The Fiscal Compact, or: where will we be in 2018?

Tom McDonnell: The debate about the fiscal compact is likely to continue for some time. Much has been made of the 'one twentieth' rule but in practice it is adherence to the rules around the structural balance which will really matter in terms of the fiscal stance post 2015.

Ireland is currently working its way through an Excessive Deficit Procedure (EDP) which requires the general government deficit to be no worse than 3% of GDP in 2015. At that point Ireland will be expected to improve its structural budget balance by converging to a medium term objective of a deficit no larger than 0.5% of GDP. The Department of Finance estimates that the structural deficit will be 3.7% in 2015. If one generously accepts this figure as accurate then the government will be obliged to adopt a fiscal stance consistent with 'correcting' the remaining gap. This will trigger additional discretionary fiscal consolidation equivalent to circa 3.2% of GDP - about €5 billion in 2012 terms (though not necessarily all in the same year). This suggests that the programme of continuous austerity will continue out to 2017/2018. A bleak prospect.

This continuous fiscal tightening combined with the huge private debt overhang will drag on the economy's capacity to generate increases in real GDP. Debt sustainability in the absence of higher inflation (anathema to the ECB) or low interest rates on government borrowings (perhaps by extending the official programme past 2013) will be challenging. The Treaty does refer to an ability to deviate from the medium term objective under 'exceptional circumstances'. It will be interesting to see how this is interpreted in practice and it is possible there may be scope for wriggle room.

The fiscal compact is certainly no panacea for the current crisis though it might ameliorate the severity of the next one. The answers to the current crisis lie elsewhere.

Posted in: Fiscal policy • Fiscal policy

Tagged with: fiscalrules • fiscal consolidation

Dr Tom McDonnell

Tom McDonnell is senior economist at the NERI and is responsible for among other things, NERI's analysis of the Republic of Ireland economy including risks, trends and forecasts. He specialises in economic growth theory, the economics of innovation, the Irish and European economies, and fiscal policy. He previously worked as an economist at TASC and before that was a lecturer in economics at NUI Galway and at DCU. He has also taught at Maynooth University.

Tom obtained his PhD in economics from NUI Galway.