The recent Ernst and Young report commissioned by the Department of Finance on the economic and budgetary impact of the proposed CCCTB is available here.
Author: Frank Barry
When a country finds itself overburdened with debt, the solution – if the debts are denominated in its own currency – is to inflate its way out of the problem. Debt is denominated in nominal terms so inflation reduces the real debt burden. Ireland cannot do this, but the ECB can. It would not do it for Ireland or Greece or Portugal alone but if Spain comes under attack, given its size relative to the European Financial Stability Facility, this option will be forced up the agenda.
What would inflating our way out of the debt entail? It can be seen as a type of orderly default. Assume for the sake of argument that the ECB is the owner of all Irish bank bonds; the Irish taxpayer currently owes these funds to the ECB. The ECB could accept a debt for equity swap, which would mean a substantial haircut, so that it – rather than the Irish taxpayer – now owns the banks. It recapitalises them by printing money and then sells them on. The downside is higher European inflation (it will have to take similar steps all across Europe because many banking debts are in fact to other banks, meaning that many will require recapitalisation) and a higher risk premium on all European debt. The risk premium could be moderated though by a pan-European regulatory system which would tackle one of the design flaws in the entire single-currency project.
The major design flaw was that there was no mechanism to tackle asymmetric (i.e. region-specific) shocks. The US has a huge federal budget which absorbs a major share of such shocks; e.g. if California goes into recession, it pays 25 cents less in federal taxes for each dollar its income drops, and it receives 10 cents more in federal funding. There is no such “fiscal federalism” in Europe (the nearest to it, the Structural Funds programmes, transfer about one cent for every dollar gap in income). Asymmetries prevail however, as is evident in that the business cycle in peripheral countries such as Ireland is out of sync with Germany and the core eurozone countries. This design flaw featured strongly in contributions made by Kevin O’Rourke, myself and others (all of us at the UCD School of Economics at the time) during the Irish national debate on whether to join the single currency. So Spain and Ireland got very much lower interest rates than were appropriate over their respective booms, which fuelled their property bubbles. The problem could have been reduced, though not eliminated, by tight pan-European regulation of the financial system.
These design flaws must be tackled in one way or another if the eurozone is not to stumble from crisis to crisis, though it is doubtful that there is the political will for substantial fiscal federalism. There is no painless way out of the current crisis, but inflating our way out of the debt and coming to grips with the design flaws look to me to be the least painful option.
I try to make these points in a politics programme recorded several days ago and due to be shown on RTE when the EU/IMF announcement is made. They’ll only use snippets so I’ve tried to join up the dots here.
The Irish Times also published my reaction to the recovery plan yesterday.
This is about the 1930s! UCD historian Mary E. Daly and I have just concluded a draft of our paper examining how the Great Depression was perceived in Ireland at the time. The paper is purely historical and makes no attempt to draw any parallels with the current situation. It might nevertheless be of interest to some readers. It is available here.
The literature on the Great Depression throws up some curious parallels and contrasts to today.
From Kindleberger (The World in Depression, 1929-1939, p. 194):
“In the electoral campaign, Roosevelt charged Hoover with total responsibility for the depression. It’s origin, he said, was entirely within the United States… Hoover, in reply, insisted that the depression had originated abroad.”
Also from Kindleberger, p. 139:
“The Unemployment Insurance Fund, being in deficit, had to be made up by the German government, which thereby suffered a budget deficit. The Socialist Party proposed raising contributions to the fund by a 4 per cent levy largely on government officials, whose contracts provided protection from unemployment.”
In Ireland, the first Fianna Fáil budget of 11 May 1932 included a tax amnesty for those with undeclared overseas accounts.
The settlement would enable them to resolve any outstanding liabilities by paying 75 per cent of the amount owed in outstanding taxes on foreign holdings from 1914 to the present, with no penalties or interest charges.
(Dáil Éireann – Volume 41 – 11 May, 1932 – In Committee on Finance. – Financial Resolutions—Minister’s Statement.)
Ronan Fanning’s book on the Department of Finance, pps. 233-4, reveals that the same government hoped to but failed to cut public service pay.
“This proved a difficult process and the reductions were widely resisted by public servants, including the senior civil servants that the government relied on to implement its policies – some , whose tenure predated the state were threatening to take early retirement under a clause in the 1921 Treaty. The proposed cuts were targeted at higher-paid public servants – including Government ministers. This dispute suggests a strong division of opinion, with the farming community very much in favour of cutting the cost of public services. One minority report to the report on this topic concluded that:
‘Even at the reduced rate there are many competent people who would gladly exchange places with public servants for the next ten years. The discontented State Servant would derive much benefit from a sojourn in the beet fields of Leinster, the cow pasture of the Kerry hills, or turf banks of the Bog of Allen for £1 a week’.”