March 8, 2009
Who will take the blame for the Great Depression of 2010?Posted in Irish Economy · 386 comments ·
Is raising taxes the best thing to do in a crisis? What economic theory tells us that, in the face of a meltdown in the economy, the best thing to do is to reduce expenditure and raise taxes? There is none. The lunatics have taken over the asylum.
Making one drastic policy mistake in fuelling the boom with cheap money and tax cuts was bad enough, but making a second one, cutting expenditure and raising taxes in the bust, would be inexcusable.
I am now about to do an unfashionable thing, I am going to make the case for dramatic income tax cuts, offset by property taxes and an expansion of moribund monetary policy through mass debt deferral.
We shouldn’t worry our heads about the implications of this idea, because, if we believe in the logic of monetary union and the irrevocable nature of the euro exchange rate, we should not be too concerned about how big the budget deficit is, or our ability to finance it – because it will be financed.
In addition, if we believe (as I do) in the Irish people, in the long-term economic implication of our demography, in our ability to attract investment based on our workforce and in our ability to create our own companies, these tax cuts will become self-financing.
Granted, these are big ifs. However, we are now following a nihilistic policy which will turn our recession into a depression and will yield us absolutely no economic benefit, either now or in the future.
The consequences of today’s Herbert Hoover approach to the economy will be exactly what happened in the US at the beginning of the 1930s,where a bad situation is made worse by policy mistakes. The Irish depression of 2010 is going to be entirely man-made. Don’t forget this when it comes to apportioning blame.
Here’s the deal. With a few notable and well-known exceptions, the consensus economists who talked about how the housing boom would plateau and achieve a ‘‘soft landing’’ are the same people who are now suggesting that Ireland should deflate its way to growth. They are aided and abetted by mandarins at the Department of Finance who have got all of their forecasts wrong. Why are we still listening to these discredited people? They know nothing!
Let’s call these people ‘the fundamentalists’, because they were -and still are -constantly invoking ‘the fundamentals’. In the boom, they told us the fundamentals were strong. Today, in the bust, they are telling us the fundamentals are weak. Now, that’s enlightening.
The fundamentalists argue that, if we don’t cut now, our budgetary situation will spin out of control and we will end up in default. They are saying this while, at the same time, being faithful supporters of the euro. These are the articles of faith for the fundamentalists -balanced budgets and a strong currency.
But when you think about it, you shouldn’t be supporters of a currency union and agitators for budgetary austerity simultaneously, because at the core of your position is a misunderstanding of how and why the world works as it does.
In defence of their position, they will talk about concepts such as ‘‘market confidence’’ or ‘‘financial credibility’’. But these platitudes mean nothing. This market is finished. It is over. Bank of Ireland is trading at 12 cent (as this column told you it would right after the recapitalisation. In fact, our early February forecast of nationalisation by Easter still looks like a fair bet). We need to understand that nothing we do now in Ireland will turn the taps on.
There is no mythical pent-up flood of money waiting to rush into Ireland once we’ve shown that we can hit some budget target or other. Show me a country that has benefited from this argument in the past 12 months. They don’t exist. In fact, the country that has seen its government paper being sucked up in trillions is the US, which is running the most expansionary budget deficit in decades.
The core of the problem is that the fundamentalists are using the economic logic of a free-floating currency to argue the budgetary policy in a country with no currency risk at all. No mistake could be more straightforward and no misunderstanding more wrong.
Sure, if we had our own currency we would have to keep our budget deficit in check, otherwise there would be a run on our currency. If we chose to defend a certain exchange rate, we’d need to raise interest rates dramatically. This monetary contraction would reinforce the economic crisis, tax revenue would fall and rates would have to go higher.
But none of this will happen in the euro. The euro allows us to analyse without concerning ourselves with the trivialities of the foreign exchange markets. The euro allows us to think clearly (which is one of its modest advantages for us).
We now need to be radical. We need to cut income taxes, raise property taxes, cut all tax incentives to property and use the money saved to give grants to companies that are employing people. We need to accelerate the new euro-wide bond initiative and use it to borrow heavily.
We should stop getting het up about the budget numbers, because whatever we do now, I can guarantee our forecasts will be wrong.
We also need to introduce debt deferral for hundreds of thousands of mortgage owners who are in negative equity, and use this debt relief as traditional monetary policy. Debt deferral gives hope and – most importantly -i t injects liquidity directly into people’s pockets. The recapitalisation needs to be revisited and a huge distressed bank bond of maybe â‚¬40 billion needs to be raised to cover the losses in the banking system.
Every infrastructural investment that would make us more productive in the future should be fast-tracked, not abandoned. We should also raise the money internally, as well as externally. Ireland has close to â‚¬300 billion in deposits. We have loads of money. Let’s just raise a national recovery bond and invite our pension funds to participate. We could make it much more tax efficient to invest in the recovery bond than foreign equity.
There are always ways and means. This is all so simple. If our debt/GDP ratio rises to 100 per cent, so what? Most of it will be our cash anyway, and what is the sanction under a monetary union? In the euro, this is only a figure and, as the economy recovers -which it will – this figure will plummet. Implicit in this approach is a cull of many of the senior civil servants who are now acting as inhibitors, rather than facilitators of, change.
Such radicalism is the only way that jobs will be saved and our country can be stabilised. If we follow the current policy of the fundamentalists, we will end up where fundamentalism of every sort always leads -up a blind ally where the world is seen, not as it is, but as they would like it to be.
The world has changed, maybe irrevocably, and we have to change with it. This crisis presents us with the greatest opportunity in decades to shake up this country. Let’s hope we seize it.