Professor John McHale:

We have looked at the Nevin institute's most recent report, which is a useful contribution to the debate. The headline is that it is recommending a €2.7 billion adjustment for 2013 instead of the €3.5 billion adjustment. There are many valuable recommendations in the report but I am not convinced by its particular proposal or the reasons it gives for it. One aspect is that it does not grapple with what is central to our report, namely, the basic trade-off between supporting the economy in the present and dealing with debt sustainability. That is missing from its report.

In terms of this €2.7 billion adjustment for 2013, it believes that the programme target, which is a general Government deficit of 7.5% of GDP, can still be met with the smaller adjustment, that is, the €2.7 billion instead of the €3.5 billion. The argument it makes is that we can have this different composition of the adjustment, as the Deputy said, that will be less damaging to the economy. It picks out particular multipliers for specific areas that makes that true in the sense that it assumes the damage done to the economy by tax increases are quite small and that the damage done by reduced capital spending is quite large, and it draws on some evidence to support the multipliers it uses.

However, there is no agreement in the economic literature on the relative size of these multipliers. The larger share of the evidence goes in the opposite direction where tax-based adjustments, that is, adjustments based on tax increases, probably do more short-term damage to the economy but those findings have been disputed. We have looked closely at that literature and we did not believe we had a basis for distinguishing between different types of adjustments in terms of their effects on the economy based on the existing state of knowledge. There is a somewhat selective use of the literature that ultimately produces this result that one could hit the 7.5% target with a smaller adjustment that is heavily weighted towards tax increases with minor expenditure changes, but it is a useful contribution to the debate in that it brings these important issues to light.

In terms of stopping payment on the promissory notes or other forms of default, at this stage we have to recognise that, rightly or wrongly, the senior bondholders in the banks have been almost completely paid off at this stage. To default on the promissory notes, therefore, essentially would be to default on the Central Bank of Ireland and, ultimately, on the euro system. It is important to note who we are defaulting on if we make that decision.

There is a huge amount of literature on the costs of default. The early part of the literature focused very much on the damage it would do to our reputation and, ultimately, our ability to borrow in the future. The empirical evidence does not support that strongly. Countries often make a surprisingly rapid return to markets after defaulting, and without apparently huge penalties in terms of the interest rates they pay in the future. There are some exceptions to that but as a general tendency what the literature has found is that the faults tend to be incredibly disruptive to the economy and are associated with often much deeper recessions.

There is also a lot of evidence that shows substantial reputational spillovers as a result of default which could be particularly important in the Irish case since it is so dependent on foreign direct investment. To the extent that it undermines confidence in the stability of Ireland's business environment for investment, those reputational costs could be severe. Based on this international evidence, default is something that should be avoided and strong commitments made to avoid default, which brings us back to the need to achieve debt sustainability so that we are not forced into a situation of default, but behind all that and the need to restore the creditworthiness of the State is the need to avoid the consequences of losing it in addition to losing official support as well.