Tuesday 18 June 2019

Brendan Keenan: Rainy day fund not the best way to combat fiscal storm

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Brendan Keenan

Brendan Keenan

Guess what was the headline on the new IMF report on global debt? 'Saving for a Rainy Day', that's what. Former minister for finance Michael Noonan might be tickled by the similarity to his 'rainy day fund', but I'm not so sure as to the wisdom of such a description.

Modest man that he is, Mr Noonan might point out that the phrase is actually in the dictionary. One definition goes: "A rainy day fund is a reserved amount of money to be used in times when regular income is disrupted or decreased in order for typical operations to continue."

The central argument advanced for such funds is that they enable a government to maintain spending and taxation levels when the economy is performing below par, so as not to make the situation worse by having to cut spending and raise taxes.

Such 'counter-cyclical' policies tend to elude governments - particularly Irish ones. But, as the IMF says, at present they are eluding most governments in the rich world. Their total debt, at more than over 100pc of their GDP, is 12 percentage points higher than at the peak of the credit bubble in 2009, and falling only slowly.

One reason is that GDP growth itself has been anaemic - especially in Europe and Japan - and debt is a measured relative to GDP. The eurozone is finally in recovery but it may not escape the long-term trend, covering decades, which shows growth per capita in advanced economies declining to less than 2pc a year.

That is one reason why governments borrowed more; to meet demands for rising living standards and requirements for public spending which are growing faster than national income. The scope for more borrowing such as that may have reached some kind of limit, which could help explain political discontent in the developed democracies. It certainly makes it difficult to actually reduce the debt ratio from those high levels - and there is more to come. The IMF calculates the implicit debt required to cover the future costs of pensions and healthcare. It pretty much doubles the present day debt figure - in Ireland's case to 140pc of GDP.

Yes, the curse of Irish GDP bedevils the IMF report. This is the same publication which found that Apple phones accounted for a quarter of Ireland's economic growth last year. They really will have to find a clearer way around these absurdities in their presentations.

One difficulty when it comes to things like rainy day funds, is that no one seems to know how to what extent debt matters. Former US vice-president Dick Cheney is back in the news with his assertion that "deficits don't matter". US President Donald Trump, the Republican party and, increasingly, the Democrats, seem to agree. And who is to gainsay them?

The recriminations about the failure of economics to predict the crash has moved on to debate about why it failed. Among the conclusions is that there was - and still is - no satisfactory model of the relationships between the financial system and levels of public and private debt.

Where models are missing - sometimes even where they are not - history may be a better guide. It certainly was when it came to the crash. In this centenary year of 1918, it seems strange to note that the World War I was fought with government debt of the participants averaging just 80pc of GDP, although that was double the pre-war level.

It was very different with World War II, but the post-war recovery brought the debt ratio back to 1912 levels of 40pc. Then, based on models which said wise government borrowing would pay for itself, debt rose steadily from the 1970s and to its present unprecedented peacetime levels.

We have been in completely unprecedented times for the last 10 years, with interest rates close to zero. Not any more though. The recent rise to 3pc in the rate on 10-year US debt brings us back to what would have been regarded as normality before the crash.

We may soon find out whether debt matters. Although the Fed wants higher rates, it does not set long-term ones itself. That requires the market to agree that 3pc is the going rate. If it sticks to that, it changes the debt question dramatically.

Ireland's National Treasury Management Agency must replace old loans equivalent to a quarter of national income in the three years 2018-2020. The agency has made the most of very low interest rates by swapping more expensive debt and building up cash reserves. There is no reason to think there will be any difficulty with borrowing requirement, but the era of very cheap debt may well be over by the time the new decade comes around.

As rates increase, something which needs no fancy modelling - the primary budget balance - comes more strongly into view. This is the balance before interest costs so, of itself, it will not be affected by rising rates. But its size determines how quickly the total balance would move into deficit, faced with a rise in borrowing costs.

A surplus in the primary balance is a government's real rainy day fund. Ireland has one, at 2.5pc of national income, but that it is about the minimum required for such an indebted country and there has been no improvement in the past five years.

In the IMF report, Ireland is one of only five advanced economies where the balance worsened in 2017. This in a country where the economy is almost certainly still in recovery phase and growth has been higher than is likely to be the case in future years. The Fiscal Council sees no marked improvement before 2021. In Irish budgetary planning, marked improvements are always three years away. None of this is captured in the phrase 'rainy day fund', even if there was money in the fund, which there isn't yet.

Putting €500m into it, as is supposed to happen next year, would add to the primary balance, but it is not at all the same thing politically. The primary balance is a permanent feature. What is the target for how big should it be when the economy is growing strongly? How much should it be allowed to fall when it is not?

There is no clearly enunciated strategy, for this or any other fiscal measure. Instead, a chunk of the surplus will be identified as the rainy day fund, on the basis that it will be easier to sell to the public. But that is only because of the implicit suggestion that it is there to be spent someday.

Not so implicit either. Why wait for rain, say the opposition, when there are so many worthwhile causes? Even the government seems to think that 'investing' the fund now in supposedly productive assets is okay.

That is the old Gordon Brown golden rule, which turned out to be brass, as in neck.

Most of the present capital budget is not for even notionally self-financing investment but is required for the replacement and maintenance of assets. More will have to be spent, but capital projects which make a net contribution to growth are difficult to identify - especially if no serious attempt to do so is made.

Whether done well or badly, capital spending still has to come from existing resources; a fact which cannot be magicked away with talk of rainy day funds.

That's more a case of the political system making hay while the sun shines.

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