Friday 22 November 2019

Future inflation rates vital element for prom note deal

IT is far too early to say whether the Government's complex deal on the promissory note makes sense.

There are many reasons to withhold judgement but the most obvious reason is that we don't know what is going to happen to inflation over the next few decades.

Finance Minister Michael Noonan made it clear last week that he expects inflation to effectively cancel out the cost of the borrowing.

Mr Noonan, who is fond of using examples from his own life to justify government policy, said he bought a house for around £3,000 when he was a young teacher and noted that 30 years later when the mortgage finished, a single month's wages could have paid for the house.

It was a good story that tells us a lot about why the baby boomer generation are so happy with their lot but it tells us little about what will happen over the next few decades.

Inflation and interest rates were running at double digits for most of Mr Noonan's working life and dominated economic thinking but there is no reason to assume this will continue.

Historically, there have been three great periods of inflation. The Black Death, the Elizabethan period when Europe was swamped by gold from the Americas and the period after World War I.

There have been very long periods without any real inflation at all. The British army paid the same for a horse on the eve of World War I as it did during the Napoleonic wars despite all the changes seen during the Victorian era.

There had been every reason to hope that good work done by Margaret Thatcher, Ronald Reagan and Bill Clinton had laid the foundations for a long period of low inflation.

With inflation close to 5pc in Britain last year, it has been obvious for sometime that some governments have no intention of taming inflation much longer. Last week's deal makes it quite clear that Irish government policy (like the policy of most heavily indebted countries) is pro-inflation.

Before we signed up to the single currency, an inflation-loving government would have inevitably led to inflation. Today, when monetary policy is dictated by the European Central Bank, we just don't know what is going to happen.

The Germans, Italians and other countries with elderly populations on fixed incomes will be prepared to do everything they can do prevent inflation poisoning their economies.

Mr Noonan and his team have done an excellent job in fighting Ireland's corner and persuading the ECB to ignore its own mandate.

The deal is a diplomatic triumph but whether it makes sense financially depends to a large degree on whether you subscribe to Mr Noonan's belief that we entering another period of sustained inflation.

That remains unlikely as long as the ECB is dominated by monetary hawks.

Irish Independent

Also in Business