This time is different as euro zone battles slump

Blame game by more frugal states, which poisoned the atmosphere in the late 2000s, is not likely this time around

Europe is facing a very difficult winter as a result of the war in Ukraine, with the resulting very high inflation and the added possibility of a shortage of gas. While Ireland may be less affected than many other European Union countries, nonetheless it will pose a major challenge for households, companies and the Government here.

European growth will slow rapidly and, if gas supplies from Russia are cut off, there will be a recession in Germany and elsewhere. However, this potential economic shock would be different from the financial crisis of a decade ago. Although all countries are more indebted following the pandemic than they were in 2019, this debt is much more sustainable than that accumulated in the 2008-2012 period.

Most governments, including Ireland’s, have borrowed long term at fixed rates, locking in the very low interest rates of the last five years. Thus, if EU governments do not borrow a lot more money, the limited amount of debt that needs to be rolled over in the next few years at higher interest rates will be eminently manageable. The one exception is the UK, where more than 30 per cent of its national debt has interest rates linked to inflation. As a consequence of rapidly rising price levels, their interest payments next year will be a serious burden.

The high rate of inflation means that nominal incomes are rising and will continue to grow next year. The Central Bank forecasts that, in Ireland, wage rates next year will rise by more than 6 per cent. As we have seen this year, higher nominal wages bring increases in tax revenue. The burden of debt relative to income is set to fall as a result.


The Central Bank estimates that our government debt will fall from 93 per cent of national income this year to 84 per cent in 2023. Inflation is likewise set to reduce the real debt burden across the EU, even in highly indebted countries such as Greece.

Effectively inflation acts as a tax on savers but it is good for borrowers on fixed interest rates.

When we borrowed to buy our home in the early 1970s, the repayments initially represented a substantial share of our after-tax income, with interest rates far higher than today’s levels. However, after six years of rapid inflation, the burden of our mortgage had fallen dramatically. So too, a period of high inflation today will substantially ease the burden of repayments, even at higher interest rates, as mortgage payments will decline as a share of household income.

The main risk for those lucky enough to own their home today would be if a European-wide recession triggered job losses here. If that occurs, people who lose their jobs, especially those with bigger loans, would run into mortgage difficulties, as happened in 2008-2012.

The impact of inflation on those depending on the rental market will vary between those in reasonably secure tenancies and those seeking accommodation.

For people looking for a place to rent, things will remain very difficult. Not only are rents for new lettings rising a lot more quickly than for those in established tenancies, but high interest rates will inhibit investment and choke off sources of new apartment supply, where institutional investors have been heavily involved. A lot of the money flowing into new apartments was driven by the low rates of return on other investments. With rising interest rates, some of this money may go elsewhere seeking higher returns, reducing the pipeline of new apartments.

Until now, the action of the European Central Bank (ECB) in buying government debt has been crucial in keeping interest rates low for governments across the euro zone, including heavily-indebted Greece and Italy. However, in recent months, as the ECB has moved to stop its purchase of government debt, those heavily-indebted countries have seen interest rates rise more rapidly than in, for instance, Germany. The ECB has indicated that, if this were to continue, it would take action to limit the gap in borrowing costs.

This is different from the approach during the post-2008 financial crisis. Firstly, and probably most important, the current economic shock is impacting all euro-zone economies, not just the most indebted. In fact, if gas supplies run short, Germany may be worst affected.

Thus the blame game by more frugal states, which poisoned the atmosphere in the late 2000s, is not likely this time around. Secondly, the heavily-indebted countries are in less trouble this time around, with stable public finances and their debt burden reducing through inflation. Finally, the ECB itself is wiser than a decade ago.