Department of Finance rules lack flexibility, says fiscal watchdog

FISCAL RULES proposed by the Department of Finance lack flexibility in some respects, and particularly in relation to cyclical sensitivity, according to the second report of the Irish Fiscal Advisory Council.

The council, which is being established to improve the quality of Ireland’s economic management, said this lack of flexibility could lead to unsound policies being pursued by Government.

It has made a number of recommendations aimed at improving what it called the credibility-flexibility trade-off.

Fiscal policy involves the level of government expenditures, transfers or taxes in the economy. Fiscal rules are fixed constraints on fiscal policy, often expressed as numerical limits.

The council said that, in the context of the proposed European treaty, which will aim to address aspects of the euro crisis, fiscal rules for Ireland should not be included in the Constitution.

Rules to be set out in a forthcoming Fiscal Responsibility Bill, should set fiscal rules in domestic legislation, according to the council. As a complement to introducing more flexibility into the proposed fiscal rules, the council has also recommended strengthening the measures that would be taken when policy fails to comply with the rules.

It said the principles of sound public finances should be set out in law and that each new government should set out explicit five-year targets for debt to GDP ratios that would include planned consolidation measures.

Government should made an annual report to the Oireachtas on its fiscal performance and a formal assessment of the government’s performance should be provided by the council.

The design of fiscal rules is particularly difficult in a small, open economy susceptible to shocks, the council noted. It said fiscal councils can provide a mechanism for raising the political costs of pursuing inappropriate policies, while continuing to allow a role for necessary judgment.

It recommended that some sort of “debt brake” be devised that would address how far the debt ratio could drift from the government’s stated target.

In order for the council to be effective, it must be designed so that a government that ignores its advice or observations would incur a reputational cost.

In order for this to be the case, the council would have to be viewed as independent of political influence and analytically sound.

The council has recommended that its members be appointed for four-year terms and that those appointments could only be ended on certain grounds. It would also require sufficient resources to implement its mandate. At the moment the eight-member council has a three-member secretariat.

The report, Strengthening Ireland's Fiscal Institutions, recommends that members of the public sector who work for the council should not gain financially but that their employer – eg a university department – would be compensated for the loss of their time. Comparable arrangements should be put in place for non-public sector workers, it recommends.