Should we ignore the spirit of the EU fiscal rules which require countries with deficits to reduce them faster in times of economic growth simply because an earlier set of figures allow for a more expansionary budget?
That is the key point underlying the controversy about Professor John McHale’s criticism of Budget 2016.
It is not some esoteric discussion about which figures for the output gap and potential GDP growth should be plugged in to a fiscal adjustment matrix.
The issue is that at a time when the economy is growing, when we can reduce the remaining deficit without significantly harming the economy, we are choosing to introduce policies that will prolong our borrowing. In the process we are stretching as far as possible the fiscal rules we adopted to try and prevent a re-run of the crisis we have just emerged from.
Professor McHale may have withdrawn part of his criticism of the Budget after accepting the Government had agreed with Europe it could use earlier figures to show compliance with the rules. But the basic flaw in the budget identified - that it was excessively expansionary - remains.
Ireland is currently in the Excessive Deficit Procedure (EDP) and has to reduce its deficit - excess of spending over revenue - to below three per cent of GDP by 2015. The mechanics of the EDP are fairly straightforward: a country is set a series of annual headline deficit target with these targets reducing systematically to the three per cent of GDP level. Ireland's targets under the EDP were set back in December 2010 and have not been adjusted in the interim.
This year’s deficit could have been as low as 1.5 per cent of GDP if the expenditure ceilings set out in last year’s budget had been adhered to. However, some of the recent gains, including potentially temporary increases in Corporation Tax, were used to fund €1.7 billion of supplementary spending for various departments in 2015. Expenditure ceilings become meaningless if they can be increased when windfall revenues are available.
From next year the fiscal landscape will be about reducing the remaining structural deficit at a particular pace and, measurement issues aside, the new rules have some in-built leeway.
If the economy is not growing and is below its potential no effort has to be made to reduce the structural deficit. The fiscal effort can be delayed until the economy improves. If the economy is showing some growth and is close to its potential then some effort to reduce the deficit is required.
The figures published by the Department of Finance back in April put us in this position with a required reduction in the structural deficit of greater than 0.5 per cent of GDP.
Of course, as 2015 has evolved the economy has continued to improve and all growth forecasts have increased. In rough terms the four per cent plus growth rates that most forecasters, including the Department of Finance, are pencilling for 2016 are above the long-run potential growth rate of the economy.
The updated figures put us in a position where the required reduction in the structural deficit should be greater than 1.0 per cent of GDP. That is, now that the economy is growing faster we should be doing more to reduce the deficit.
By the letter of the fiscal rules it appears the deficit reduction required is that which corresponds to the April figures. The spirit of the rules - which are intended to avoid the mistakes of the past - would say that now is the time to eliminate the deficit.
Ireland would come well short of meeting the required reduction in the structural deficit if we applied the deficit rule rather than the EDP target to this year’s figures. The budget documents show an improvement in the structural deficit of just 0.2 per cent of GDP is expected in 2015.
If the structural deficit rule and the expenditure benchmark are good rules for 2016, and the budget documents make various positive references to adhering by those rules in 2016, surely then they are also good rules for 2015?
Fiscal rules are useful but imperfect. They are a guide not a crutch. Irish fiscal policy for 2015 was framed based on a target set in 2010 when the notion of six per cent growth in the Irish economy would have been derided. The economic conditions are hugely different now. Our fiscal stance may adhere to the letter of the fiscal rules but if you think it is too expansionary for the unknown twists in the road that might lie ahead then you are probably right.
Séamus Coffey is lectures in economics at UCD