Ireland's Tough Decisions Create Fiscal Credibility

Ireland, like other European Union nations including Spain, Portugal, and Greece, risked losing the confidence of its creditors when it did not have a strategy to get its fiscal house in order after taking on massive debt to rescue its economy and financial system over the past few years. 

Last year, Ireland faced the same fiscal problems that Greece faces now (with the exception that Ireland was hurt by the formerly high flying housing market and “bad” banks).  Investors demanded a high risk premia and credit ratings agencies downgraded Ireland’s sovereign debt, based on rising fears that Ireland could not manage its fiscal accounts.  Investors worried that the country would have to turn to inflation to finance its debts.  Some thought in the worst case that Ireland might default on its debt and the cost of insuring against that default rose significantly.  But the Irish government acted. It developed tough budgets that included significant cuts to government spending and raising additional revenue.   

This wise action has not been without pain.  Government cuts have hurt public services and public servants and the government has faced high disapproval ratings (see Wall Street Journal, March 10, 2010).  But as the Wall Street Journal reported, there has also been an upside.   Despite still facing high deficits and debt, the cost of insuring against an Irish default has shrank and is much lower than the similar cost for Greek debt (Greece fails similar problems but has been slow to implement budgetary changes). 

The United States should follow the Irish example (and those of other countries who have undertaken fiscal turnarounds (see CRFB paper on fiscal turnaround success stories) Developing a credible plan to address a nation’s debt can assuage investors’ fears about default and fiscal policy.   The United States has the luxury and flexibility of avoiding the harsh and quick cuts that Ireland had to make and can wait until the economic recovery has firmly taken hold.  But to buy some breathing room that Ireland did not have (and that Greece may have lost), the United States must show its creditors that it is serious about stabilizing the federal debt over a reasonable timeframe.