Only the severest policy can restore confidence
IN ALL the furore surrounding Greece, it has been easy to forget about the other Eurozone members struggling to stay afloat. Portugal, Spain and Ireland have all been suffering from ballooning deficits and rapidly rising unemployment, to the extent that all three have experienced government debt downgrades by at least one ratings agency.
But while their problems are hardly isolated, these countries have been particularly hard-hit because their governments have found their policy responses strangled by Eurozone membership. These countries do not have the luxury of tailoring expansionary monetary policy and exchange rate depreciation to meet their own needs – instead they must make do with a blanket interest rate deemed appropriate for the whole bloc and resort to fiscal policy.
Greece has failed to convince anybody that its ambitious pledge to bring the budget deficit under control – corruption and false promises in Greek politics being just some of the more sceptical reasons among the country’s own economists. But Ireland has managed to go from an economy in freefall to a country back on a steady path towards recovery in the space of only five months, despite a jobless rate of 12.5 per cent, a weak housing market and being a member of the Eurozone. No longer is Ireland the sick man of Europe.
What has been behind this remarkable turnaround in both perceptions and reality? Unlike Greece, the Irish government has imposed an austere budget, which includes spending cuts of €4bn, or about 7 per cent of the annual budget.
Irish minister for finance Brian Lenihan argued that continued borrowing would not be viable for three reasons. First, the spiralling cost of servicing debt; second, international lenders need to retain their faith in the government’s ability to restore order to the public finances; and third, only decisive action will restore confidence.
Lombard Street Research’s Jamie Dannhauser says that Ireland probably imparted far too stringent policies in its December budget. Perhaps, but excess severity was exactly what was needed to convince markets that Irish fiscal policy was both sensible and attainable. Only then would Ireland’s policies not be hampered by debt downgrades and lack of market confidence. Although Ireland came from a stronger base, its actions show how a deficit should be dealt with. Spain and Portugal would do well to follow suit.