these pressures the budget should have raised taxes, slowing the growth in employment to what the economy can absorb.
We are not alone in facing this type of problem. In some French towns where employment growth is putting pressure in the housing market, planning permission for a major new employer is made conditional on the new employer building more apartments.
That is not a feasible solution for a country, but it does highlight the need for fiscal policy to ensure that an economy does not outgrow its infrastructure.
