ECONOMICS: Euro will not be influenced by matters in Ireland and the ECB will hardly take the fiscal position of a peripheral economy into account when setting interest rates, writes Dan McLaughlin.
Perception is reality, we are assured by people in marketing, and the 2003 Budget is generally perceived as being "tight" or "tough", albeit largely stemming from the reception given to the spending Estimates, which of course are published a few weeks before budget day.
Another, related view, commonly expressed, is that Charlie McCreevy's sixth budget is yet another example of what is a long history of pro-cyclical fiscal policy in Ireland - the Exchequer injects additional cash into a booming economy, or dampens demand at a time of slower economic growth.
A better approach, it is argued is to act counter to the cycle: the Exchequer should run an expansionary budget in a downturn and adopt a more restrictive stance in an upturn.
Fine in theory, but reality is often messy and the evidence doesn't quite support the perception that Irish fiscal policy is as perverse as often portrayed
A simple approach to quantifying the budgetary stance is to compare the projected deficit to that of the previous year - a bigger deficit (or smaller surplus) implies an expansionary budget.
Simplicity has its drawbacks though. The Exchequer's financial position is itself affected by the state of the economy, so deficits tend to rise (or surpluses shrink) in a slowdown, as unemployment transfers rise and tax receipts lose their buoyancy or even fall. Indeed, these "automatic stabilisers" will dampen the negative impact of a deceleration in private sector spending.
A more appropriate measure of the fiscal stance therefore is to adjust the budgetary position for the economic cycle, so allowing a more valid comparison between one year and the next.
Using this criterion, the 1998 and 1999 budgets, which are perceived as being expansionary, were actually contractionary, but the 2001 budget is revealed as being extraordinarily expansionary, injecting the equivalent of over 2.2 per cent of GDP into the economy.
Yet we now know that growth slowed sharply through that year, so an expansionary policy may have been what was required - without it the economy would have slowed even more.
An alternative explanation is that fiscal policy has little impact on such an open economy as Ireland's, with activity and prices much more influenced by global trade flows, world price trends and the exchange rate, so one shouldn't be too exercised by the budgetary stance.
Another issue is the difference between the perceived budget stance on the day of delivery and that stance following the budget outcome - fiscal policy "ex post" can look very different to that "ex ante".
Take the 2001 budget. The Finance Minister projected a general budget surplus of €5 billion, against a background of an expected GDP figure of €116 billion, so the surplus was seen as the equivalent of 4.3 per cent of GDP, and, as such, marginally lower than the 2000 out-turn. In the event the budget surplus came in at only €2 billion, and the CSO puts 2001 GDP at €114 billion, so the result was a fiscal surplus equivalent to 1.7 per cent of GDP.
The net result was that the 2001 budget was less expansionary than originally planned because growth was less buoyant than originally projected.
Similarly in the 2002 budget with the Minister planning for a general Government surplus of more than €800 million, or 0.7 per cent of GDP, which at the time was interpreted as neutral in terms of the policy stance by the Department of Finance.
Again, though events have conspired to render this judgment premature, the Government now expects the 2002 balance to have shifted to a deficit, equivalent to 0.3 per cent of GDP, which is a bigger swing than warranted by the change to the Department's original GDP forecast, which was revised down only marginally (and perhaps in error). Consequently the 2002 budget now looks more expansionary than it did at the time.
Finally, Ireland's membership of the euro also influences the impact of budgetary policy by removing or at least dampening any feedback through the financial markets.
Prior to EMU, the currency market would be one barometer of investor reaction to the efforts of the Finance Minister, and punishment dished out to "bad" budgets via selling of the punt. This could in turn lead to higher interest rates, as the Central Bank waded in to protect the currency from further depreciation.
Similarly, holders of Government debt could influence the cost of servicing that debt, and hence future budgets, by either selling bonds or buying more.
The euro hasn't removed the latter risk but Irish debt is now a very small part of a much larger euro- denominated pool and, as such, the domestic budget has little or no influence on the cost of borrowing payable by the State.
Moreover, the euro will not be influenced by matters in Ireland, good, bad or indifferent, and the ECB will hardly take the fiscal position of a small peripheral economy into account when setting interest rates.
The stability pact is a constraint, of course, but not a relevant one for Ireland at present, so Mr McCreevy's only real constraint is his own political and economic judgment, with the electorate the final arbiter, as it should be.
Dr Dan McLaughlin is chief economist at Bank of Ireland
