When the Minister for Finance was laying out his plans for the budget in the summer, he anticipated a significant recovery in the economy this autumn and an improving situation in the government's finances.
At the time, the Irish Fiscal Advisory Council said that they thought his numbers were on the pessimistic side. As it turns out, there has been a dramatic improvement in the economic and budgetary prospects in just three months.
Instead of a deficit for this year of 9.4 per cent of national income forecast in the summer, after the giveaways of the budget the deficit for this year is now expected to be 5.9 per cent. That is a massive turnaround in a few months.
Possibly even more significant, the improvement is expected to carry through to future years, with higher growth forecast out to 2025 and a related revision to the likely trend in government borrowing.
A return to a normal savings rate will anyway result in a consumer boom. If even a fraction of the pent-up savings is also spent next year, it would further fuel demand
In the summer the council was critical of the Government planning to run a continuing deficit out to 2025. Today the forecast is for a small surplus by 2025, and the council have, as a result, revised their views.
The successful outcome of the Government’s negotiations on corporation tax has also helped to provide a more certain future for the public finances and it should help bolster our position with our friends in Europe. There remains uncertainty arising from the vagaries of the US system of government. US tax legislation could yet provide surprises for Ireland.
However, having agreed a 15 per cent tax rate for large firms who are mobile, I can see no justification for keeping the 12.5 per cent rate for smaller firms. Corporation tax has never been seen as a crucial factor in such firms’ success. Other support mechanisms are preferable.
A key issue in the uncertainty about the future is what households in Ireland and in other countries will do with the massive savings they have built up over the last 18 months of pandemic. In Ireland these "excess" household savings have amounted almost 15 per cent of national income.
Household savings
A return to a normal savings rate will anyway result in a consumer boom. If even a fraction of the pent-up savings is also spent next year, it would further fuel demand. If the volume of spending rises beyond the capacity of the economy to deliver, that will exacerbate inflationary pressures. If we all want to install new kitchens next year, builders won’t be able to deliver, and prices will rise.
The last time there was a large build-up in savings was during the second World War. Research by myself, Seán Kenny and Alexandra Cermeno shows that in Ireland and Sweden strict wartime rationing also led to a very large accumulation of household savings.
After the war, in 1947 and 1948, about a quarter of these savings were spent on consumer goods, but in both countries a higher share went into the housing market, driving prices up by a half over a three-year period. If this pattern were replicated over the next two years, it would result in a surge in house price inflation.
However, in addition to the effect of releasing the “wall” of excess savings, the Government is also ramping up demand for housing. Adding to pressure for housing when private sector demand is likely to peak can have only one consequence, inflation. In this environment, the decision in the budget to continue the Help to Buy scheme was unwise.
A tightening of fiscal policy would have nothing to do with reducing the debt
While the Department of Housing are happy about spending more money, the Department of Finance have signalled their concern about the possible inflationary consequences.
While action is being taken to increase housing supply to calm an overheating market, these measures take time to deliver results, possibly making the biggest impact in the lifetime of the next government.
Given the success of our economic recovery post-lockdown, it might have been wiser to have extracted some spending power from the economy through raising taxation in the budget. But that could also have proved a risky strategy, as coronavirus is not yet defeated.
However, if the economy continues on its present course, it will reach capacity next year. Under these circumstances, Budget 2023 should plan to rein in overall demand through raising taxes.
Such a tightening of fiscal policy would have nothing to do with reducing the debt. Rather it would be about matching the demand in the economy to its restricted ability to deliver. For a Government half-way through its term of office, such a prudent approach to managing the economy in all our interests may be difficult to achieve.
