Low in­ter­est rates have helped the re­cov­ery

The Irish Times - Business - - FRONT PAGE - John FitzGer­ald

The fi­nan­cial cri­sis of the last decade brought mis­ery to many and im­posed ma­jor costs on nearly ev­ery­one in Ire­land. For­tu­nately, the econ­omy has re­cov­ered well from that trauma, although some house­holds are still un­der wa­ter as a re­sult of their ac­cu­mu­lated debt.

Since 2012 we have seen a very vig­or­ous re­cov­ery and we may ap­proach full em­ploy­ment again in 2019. The eco­nomic turnaround, though painfully achieved, was faster than our re­cov­ery from the fis­cal cri­sis of the 1980s. This is partly due to the lessons from the 1980s, learned at huge cost, and also partly to the mon­e­tary pol­icy pur­sued by the Euro­pean Cen­tral Bank (ECB) over the past five years.

In the 1980s, a num­ber of mis­takes were made in deal­ing with the very se­vere cri­sis in the pub­lic fi­nances. Af­ter two very tough bud­gets in 1983 and 1984, the coali­tion govern­ment eased off too soon. This meant that a two fur­ther ex­cep­tion­ally dif­fi­cult bud­gets were needed in 1988 and 1989 be­fore the dragon of over­bor­row­ing was tamed. As a re­sult, the painful ad­just­ment was spread over most of that decade.

This time around, the nec­es­sary ad­just­ment was con­cen­trated into four years. Re­cov­ery is faster when tough medicine is taken quickly. It can also be less de­mor­al­is­ing for ev­ery­one than a pe­riod of dif­fi­cult bud­gets that seems to con­tinue in­def­i­nitely.

The man­age­ment of the na­tional debt was also much more ef­fec­tive this time around. While the need for a bailout by the EU and the In­ter­na­tional Mon­e­tary Fund was hu­mil­i­at­ing, the even­tual terms for the fund­ing they pro­vided were far bet­ter than ex­pe­ri­enced in the 1980s. In ad­di­tion, from early 2008, the Na­tional Trea­sury Man­age­ment Agency (NTMA) bor­rowed enough to build up very large re­serves of cash. This meant the State was in a stronger ne­go­ti­at­ing po­si­tion with the troika and it even­tu­ally smoothed the exit from the bailout.

No cush­ion

In the early 1980s, no such cush­ion was avail­able and the State found it­self at the mercy of the mar­kets for much of the decade.

As the fis­cal cri­sis con­tin­ued, the coali­tion govern­ment of the day bor­rowed a lot of money abroad in 1986 to rem­edy the State’s weak bar­gain­ing po­si­tion. They then used an ac­count­ing de­vice to “hide” the re­sult­ing cash abroad, while at the same time in­clud­ing the bor­row­ing in the na­tional debt. On pa­per, this made the State’s fi­nan­cial po­si­tion look even worse than it was – a higher debt with no off­set­ting cash bal­ances.

When the in­com­ing govern­ment took of­fice in 1987 and in­di­cated that it would deal with the legacy of the fis­cal cri­sis, it was then able to use the cash held abroad to avoid bor­row­ing for a sig­nif­i­cant pe­riod. When the mar­kets re­alised that the State’s fi­nan­cial po­si­tion was bet­ter than they ex­pected, in­ter­est rates fell. This helped ease some of the ef­fects of the ex­pen­di­ture cuts on the econ­omy.

Through­out most of the 1980s, the govern­ment met a sub­stan­tial pro­por­tion of its fund­ing needs by bor­row­ing at home in Ir­ish pounds. While this avoided any ex­change risk on the bor­row­ing, it came at a price. Over the 1980s, the in­ter­est rate on bor­row­ing in Ir­ish pounds was much higher than if the govern­ment had bor­rowed in dol­lars or deutschmarks.

Even al­low­ing for the de­pre­ci­a­tion of the ex­change rate over the pe­riod, bor­row­ing in Ir­ish pounds cost three to four per­cent­age points more than if the bor­row­ing had been in ei­ther of those for­eign cur­ren­cies. This added very

Re­cov­ery is faster when tough medicine is taken quickly. It can also be less de­mor­al­is­ing for ev­ery­one

sub­stan­tially to the in­ter­est bill on the in­flated na­tional debt that was the legacy of the 1980s cri­sis.

A ma­jor con­trast be­tween the af­ter­math of the 1980s and the af­ter­math of the 2007 crash is that lower in­ter­est rates to­day make fi­nanc­ing the re­sul­tant debt much more man­age­able. In 1990, in­ter­est pay­ments ac­counted for 8 per cent of na­tional in­come whereas to­day, with an even higher debt bur­den, they ac­count for only 3 per cent of na­tional in­come.

The legacy of high-in­ter­est debt meant that, in the early 1990s, even as some growth re­sumed, the govern­ment had limited re­sources avail­able to im­prove pub­lic ser­vices. This time around, the very low in­ter­est rate on long-term bor­row­ing has cer­tainly ben­e­fited in­debted gov­ern­ments, such as our own. It has also pro­vided a much more favourable en­vi­ron­ment for pri­vate in­vestors.

While the low long-term in­ter­est rates last, the NTMA is re­fi­nanc­ing the debt at long ma­tu­ri­ties. This should mean that, un­less we un­der­take a new bor­row­ing spree, the in­ter­est bur­den on the high na­tional debt will not be a se­ri­ous con­straint in the com­ing years.

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