Low interest rates have helped the recovery
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.
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.