ASSIGNMENT 4

CASE- Fiscal Policy and the Case of Expansionary

Fiscal Contraction in Ireland in the 1980s

Name- Jay Jhaveri

Roll No- BD21071

Case Background
The article discusses about two major policy approach which include a monetarist view
which focusses on monetary policy and a Keynesian view which focusses on fiscal policy
measures to revive an economy. The article states major differences between the two and
with a help of the example of Irish economy in the late 80’s it shows how adoption of a
particular approach helped Ireland get out of the economic and financial burden which it was
stuck in. Among the Fiscal policy view, there lies two different types of policy i.e
Expansionary fiscal policy and a Contractionary Fiscal Policy. The government of Ireland
adopted the Expansionary Fiscal policy to pull Ireland out of the shackles of a financial crisis
and clouds of fear which it faced over the last 10 years. The measures were introduced during
the budget announcement and some fundamental goals were set to revive the economy.

KEY ISSUES AND CHALLENGES

The following major issues were faced by the Irish government:

1. Income effect problems

In microeconomics, the income effect is the shift in demand for a commodity or service
produced by a shift in a consumer's purchasing power as a result of a shift in real income.
This can be due to an increase in salaries, for example, or because current income is freed
up due to a fall or increase in the price of a good on which money is spent.
Contractionary policy is a monetary metric that refers to either a reduction in government
spending—particularly deficit spending—or a drop in a central bank's rate of monetary
expansion. It's a macroeconomic tactic used to address rising inflation and other
economic distortions caused by central banks or government intervention.
Due to the adoption of fiscal contractionary policies, the government spending reduced
due to which the products produce by various class of societies were not consumed and
this led to a reduction in the disposable income of the population which in turn reduced
the purchasing power. In the initial years, there was no increase in wages of people
 working in factories and industries. For the year 1981 and 1982, there were negative wage
increase which referred to a decrease in wages compared to the previous years. It
stabilized after a few years but the increase was not enough in comparison to the inflation
in the economy.

Unemployment
One of the major problems that the Irish government could not solve was the problem of
unemployment in the economy. Unemployment refers to the that class of people who are
willing to work, have the required qualifications and the will to work but are still not able
to find employment. The rate of unemployment is found by dividing the total number of
unemployed people by the total workforce available in the country. The below table
shows the rate of Unemployment in the country.
Exhibit 11 Unemployment

Thousand As % of Labor Force1

s
1980 101.5 8.1
1981 127.9 10.1
1982 156.6 12.1
1983 192.7 14.7
1984 214.2 16.4
1985 230.6 17.7
1986 236.4 18.1
1987 247.3 18.8
1988 241.4 18.4
1989 231.6 17.9
1990 Q1 223.9 17.2
Q2 222.5 17.1
Q3 225.6 17.3
Q4 226.9 17.4
1990 224.7 17.2
Average
1991 Q1 237.5 18.2
Q2 251.5 19.3

It can be clearly seen from the table that the rate of unemployment increased constantly.
Some of the major reasons were Government’s aim to reduce the spending i.e., spending
on public welfare services and development of infrastructure. In an ideal scenario when
the government wants to curb the unemployment rate, it start spending on the economy
welfare and thus creating jobs in the area of infrastructure and various other schemes. In
order to bring down the deficit it focused too much on cutting the expenses and thus could
not create enough employment opportunities which resulted in an unemployment rate
increase from 8 % to nearly 19%. The Government was successful in achieving its other
targets of reducing national borrowings, debt and Narrowing deficit but amidst the
process, it could not control the rate of unemployment in the country.
 ANALYSIS OF IRISH ECONOMY

Ireland’s economy was hit by various factors such as high inflation, increasing
unemployment, high inudtsry costs. Up until 1986 the country suffered from a current
account deficit, there was a constant increase in unemployment rates where the rates climbed
from around 8% to 19% by the end of 1990. The country also had high foreign borrowing
which led to a slow growth of economy as the government was not able to repay the loans
that it took from the neighboring countries.
The incompetency of the government was seen as the effect on the economy. Fortunately for
the country of Ireland, there was a change in the government. The Fianna fail party was
successful in gaining the power in the economy after a major devaluation in the currency of
Irish pound against the German mark. The Irish pound had been devalued against the UK
pound too in order to restore the competitiveness of the trading partner.
The first task that the new government had to take up was the task of creating a new budget.
A budget had to be formed in such a way that it would tackle the issues that Ireland was
facing from over a decade. When the budget was announced, it was perceived by the people
to be a very harsh budget and a budget which would not prove to do a lot of good to the
people of the country. On the flip side, it was done to control Government expenditures,
reduced deficit and come out of the financial crisis black clouds which were hovering over
Irish Economy.
The three fundamental principles of the budget were:

 Public finance targets had to be consistent with good management of the economy.
 Borrowing and the servicing of national debt were to be significantly reduced.
 Particular focus was to be placed on productive economic activity and employment
growth

The Government tried and focused on implementing the budget based on the abive three
principles but was able to implement only two of them but they were able to successfully
implement the targets and achieve them. The major achievements of the budget and the fiscal
policy which it adopted were:
1. The 1987 Exchequer (finance ministry) borrowing requirement was targeted at 1.85
billion Irish pounds (IEP), or 10.7% of GNP. This was a significant reduction from
the 1986 borrowing requirement target of IEP 2.15 billion, or 13% of GNP. but the
actual borrowing requirement came in IEP 72 million below target due to lower-than-
expected spending.

2. The current budget deficit target was reduced from 8.5% of GNP to 6.9% of
GNP, representing IEP 1.2 billion
The current budget deficit came in IEP 20 million below target due to increased
savings on expenditure.
Another major issue that the administration intended to address was wage growth. In 1988,
the Programme for National Recovery began indexing social aid and government pay to
inflation. Weekly earnings gains in the industrial sector declined from 4.9 percent in 1987 to
4.3 percent in 1988. What's more, salaries in Ireland's main trading partners were rising at a
significantly faster rate. Moderate wage growth, along with Ireland's favorable exchange rate,
was predicted to have resulted in a 3% increase in cost competitiveness over the UK.
The goal of monetary policy was to keep the Irish pound strong while also maintaining its
stability. Markets began to believe that the Fianna Fail administration would not release an
expansionary inflationary event in the future after the austere 1987 budget. Between March
and December 1987, this expectation resulted in improved confidence and a 5% decline in
interest rates. Inflation in the consumer price index fell to 3.2 percent, the lowest level since
the 1960s. Interest rates fell another percentage point in 1988, despite a less favourable
worldwide climate. Irish retail rates were 6 percentage points lower than those in the UK by
the second half of 1988.
In 1988, private consumption surged by almost 3% as families reduced their savings ratio.
Similarly, investment increased by 10% in 1989 after picking up in the second part of 1988.
A boom in the housing sector, in particular, fueled growth, with planning permission for
construction projects growing by 20% in 1989. Public consumption, on the other hand,
decreased by 10% between 1986 and 1989. Domestic demand and investment more than
compensated for the decline in public consumption and investment, increasing the demand
for private sector jobs.
The government's achievement in meeting its aggressive national debt and public finance
targets was aided by this upbeat economic climate, which not only boosted GDP. Debt
payment costs were lowered due to the lower interest rate. Similarly, as the private sector
sought more labour to meet increased domestic demand and investment, social welfare
payments were lowered. Indirect taxes also benefited from the strengthening economy in
terms of revenue. A widening of the tax base and an increase in high-priced items, for
example, enhanced VAT (value-added tax).