Keep an Eye on Ireland

It is worth paying attention to Ireland. It has become Paul Krugman’s poster child for why proponents of fiscal austerity are wrong…yet Ireland displays greenshoots of recovery.

Like much of the world, Ireland’s economy suffered mightily in the last several years. But Ireland’s government was already running large deficits, adding to a mounting pile of public debt and a sour outlook from the bond markets. The Keynesian prescription is to ignore the bond markets and boost spending to stimulate the economy. Since private spending dropped, they say government spending must make up that shortfall. Thanks to more government borrowing, people will spend and generate a recovery.

But Ireland did the opposite.  It enacted a program of aggressive fiscal austerity, slashing spending across the board, cutting public sector salaries by 15 percent, and suffering the short-term pain such measures inevitably produce. What has been the outcome since? Ireland’s economy returned to growth in the first quarter at 2.7 percent. The Irish Times reports:

The economic tide is slowly turning. For the first time in three years, there are now more reasons for hope than for despair… foundations of a jobs-generating recovery are falling into place.

But GMU economist Tyler Cowen urges caution:

Don’t get too giddy with optimism: the Irish economy had declined fifteen percent [since the crisis began].  Still, it’s far too early to judge the Irish experiment in pre-emptive fiscal austerity to be a failure.

Cowen points out that much of Ireland’s economic fate is outside its control. Ireland is a small nation, very much dependent upon economic conditions in the rest of the world. The advocates of Big Government spending won’t acknowledge that fact if Ireland’s economy sours.  If it does, pundits like Krugman will claim it’s evidence that the only solution is continued deficit spending.

If Ireland recovers, it could do much to bolster confidence in sound fiscal policy.