Fiscal consolidation ‘could lead’ to lower-than-predicted economic growth

FISCAL consolidation is now the driving force in many economies and could result in lower than previously expected growth in the years ahead.

Concerns are growing that, with pressure on governments to get their fiscal policies into shape, budget constraints could undermine future growth potential, said Michael Crowley, economist, Bank of Ireland.

“Fiscal consolidation is now the name of the game in many countries,” he said.

The imposition of fiscal constraints is now “contributing to concerns about the growth outlook, with the UK the latest to join this particular party”, he said in the bank’s latest weekly commentary.

“The degree of fiscal tightening envisaged over the next couple of years — at 2% of GDP in terms of the reduction in the (cyclically adjusted) current budget deficit — is twice as large as previously planned under the old Labour government.”

That represents an “impressive headwind to economic growth” while the new Office for Budget Responsibility (OBR) has revised down its forecasts for GDP growth in 2010, marginally to 1.2% from 1.3%, and to 2.3% from 2.6% for next year.

BOE governor Mervyn King said, in the context of planned fiscal consolidation announced in the budget this week, a weaker outlook for economic growth could be met by an easing of monetary policy. That could be done by pumping money into the British economy (quantitative easing), given that interest rates are already close to zero, said King.

In the US, the Federal Reserve said on Wednesday signs of recovery are less obvious than it previously thought. It made its comments following the decision to keeping interest rates pegged at historic lows.

How to prime the global economy will be a key concern of the G20 member states meeting in Toronto.

Those concerns apart Crowley believes Ireland’s first quarter national accounts for 2010 “will snap an eight quarter negative streak and record small, but positive, quarterly GDP growth”.