Although it is widely accepted that the outlook for the world economy has worsened considerably since early September, it is disturbing that there is considerable disagreement as to how best to counter the looming downturn. Admittedly, the European Central Bank (ECB) did deliver a timely rate cut in the middle of last month. Since then, however, the prevailing view on this side of the Atlantic seems to be that the exceptional uncertainty that surrounds global economic prospects warrants a cautious response. That could be a costly mistake.
In the US, the policy reaction has been very different both in style and substance. It might be argued that this reflects a "patriotic" response to terrorist attacks, on the US, but the reality is that the resultant economic fallout will be felt worldwide.
The Federal Reserve has stepped up an already aggressive sequence of rate cuts but a more notable development has been the preparation of a rapid and potentially massive budget stimulus package.
In Europe, in stark contrast, talk has centred on the importance of "prudent" fiscal policy. In part, this emphasis reflects fears that any budget easing would displease the ECB and lessen the scope for further rate cuts. More disturbingly, it may also reflect a view that budget policy has little to contribute in current circumstances. It is worrying that the European Commission this week suggested Irish budget policy should still focus on overheating risks. Similarly, the ESRI's recommendation that Mr McCreevy introduce a broadly neutral package suggests either limited ambition or major concerns about the way budgets influence this economy.
These are not normal times. I think there are important lessons for Ireland to learn from the decisive nature of the US economic policy response. At very least, the speed and scale of Washington's reaction indicates the level of official concern about downside risks for the US economy. Given the importance of links between the two economies, this suggests Mr McCreevy should at least consider the case for substantive action in the next budget.
There are many parallels that further argue that Mr McCreevy should watch US budgetary developments. Both economies experienced serious problems with their public finances in the 1980s that restrained growth, while in recent years a marked improvement in budgetary positions was a prominent feature of greatly improved economic performances.
Early estimates of this year's fiscal surplus in the US and Ireland bore comparison and, in each case, a weaker than expected economy has resulted in a much poorer budget out-turn that will impinge on the 2002 arithmetic as well.
In recent weeks the White House has prepared a substantial stimulus package that will probably lead to a budget deficit in the US in 2002. Part of this, such as emergency relief to deal with the immediate fallout from the terrorist attacks, is scarcely discretionary. However, decisions to assist airlines and proposals to support household and business spending underscore a determination to give a decisive boost to US economic activity in the year ahead.
The precise content and magnitude of the US budgetary package is still unclear. Initiatives under consideration range from increased tax-deductibility of business expenses and longer access to unemployment benefits to more radical proposals on capital gains taxes and accelerated personal tax cuts. The Bush administration sought to put in place an additional package amounting to some $60-$75 billion (€67-€84 billion), but an array of measures have been proposed in Congress that could total $200-$300 billion.
With Treasury Secretary, Paul O'Neill, deriding some of these proposals as "showbusiness", it seems likely that the final package won't be too far above initial White House estimates. This means budget policy will deliver a stimulus to the US economy equivalent to around one-and-a-half percentage points of GDP in 2002.
What might Ireland learn from the US? It seems to me that US policymakers' reading of the economic climate and their response is far more responsible than that seen this far in Europe.
As a result I think budget 2002 should be framed to offer significant support to activity and employment in Ireland in the coming year. Financial markets have largely ignored the return to "red ink" in US budget figures and the significance of a modest Irish budget deficit should not be exaggerated in the current climate.
A supportive Irish budget package should have two complementary ingredients that seem to be key elements in US proposals. At a mechanical level, it should provide a meaningful boost to household spending power and to the investment climate. Equally important is the need to underpin confidence. Early and decisive action in the US is helping sentiment. An Irish budget that is seen to focus on current economic needs could make a meaningful contribution to the outlook for the Irish economy next year.
In this context, I would argue strongly for substantial spending on infrastructure and a further easing in the tax burden, albeit on a more modest scale than last year. In so far as poorer confidence domestically has been particularly focused on the housing market, it may also be that specific initiatives to support this key sector - such as reduced stamp duties - may be warranted.
Of course helping confidence is not always straightforward. It is not simply a matter of giving money away. One reason why there are such concerns about budget policy in Europe is that painful experience has taught us that fiscal initiatives are difficult to rein back when they are no longer needed and often lead to permanently higher taxation. A key aspect, if budget 2002 is to support confidence in the Irish economy, is that any stimulus must be seen to be temporary.
Mr McCreevy must also begin to demonstrate a capacity to set Irish public spending on a trajectory that is sustainable into the medium term. In this regard, reliance on a sleight of hand rather than decisive measures would probably hurt rather than help confidence in this economy and its management. If Mr McCreevy can marry US responsiveness to today's needs to European concerns about tomorrow's debts, he will brighten the Irish economic outlook considerably.
Austin Hughes is chief economist with IIB Bank
