Why we must reject the idea of a debt jubilee
Our continued access to the bond market will depend on how credible our commitments are on future taxation and spending, writes Colm McCarthy
ACCORDING to the Old Testament, God advised Moses that rulers should arrange, once every 50 years, a debt jubilee, to include the freeing of prisoners and release for the enslaved, as well as the forgiveness of amounts owing to moneylenders. Since the Covid crisis has piled extra debt on overborrowed governments and businesses, a debt jubilee sounds just the ticket. The Irish Times columnist David McWilliams likes the idea: “This means repricing the entire debt structure of the economy, which is something the ECB has given central banks permission to do.”
Cutting the level of debt has the troublesome feature that debt owners think they own an asset and object if policy makes it shrink. The biggest owners are banks — moneylenders, as unpopular now as in biblical times. Their assets are loans, but their liabilities consist largely of the public’s money, so they cannot absorb a hit to asset values without defaulting on the public.
Government debt belongs to somebody too, including foreigners who might take a dim view. The traditional route to debt reduction, after wars for example, is a long period of financial repression, low interest rates combined with higher inflation, a slow screwing of creditors as the real burden of debt is reduced. This is most definitely not on the European Central Bank’s agenda.
Nor has it given central banks permission to “reprice the entire debt structure of the economy”, as David McWilliams imagines. National central banks are no more than local offices of the ECB when it comes to monetary policy and cannot pursue the options open to those which enjoy the prerogatives of an independent currency.
Ireland has not had an independent currency since 1999 and does not have a central bank in the traditional sense. The Irish Central Bank cannot finance the Irish Government, as central banks in the UK, Japan, the United States and many other countries are doing or plan to do. They are free to buy government debt in order to keep down debt service costs.
National central banks in the eurozone do not enjoy this freedom. The ECB in Frankfurt has been supporting the bond markets of the member countries and has expanded this activity in response to the Covid downturn. But its commitment has been constrained by the opposition of Austria, Germany, the Netherlands and others, to the disappointment of indebted countries felt to be in the firing line, notably Italy where bond yields need to be stabilised at an affordable level. The yield on the Italian 10-year bond is more than 2pc higher than the corresponding German version and could drift higher if ECB support is seen to be uncertain.
Last Tuesday week in Karlsruhe, the German constitutional court took aim at the activities of the ECB in supporting eurozone government bond markets. While not dealing explicitly with the ECB’s response to the pandemic, the judges ruled that the German constitution constrains the involvement of Germany’s central bank, the Bundesbank, in the ECB’s bond-buying activities.
This is politically explosive, since the court, the Bundesverfassungsgericht, appears to legal experts to have placed itself above the European Court in Luxembourg in the interpretation of European law.
It also appears to assert that the ECB bond purchase programme in place prior to the pandemic is in violation of the German constitution.
The Financial Times dubbed this “an act of judicial secession” and some commentators foresee an actual German exit from the common currency area.
The decision triggered another bout of nerves in the Italian bond market. What happens in Italy matters greatly to Ireland and to the other eurozone members with heavy debt burdens. Ireland’s access to bond markets looks secure for now and for as long as ECB support continues, but another bout of irresolution in Frankfurt would be damaging.
The conduct of domestic policy matters too — the markets accept that large budget deficits are inevitable everywhere but will begin to react if any of the indebted countries fail to deliver credible pathways back to budget balance.
Some of the policy discussion in Ireland in the last few weeks has proceeded as if no conditionality attaches to plans for taxation and spending. Austerity, we are told, has been banished from the political lexicon — the people apparently voted for ‘change’, which
has been taken to mean borrowing indefinitely.
That there has been no austerity (rising tax burdens and spending reductions) for five years is ignored, as is the reality that continued access to the bond market will be conditional on credible commitments to restore budget balance.
Instead there has been a procession of demands for the indefinite extension of emergency spending programmes, for new ones and for reductions in tax rates. Ibec, the main employers’ representative body, argued that: “A range of targeted stimulus measures should be provided as soon as containment measures are removed. These should include tax
changes to support employee voucher benefits, additional social welfare payments, grants to aid required social distancing investments and the reintroduction and expansion of the 9pc hospitality VAT rate.”
The case for stimulus in the face of a supply shock needs to be argued rather than asserted — the fall in activity has not arisen through demand deficiency but through governmental fiat, the compulsory shutdown of productive activity.
Ibec feels that €15bn of additional measures, running as far out as 2023, should be undertaken with no conditionality about the capacity of the State to borrow the money.
It is already clear that at least €20bn will have to be borrowed this year and that 2021 will see another big deficit even if things go well. The debt is sustainable only if the markets can see an end to deficits. There will be no grants from Europe and loans routed through European institutions are debt, not grants.
The Fianna Fail and Fine Gael parties have indicated, in their framework document for the coalition talks with the Greens, that they will not increase either income tax or the universal social charge. They have also committed to maintaining the basic rates of social welfare payments.
These are large commitments and there will be vociferous opposition to the withdrawal of the €350 per week payment for those whose unemployment is attributable to Covid-19.
There will be a budget five months hence and the opportunity should be taken to bolster government revenue for the longer term.
There are options that should prove attractive to the Greens, like a substantial hike in carbon tax and the elimination of the excise duty differential favouring diesel.