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Appropriate fiscal stance imperative for Budget 2021

The measures necessary to slow the spread of Covid-19 have induced an extraordinary contraction in economic activity globally. The Spring 2020 Economic Forecast issued by the European Commission projects that EU GDP will contract by a record 7.75 per cent in 2020 as a central scenario, and projects a contraction of 11 per cent in face of a ‘second-wave’, and 16 per cent if containment measures continue for longer. Modified Domestic Demand, an indicator that excludes the impact of aircraft leasing and trade in R&D-related IPP imports, decreased by 16.4 per cent in Q2 2020, driven by falls in personal consumption and domestic capital formation of 19.6 per cent and 28.2 per cent respectively.

The European Commission has noted that the EU-wide collapse in consumer spending and investment by households and companies has contributed to an unprecedented shock to economic activity, with a concomitant disruption to the circular flow of income between households and firms.

As household incomes contract, expenditure on goods and services contract, threatening families with poverty and firms with insolvency. The efforts to support household income in Ireland by Government through the Pandemic Unemployment Payment and Temporary Wage Subsidy Scheme have played a key role in sustaining households and businesses.

Given the scale of disruption, it must be recognised that extraordinary Government expenditure will be required to sustain demand and to support incomes through the immediate crisis and emergence from the public health restrictions, through the recovery period, and through the return to a new, sustainable, long-term trajectory for the economy.

In Ireland, over the past decade and more, we have become accustomed to being guided by an overall budget target that has adjusted to changing realities over time.  After the crash of 2008 the focus was on reducing borrowing. Then it moved on to focusing on balancing income and expenditure. More recently, as we were more or less paying our way, the focus had been shifting towards reducing the national debt. The post-Covid-19 world changes all that.

In the years ahead, as we move through the public health restrictions and into a recovery period, the fiscal stance adopted by Ireland must have a different focus.  The objective must be to support demand by supporting the incomes of citizens and through Government capital expenditure, rather than achieving some arbitrary deficit target.

It is vital that the fiscal stance adopted by Ireland in response to the Covid-19 crisis  supports an economic recovery, rather than preventing one and causing permanent damage to our long-term economic capacity and, more importantly, to the well-being of our citizens.

This has been recognised by the Irish Fiscal Advisory Council who have noted that ‘the appropriate fiscal stance for the coming years will depend on how the crisis evolves’.

The importance of supporting economic activity has been recognised by the European Commission; in their proposals for the EU MFF 2021-2027, the Commission have recognised both that additional fiscal resources are necessary and that they should be frontloaded to 2020-2022. There will, we acknowledge, be significant differences in the criteria used to determine the country’s  fiscal stance as we emerge from the Covid-19 public health restrictions.

Social Justice Ireland proposes that:

  • For the years 2020-2022, or until Ireland reaches full employment (if earlier than 2022), the fiscal stance adopted by Ireland should be determined by an unemployment target, rather than a deficit target, in recognition of the role domestic demand plays in sustaining domestic employment; and,
  • The State should begin to plan now for the additional tax measures necessary, over the long-term, to finance the Government expenditure required to finance universal services and income supports for our citizens.

It is acknowledged that the adoption of an unemployment rate target for 2020-2022 would represent a shift in the fiscal policy framework, and a temporary departure from the EU fiscal rules. It is also acknowledged that this policy depends on the ongoing accommodating stance adopted by the ECB.  However, at present it is clear the Commission are willing to suspend the fiscal rules and the ECB are willing to do what is required to support economic recovery.

As the increase in unemployment in Ireland has been entirely caused by a temporary collapse in demand for labour, the adoption of a short-term demand management policy represents the most effective means to restore economic activity. The goal is not to allow a potentially temporary situation develop into a long-term crisis.

In particular, in the face of a potential second wave of Covid-19, Government should be prepared to re-introduce all public health restrictions required and to take all fiscal measures required to support demand and incomes. Austerity with the simple objective of reducing the debt and deficit would be a serious mistake, and would, over time, undermine the very objective it seeks to achieve by permanently destroying the economic capacity of the country.