Posts Tagged ‘irish debt brake’

Bring the pain!!!

Some time ago I wrote an article on the ‘debt brake’ that Fine Gael have proposed. There I argued that the idea is complete madness. I’m now starting to think that this is the most dangerous policy that the new government is likely to try to implement.

Sure, Fine Gael are currently obsessed with deficit reduction, but I reckon this concern is going to disappear as reality sinks in. The economy will, as it were, naturally shrug off the constraints Fine Gael will try to impose on it – however, shrugging off a constitutional amendment that caps deficit-spending at a set level will be more difficult.

The Australian economist Bill Mitchell has an excellent article on his blog that deals with debt-brakes and other sorts of irresponsible neo-liberal hokum that he calls ‘fiscal rules’. So, let’s run through the major points of his article.

Mitchell is crystal clear about the results of governments imposing arbitrary fiscal rules upon their economies:

Fiscal rules can take lots of different shapes all of which entrench chronic unemployment and poverty.

In this he is in full agreement with the Financial Times’ Wolfgang Munchau, who, apropos of Angela Merkal’s fiscal insanity, writes:

[The new] constitutional law will produce a pro-cyclical fiscal policy with immediate effect.

By ‘pro-cyclical’ Munchau means that the ‘debt-brake’ will cause persistent recessions in the German economy – these recessions will then be self-reinforcing.

Alternatively, if growth begins to take-off as the deficit is being cut there could be an upswing in growth. Munchau sees both of these outcomes as dangerous:

Either of those scenarios, even the positive one, is going to be hugely damaging to the eurozone. In the first case, the German economy would become a structural basket case, and would drag down the rest of Europe for a generation. In the second case, economic and political tensions inside the eurozone are going to become unbearable.

So, why on earth are Germany instituting this law? Munchau puts it succinctly:

[It] cannot be economic, for there is no rule in economics to suggest that zero is the correct level of debt, which is what a balanced budget would effectively imply in the very long run. The optimal debt-to-GDP ratio might be lower for Germany than for some other countries, but it surely is not zero. While the balanced budget law is economically illiterate, it is also universally popular. Average Germans do not primarily regard debt in terms of its economic meaning, but as a moral issue … This general level of debt-aversion is bizarre. Many ordinary Germans regard debt as morally objectionable, even if it is put to proper use. They see the financial crisis primarily as a moral crisis of Anglo-Saxon capitalism. The balanced budget constitutional law is therefore not about economics. It is a moral crusade, and it is the last thing, Germany, the eurozone and the world need right now.

Sound familiar? Well, this is precisely what’s happening in Ireland right now. Our moral crusaders – the ever Christian Fine Gael – also seek to cut the ‘objectionable’ budget deficit and they’re getting plenty of support from their priestly neighbours in Germany. How strange people’s motivations often are – Munchau is right when he refers to the German policy as a ‘hair shirt’; this is pain for the sake of pain, pain that is seen by those in power as somehow morally cleansing.

Mitchell points to another recent Euroexample of attempts to impose fiscal straitjackets on sovereign states – the Stability and Growth Pact (SGP) that was hammered-out in the Maastricht Treaty in 1992. Mitchell points out that this was a resounding failure. He writes of what occurs when an economic downturn hits, automatically bringing economic fundamentals into conflict with the SGP madness:

A sharp negative demand shock which causes an economic downturn will reduce tax receipts and increase benefits, automatically increasing the deficit. Reducing government expenditures in that situation to meet the rule will worsen (prolong) the recession, which is then likely to involve the country in further SGP rule violations. The vicious circle of spending cuts implied is unsustainable and amounts to fiscal vandalism. In other words, fiscal policy becomes pro-cyclical under the SGP rule violating any sensible ambitions that are the ambit of responsible fiscal management. This is the major reason that France and Germany have refused to comply with the 3 per cent rule over the last several fiscal years (prior to 2008).

Yep, the French and Germans did precisely what any non-suicidal sovereign would do – they simply ignored the rules and ran a deficit anyway.

Mitchell even goes one further than Munchau. He sees the motivating factor behind the likes of debt-brakes and the SGP as a strongly ideological one:

We cannot help but have the impression that some politicians are not primarily concerned about the size of the budget deficit, but covet the 3 per cent rule as a welcome excuse to force their ideological predilection for small government. In other words, the ideological bias against public activity, particularly in the social security sphere, is dressed up as prudential economic management to give the crude religious zeal an air of authority and respectability.

Food for thought, perhaps.

Mitchell’s conclusions on the imposition of debt-brakes are stark:

Perhaps there will be a silver lining to this madness. It might be the last straw for the Eurozone which would force the countries to rethink the system and preferably provide some coherent currency sovereignty in line with the monetary arrangements – so kill the zone altogether or create a single fiscal unit.

I’m beginning to see the wisdom of this approach more and more, as the Eurocrats become increasingly insnae by the day. However, such a view doesn’t help me as I watch the men who will make up the next Irish government walk the country over the edge of a cliff.

And now, from an Australian economist to a group of very odd Australian musicians recording some very strange Australian rock music in the late 1970s…

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