Saturday 22 November 2014

Penny slowly dropping that austerity on its own won't work

Published 03/06/2014 | 02:30

Spain's Prime Minister Mariano Rajoy
Spain's Prime Minister Mariano Rajoy

Europe's leaders are in danger of copping on that austerity alone doesn't work. Spain's Prime Minister Mariano Rajoy has outlined a series of tax cuts, mostly to corporate tax, and a €6.3bn stimulus package, almost half of which will be paid by the private sector.

Italy's Matteo Renzi has argued tirelessly for a relaxation of the rules governing spending at the national level while giving a tax cut to low-income earners of €1,000 a year. Noises are now being made across Europe that a low growth, low inflation, high unemployment situation cannot be allowed to persist.

In Frankfurt the ECB is getting ready to buy up assets left, right and centre in order to push cash into the system to stimulate inflation. The threat of deflation is real now. When I wrote about it a few weeks ago, it was only a possibility and mooted as such. Not so now. If the ECB moves towards a negative interest rate and asset-buying programme, the ECB's asset buying programme should do a few things.

First, it makes banks' balance sheets look and feel a lot healthier–a bit like the L'Oreal hair ads, but with a less scientific explanation at the end – and this allows the banks to borrow more and quietly get rid of their non-performing assets at the same time.

Second, it does result in more lending to the real economy, which helps stimulate employment growth and real economic activity, as well as inflation. Third, the asset-buying programme certainly helps people who own stocks and bonds, as the value of these assets will boom up in line with the monetary stimulus. So for those privileged few across Europe who own stocks and bonds, it is happy days. The talk will turn to 'taper' very quickly, but after the US experience, we know what that will look like.

So: is austerity as a concept over? Can the new Labour leader, whoever he or she is, take over and promise an end to ever-increasing taxes, ever-dropping disposable incomes and stagnant service levels?

No they can't, and they should be very, very careful not to over-promise on the campaign trail in this regard. There be dragons that way, as previous Labour leaders have learned. It is not Frankfurt's way or Labour's way. It is just simply Frankfurt's way. End of. Ireland is still part of the Excessive Deficit Procedure. The latest ESRI quarterly commentary makes the point that the Government's finances are improving at a slightly faster than expected pace. This means we may hit the troika-mandated 3pc of national income deficit target without serious adjustments required in the forthcoming Budget simply by relying on existing forward momentum and the action of automatic stabilisers like drops in the need to pay out unemployment benefit and increases in the levels of tax the Government takes in.

In Budget 2014 the Government agreed about €0.9bn in revenue cuts and €1.6bn in expenditure cuts, but the composition of the 2015 adjustment of around €2bn hasn't been outlined yet. The imposition of the Excessive Deficit Procedure is pursuant to Article 104(6) of the Treaty establishing the European Community. In other words, the Irish authorities have little to no choice about whether to implement it or not. They can only hope the ESRI's rather optimistic forecasts turn out to be true. This is why Michael Noonan constantly hedges his bets, saying things like "If I have the money that is where I will go. I would like to reduce the threshold at which people hit the higher rate". The emphasis here is on the first part of the sentence. 'If' he has the money.

Last week at the University of Limerick we held a conference aimed at understanding the social, political, and economic aspects of austerity. The speakers were uniformly excellent, but one of the most important contributions came from a discussion held between the sessions. A very perceptive audience member noted the future of Europe and the European project would be decided through the fates of the large social democratic parties. Why? Because they put the European project together in the first place. To save the social democratic parties, Europe's leaders need to learn that austerity alone won't save Europe. Let's hope they learn before it is too late.

Stephen Kinsella is senior lecturer in Economics at the University of Limerick

Irish Independent

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