Government spending ‘will not stimulate economy’ in 2011

THERE is no foreseeable way government spending can stimulate the economy’s fragile recovery next year, according to UniCredit economist Gillian Edgeworth.

She believes the economy has turned a corner and the recovery remains fragile. But she said the Government faces the task of not only passing a budget at huge political cost but also engineering a fiscal plan which does not erode the tentative recovery.

“There is no foreseeable outcome where fiscal policy supports the economy next year. But the Government hopes to present a budget which, via an improvement in credibility and confidence, lowers interest rates and offsets some of the downward pressure on economic activity from the fiscal contraction.

“The potential sources of savings are plentiful given the extent to which fiscal policy was expansionary in nature over recent years,” the London-based economist said.

Ms Edgeworth said it will be 2019 before gross public debt will fall below 90% again.

“This year gross public debt will finish the year at 98% of GDP,” she said.

“Assuming the Government is not forced to absorb further banking sector related costs and it adheres to its fiscal consolidation strategy set out in the 2010 Stability Programme, we estimate public debt will continue to rise to 104% of GDP by 2012 before declining to 90% of GDP by 2019.

“While representing a very significant increase over recent years, public debt will remain below the 110% of GDP forecast by the IMF for the G7 countries at the end of this year. The risks to this scenario are heavily weighted to the upside, however,” she added.

The UniCredit economist said that a delay to fiscal consolidation is not an option and would arguably prove counterproductive.

“It is also crucial to avoid a scenario whereby the fiscal contraction is so severe it backfires, ie, it translates into a further leg downwards in economic activity and government revenue, forcing the Government to put further measures forward,” she said.

Ms Edgeworth noted while the Government has ruled out an increase to the 12.5% corporate tax rate, tax increases in other areas seem unavoidable.

She noted Ireland’s tax burden, at 27.8%, of GDP is the lowest in the EMU, which has an average of 39.1%.

Ms Edgeworth said some non-trivial downside risks to Irish economic growth have also emerged over recent months.

“Ireland is unique within EMU in that its largest trading partners are the US and the UK.

“Recent euro gains are not helpful – 22% of merchandise exports are destined for the US, 16% for the UK,” she said.

She said that while there is some tentative evidence that unemployment is starting to bottom out, any ECB rate hikes next year will weigh on the consumer.