Economics: There was much to commend in the recent Medium-Term Review from the Economics and Social Research Institute (ESRI). In general, it was a sober and sobering evaluation of the prospects for the Irish economy.

The so-called "benchmark forecast" that formed its centrepiece may have erred on the side of optimism, but this is an estimate of the economy's potential growth rate and is akin to a best-case scenario.

One of the report's great strengths is the attention paid to circumstances and behaviours required to realise that potential, and the downside that would attach to disappointment or failure on these fronts.

But if the overall tone of the Review was welcome, there was also a number of discordant notes, among them the sounds of old scores being settled.

One of the old battles that rumbles on and was rejoined by the Review's authors (in a restrained enough fashion in the report but with decidedly more edge in some of the post-publication interviews) concerns budgetary policy, especially Charlie McCreevy's budgets of 2000 and 2001.

According to the ESRI, these budgets were inappropriately expansionary and must share the blame for the recent overheated state of the economy and loss of competitiveness.

The first point that needs to be made here is that, whatever role these budgets may have played in exacerbating overheating - and the proposition that they had any such effect is not universally accepted among economists, even academic economists - it was not a primary role.

The economy was well advanced on a powerful growth trajectory before the budgets of 2000 and 2001 were twinkles in Mr McCreevy's eye, thanks to a range of stimuli. Among the most powerful of these were the sharp fall in interest rates and the huge currency depreciation associated with our participation in Economic and Monetary Union. Between 1997 and 2000, real short-term interest rates fell by six percentage points here, while the currency dropped by 15 per cent in value.

The extraordinary growth of economic activity fuelled by these and other factors generated enormous tax revenues and big surpluses for the Exchequer. Between 1995 and 2000, for example, tax receipts almost doubled from €14 billion to €27 billion.

What was a Minister for Finance to do with the huge windfalls at his disposal? Raise public spending? Cut tax rates? Or allow the budget surpluses to increase further?

The ESRI favoured the last course (indeed, at the time, the ESRI proposed that taxes be raised), and sees at least some of the difficulties experienced by the economy in more recent years as vindication of its position.

However, the ESRI view makes no allowance for the political economy of budget surpluses. Large and growing surpluses create the not unreasonable perception that taxes are too high relative to spending. From this flows two sets of pressures - to cut taxes and raise public spending, often on ludicrous projects and/or with more than usually scant regard to value-for-money criteria (because a budget surplus is seen as a repository of "free money").

It might be argued that the job of a finance minister is to resist all these pressures. But, to what end?

By 2000, even after a sequence of substantial tax cuts, the budget surplus had ballooned to 4.5 per cent of gross domestic product, or almost €5 billion. How much bigger should it have been allowed become?

Alternatively, a finance minister might decide to avert the dangers inherent in the pressures for higher spending (daft projects, large-scale waste, etc.) by cutting taxes. This is probably where Mr McCreevy's instincts lay but, cabinet government being what it is, his preferences would have had to be pooled with those of colleagues who favoured higher spending.

In any event, budgetary policy in the latter years of the Celtic Tiger era was all about making budget surpluses smaller than they would otherwise have been. This was all but inevitable.

Mistakes were almost certainly made and it is legitimate to argue that tax reduction packages might have been better designed and/or that spending was increased in an indiscriminate way and/or that the balance between tax cuts and spending increases was tilted too much in the latter direction. But to dismiss the overall strategy as stupid, as one of the ESRI authors did in a radio interview, is going much too far.

Did the reduction of budget surpluses exacerbate overheating? Did the big tax cuts of 2000 and 2001, for example, contribute to inflation? My own view is that they probably did. However, I think that the effect was somewhere between marginal and modest, given the openness of the Irish economy, the likelihood that the reductions in income tax had some positive effect on labour supply, and given the large surpluses of the time.

When budget surpluses are large and persistent, taxpayers may form the view that taxes are going to be substantially reduced sooner or later and raise their expectations of their long-term disposable incomes and spending accordingly. In these circumstances, tax cuts may do little more than confirm spending plans that have already been made and may have little incremental effect on demand.

In conclusion, budgetary policy was, at most, only a bit player in the overheating of the Irish economy. Certainly, relative to the impetus provided by sharply falling exchange rates and interest rates, it had no more than a walk-on part.

Moreover, whatever modest role it may have played in aggravating inflation needs to be seen as stemming from an entirely understandable response to the problem of large budget surpluses at a time when it was considered likely (even by the ESRI) that such surpluses would persist for many years into the future.

Jim O'Leary is currently lecturing in economics at NUI-Maynooth. He can be contacted at jim.oleary@may.ie