Irish response to crisis will make economy stall

Senior economist accuses government of trying to 'sloganeer' the country back to life

Ireland's most high-profile economist has claimed the country's response to its financial crisis is "like watching a slow car crash".

The economy contracted in the second quarter while a bond auction on Tuesday revealed how expensive the country's runaway deficit has become. Ireland's Central Statistics Office said GDP had dropped by 1.2 per cent between April and June.

The news added weight to the growing clamour within Ireland for the government to stop its harsh fiscal tightening measures and focus on increasing liquidity and stimulating the flagging economy.

Economist David McWilliams, who is credited with being the first to predict Ireland's financial problems, said: "For me as an Irish citizen, this is like watching a slow car crash. The more they cut, the more the economy will continue to stagnate. The Irish government seems to think they can emote the economy to life by sloganeering, but people who don't understand economics have taken over."

Pressure piled up further last Tuesday when the Irish government borrowed nearly $2bn, but at an interest rate more than 4 percentage points dearer than German treasury bonds – Europe's benchmark. This is the highest "risk premium" since the euro was introduced in 1999. It shows how high international investors consider the risk of an Irish sovereign default because of the government's inability to detail the full cost of its banking bail-out, which could be as much as €50bn.

"The Irish government is using the bond markets as a financial skip into which it wants to put all the financial sins of the politicians. But the bond markets are saying either you can have your banking bail out or your welfare state – you choose."

However, Ireland is being applauded internationally for its efforts to rebalance its public finances and reduce its borrowing, currently at €100bn, to 3 per cent of its GDP by 2014.

Jim Power, an economist at Friends First, said Ireland now had a 4 per cent annual cost of funding its debt. "Raising €1.5bn when you owe a total of €100bn is a drop in the ocean," he said. "If this sort of bond yield persists, a lot of Irish debt as it matures is going to have to be refinanced as this higher rate and will be a real burden on the economy."

Ireland is not facing a "double dip" because it has never emerged from recession, he said. Its first quarter 2.2 per cent growth was an abberation, driven by activity in the multinational sectors. As people raise their savings level and exports slow, the shocking drop in GDP in the second quarter could continue.

"There is considerable fiscal pain for Ireland for the foreseeable future," said Mr Power. "We have to be extremely mindful of what the international bond markets are telling us. Ireland has been spending too much and taking in too little taxes and we have to rebalance the public finances."