Save now for the rainy days ahead

 

In 1998 the Government recorded its first budget surplus since the 1940s. This raises the question as to how this surplus can be best used in the interest of the State.

The traditional conservative banker in me would suggest that today's surplus be deposited and left available for use by a future Finance Minister. The theory being that in times of strong economic growth the Government can afford to save. Then in times of recession it is appropriate to run a budget deficit financed either by past or future savings. The concept is no different than managing the household budget - alright to spend more than current income provided it is repaid from either existing savings, or from future income.

Is it realistic from a political perspective to expect any Finance Minister to forgo the opportunity of bringing good news to his electorate to support a future incumbent in tackling future economic problems? All the more so if such a future incumbent could be from the opposition benches. The national interest would be best served by Mr McCreevy depositing the current surplus in the banking system. Such a selfless action would surely mark him (and his Government) out as exceptional placing the long term national interest above short term party political gain. Ideally, therefore these savings (accumulated over years) combined with borrowings would be available to counteract the recession which will undoubtedly occur sometime in the future. It should also be possible to place some restrictions on how such savings could be spent. Clearly it would be unacceptable to allow today's savings to be frittered away by some future Government seeking re-election.

EU rules stipulate that the maximum deficit in a year can be 3 per cent whilst the debt/GNP ratio cannot exceed 60 per cent. Such rules on first glance would appear sensible - preventing national governments from running the massive deficits of the 1970s and 1980s forcing future generations to pay for our consumption. However the way in which the rules are written mean that any savings today are deducted from the national debt and not available for future spending. In effect therefore the maximum deficit available to a government in a particular year is 3 per cent of GNP regardless of the extent of past savings. The implication of this rule is that a significant incentive for a government to "save" in times of surplus is removed, as the State will not be in a position to enjoy the benefits of such savings in the future.

Indeed this situation would encourage a Minister for Finance to actually spend money because there is no available "savings" mechanism, just as you would not expect a householder to save money if he could not access it in the future. Therefore the Government is being encouraged to spend in an already rapidly growing economy - which is probably not desirable.

Where has this very precise figure of 3 per cent come from? Economists, no doubt, can show that over the long term a 3 per cent annual deficit is consistent with a debt/ GNP ratio of 60 per cent. However this is irrelevant to the justifiable using of a budget deficit to counteract the short term effects of a recession.

The extent to which a deficit is acceptable depends on the scale of the recession - 3 per cent is, at best, a very arbitrary figure. Indeed, attempting to stay within this 3 per cent limit may impose huge and unnecessary hardship on an economy whilst a larger deficit may allow a recession to be shortened with no long-term damage done to the economy. It could be argued that the French economy to day is far weaker than it need be as a result of it economic planners blindly attempting to stay within the `3 per cent rule'. The stability and growth pact does provide some very limited flexibility in theory, however the 3 per cent limit on deficits has almost now become an international standard. It is likely that a State would be penalised if it were to breach this significantly by way of lower credit ratings and an increased cost of funding that deficit. It appears unfair to place the same 3 per cent restriction on a State that has zero debt/GNP, as a State with for example 55 per cent debt/GNP ratio.

EU rules of accounting therefore would be far better if they facilitated savings in times of budget surpluses and the using of those savings along with deficits to fight future recession. Also the exchange of the 3 per cent limit on an annual budget deficit for a more flexible approach will help in fighting future recession. It may appear academic to consider the EU restrictions on budget deficits while we are running a significant and growing surplus. But it is now while we are comfortable that such issues should be sorted out rather than in the pressurised environment of times of deficit when we would be open to the charge of wanting to adjust the rules to solve a crisis.

Tiarnan O'Mahoney is a director of Anglo Irish Bank Corporation plc.These views are private and do not represent the views of the bank