Ireland and the Eurozone Fiscal Herd
Twice a year, the European Commission releases detailed forecasts for the European economy. Its Spring 2020 Economic Forecast was published on May 6th and it came with the following tagline “a deep and uneven recession, an uncertain recovery”.
The phrase “uneven” stands out the most. The eurozone has 19 members and each is facing a different impact from COVID-19. Some countries began from weak positions and others have industries that are well placed to weather the economic storm.
Ireland’s forecasts illustrate the extreme optimism built into these figures. It assumes a 7.9% GDP decline in 2020, versus 10.5% in the Government’s own Stability Programme Update. Unemployment is only forecast at 7.4%, versus the Government’s 13.9%. Both sets of forecasts don’t consider potential bailouts for transport operators and universities. They don’t allow for the unforeseen.
But optimism aside, what the Commission gets right is the uneven picture between countries, even if the magnitude of the drop is wrong.
This can be seen in the forecasts for fiscal deficits. Spain and Italy, whose tourism sectors are potentially shut for the summer, fare worst. Germany and Luxembourg fare best, with the latter forecast to run a modest surplus (again, the magnitude here is so wrong).
Ireland sits perfectly in the middle of this pack. 9 countries have larger deficits. 9 have smaller. We’re at the centre of the “herd”.
A month ago I began tweeting about the deficit and I raised the prospect of needing to impose austerity again on the Irish economy. What I didn’t communicate clearly enough is that the need for austerity, in the immediate aftermath of this crisis, is low. I’ve written since about how we may only require modest measures at the October budget and how a return to growth in 2021 will bring the deficit down sharply. There may come a time when we need to more clearly chart a path of deficit reduction, but now is not that time.
Being part of this new fiscal herd brings protection that other countries experienced during the last crisis. In 2011 and 2012, the interest rate charged on government debt shot up in the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) and Cyprus. Notably, it fell or stayed unchanged in most other eurozone countries, despite most countries continuing to run wide deficits and build larger piles of debt.
What is evident from this period is a form of fiscal herd immunity. Only the countries with the weakest budgets faced the surge in interest rates. The same phenomenon should hold true again, only this time, PIGS only has one ‘I’. The bond buying from the ECB may mean that no country sees a spike in interest rates, but we can’t bet on that being true.
Ireland’s optimal course going forward should be to run deficits at the eurozone average; at the centre of the herd. That avoids the risk of being picked off at the edge by international markets.
Along with writing here, look out for my blog contributions on the Carraighill website.
