Covid-19: Why heavy borrowing is different now than during the crash

John FitzGerald: Borrowing is an appropriate response to pandemic for several reasons

Much of the new debt being issued by the Government will end up being bought by the ECB. File photograph: Yara Nardi/Reuters

Much of the new debt being issued by the Government will end up being bought by the ECB. File photograph: Yara Nardi/Reuters

 

In the current crisis, most economists have recommended that governments should borrow heavily to support their economies. This does not reflect a change of heart from the crisis a decade ago: rather, it is a recognition that the circumstances this time around are very different from 2009 and 2010.

Between 2007 and 2013 the national debt rose by more than €130 billion, just in excess of one-third of it to bail out the banks, and the rest to fund everyday services. By contrast, current expectations are that the Government will end up borrowing something more than €30 billion in the current crisis. Thus, provided that the EU economy recovers as expected, the funding requirement of the Irish Government is much smaller than the last time, making borrowing feasible without endangering the long-term financial stability of the State.

Thanks to the action of the ECB, a second difference from a decade ago is that interest rates are exceptionally low, whereas for the State in 2010 they were prohibitive. Thus, while the substantial borrowing today will be a charge on future generations, it will not be a very heavy charge.

The third reason for borrowing is that, while the Government is borrowing 10 per cent or more of national income this year, the household sector is saving at almost the same rate because it cannot get out to spend its income. The collapse in consumption and investment will mean that the economy will be producing well below its capacity and a stimulus to make use of that unused capacity makes sense. The problem this year is that the stimulus is, of necessity, being saved by households and only when we get nearer to pre-Covid-19 normality will that stimulus have its full effect.

Firm foundations

The fourth reason why borrowing is appropriate to deal with the crisis is that growth in the economy up to March was built on firm foundations: the State was running a significant surplus on the current account of the balance of payments. By contrast, in 2007 the State was already borrowing heavily abroad to fund an unsustainable level of investment.

Much of the new debt being issued by the Government will end up being bought by the ECB. The household sector, who are the beneficiaries of the debt-financed income support, will leave a lot of this income on deposit in banks and they, in turn, will lodge it back in the ECB. This circular transaction means that, after the crisis is over, the State’s net indebtedness will not have changed much. Indirectly, with the help of the ECB, the Government is borrowing from the people of Ireland.

This pattern is being repeated over much of the EU, with more generous stimulus packages the norm in northern countries and more limited supports in some southern countries, reflecting their more constrained public finances. In each country the rise in government borrowing will be substantially offset by a rise in household savings. As a result, the current account balances of individual EU countries are unlikely to change much this year, with, for example, a small fall in the German and Irish surpluses, and a small rise in the Spanish surplus.

Accelerating rebound

Hopefully, as things return to normality in 2021 and 2022, some of the household savings from this year are likely to be spent, accelerating the economic rebound. In countries that are lucky to have a very vigorous recovery, it is likely that their current accounts may deteriorate, with some increase in net foreign indebtedness. However, the resulting changes in foreign indebtedness are likely to be small, certainly compared with what happened in the crisis a decade ago. As Japan, with a debt/GDP ratio of more than 200 per cent, has shown, a debt burden is more sustainable when the money has been borrowed from a country’s own citizens.

In the recovery phase, the public finances in each country will have to be restored to balance. If the Government continued to borrow as normal consumption resumes, and the economy approaches its capacity output, such funds would have to be sourced abroad. As in the run-up to the 2008 crash, borrowing from abroad would have the effect of funding a higher standard of living here. We would be borrowing to pay for importing more than we produce.

The State, as one of the richest countries in the world, is unlikely to find some fairy godparent who would be prepared pay for such extravagance indefinitely. So, balancing the books will still be necessary when the economy has recovered.

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