New Research Highlights the Varying Impact of Fiscal Policy on the Irish Economy

A Special Article, published today (Wednesday, 8th October) by the ESRI in its Quarterly Economic Commentary examines the impact of fiscal policy in an Irish context when it is evaluated at different stages of the economic cycle. The Article, Irish fiscal policy in good times and in bad: Its impact during different stages of the economic cycle, examined estimates from 1965-2012 and finds that the impact of fiscal policy on output can vary during the economic cycle. In particular, the Article shows that an increase in government consumption will raise economic activity when the economy is operating below its potential level. There does not appear to be any long-run benefit of fiscal policy to activity when the economy is operating above potential. Speaking about the Article, one of the authors, Professor Kieran McQuinn, said “Our results, which are in keeping with recent international research, indicate that fiscal policy measures can have a different impact on economic activity depending on where the economy is at vis-à-vis its long-run potential level. For example, the recent programme of fiscal consolidation, which was undertaken at a point when the economy was clearly below its potential level, may have had a larger-than-average contractionary impact on economic activity.” “Overall, therefore, the impact of fiscal policy at different stages of the economic cycle should be borne in mind when formulating budgetary policy.” The paper employs the well-established vector auto-regression (VAR) methodology to provide fiscal multiplier measures for Ireland, as well as to consider the effects of government consumption on unemployment. Besides providing estimates conducted over the full sample (1965 – 2012) using the standard VAR approach, a variant of that VAR methodology is also used to provide estimates of fiscal multipliers between different states of the economic cycle.