Thursday, November 25, 2010

Ireland bites the bullet

The Irish government has announced big spending cuts and increased taxes to trim (sorry - slash) the budget deficit to 3% of GDP by 2014. The deficit is projected to be 12% of GDP this year, or 32% if you include the bank bailout. Measures include welfare cuts of 2.8 billion euros and 1.9 billion euros in income tax increases, an increase in sales taxes, a 10% pay reduction for new entrants to the state workforce and a decrease in the minimum wage. the underlying macro-economic forecasts include average GDP growth of 2.7% per annum over the next four years. That sounds a tad optimistic.

The GFC and its aftermath was largely about bringing living standards back within incomes. This has been playing out in households around the developed world as households reduce consumption and focus on retiring debt. Governments need to do the same thing. As we said at the time of the launch of the European Financial Stability Mechhanism in May, the EFSM was not a solution to the problem, but allowed some time to Governments to get there act together and reveal credible plans for medium-term fiscal consolidation. This would inevitably be politcally fraught, as the Irish government is finding out. Other Government's, and not just in Europe, need to similarly bite the bullet before bond markets seek more urgent gratification.