Patrick Honohan: Can we continue to spend our way out of trouble?

‘Anything we can actually do we can afford.” This aphorism from JM Keynes, the father of modern fiscal policy, has been doing the rounds as economists ponder soaring government debt and rising prices. It sounds like a licence for untrammelled public spending and is being taken as such by some nonchalant enthusiasts of government deficits.

There certainly has been a lot of deficit financing in the past 18 months. But Keynes, who died just over 75 years ago, was a clever wordsmith; speaking in the darkest days of the second World War about how society makes its choices, he did not intend to evoke a magic money tree.

The continuing economic disruption resulting from the pandemic is not unlike wartime conditions. Even if the numbers at work are increasing with an easing of shutdowns, the increasingly transmissible virus variants guarantee continued pressure on a global economic system that has already been struggling to cope. Knock-on and whiplash effects in production and supply have been manifested in sharp jumps in prices and long delivery delays which have complicated economic life and stressed many households.

Faced with this persistent economic roller coaster, can governments simply continue to spend their way out of trouble? Keen to protect the incomes of those whose livelihood was damaged by the shutdowns, and facing huge additional healthcare costs, most governments that could manage to do so have rightly been running deficits of unprecedented size. Central banks wisely accommodated the pressures on money markets with the result that interest rates fell rather than rising.

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Low rates mean that governments can carry much higher debt. The additional debt taken on by the Irish Government in the pandemic has cost very little in servicing. Indeed, the average percentage interest cost on the total debt is at a record low. So far so good, then, for keeping the public finances on the rails despite the almost unprecedented speed of debt accumulation.

To be sure, high debt is still not unproblematic: it means greater vulnerability to interest rate increases, not only when new deficits are incurred, but when maturing debt has to be refinanced.

Nevertheless, the prospects are for interest rates to remain generally low. Monetary policy will be a factor here. Many central bankers are concerned with the sharp recent increase in prices, even if they recognise that some of these increases are likely to be transitory, and that they follow a long period in which inflation has been undershooting the European Central Bank’s (ECB) own target. (The cumulative undershoot over the past decade is about 8 per cent.) The ECB has now signalled a slight retreat from the exceptionally liberal purchasing of bonds that has prevailed since early 2020.

But even without the help of central bank action, borrowing costs for governments with good credit ratings have been trending downward for many years, reflecting the savings preferences especially of wealthy individuals in ageing populations worldwide.

The Government’s borrowing costs can thus remain low, but only as long as financial market confidence in the Republic’s creditworthiness remains strong.

The Government has managed to keep the Republic’s rate of borrowing during the pandemic inconspicuously in the middle of the pack of other countries. Still, recent changes to the fiscal plan edges us up among the higher borrowers. On one measure, the State’s fiscal deficit for 2022 looks like being outstripped in the EU only by Romania .

Our ability, twice in 40 years, to restore fiscal balance from a precarious position underpins the Republic’s reputation with international investors: maintaining that reputation is vital for our national wellbeing.

The pandemic spending will continue to add to debt for a while yet

The Fiscal Advisory Council and the Central Bank are therefore not wrong to urge caution. Indeed, the Department of Finance itself marks the debt ratio as the only amber flag in its heat map of macroeconomic imbalances for next year. No wonder the Government has projected a reduction in the deficit over the years ahead.

But it would be a large mistake to sacrifice needed long-term public spending on that altar. The pandemic spending will continue to add to debt for a while yet; and when it has subsided these long-term needs will be as pressing as ever, and there will be little room then for further debt financing.

While some improvements in housing, healthcare and other social services can be achieved through legislative initiatives that don’t increase government spending, most do; witness the projected costs of Sláintecare and the new housing plan.

We need to face up to the fact that part of the long-term financing of these and other pressing needs, including addressing climate change, will have to come from additional tax revenue. Higher and more effective carbon and vacant property taxes should be part of this, not least because they help induce welfare improving behaviour, but they will not by themselves be enough. Neither will additional money from Europe be enough: the NextGenerationEU funds of almost €1 billion, approved in Brussels this week, represent Ireland’s portion of an excellent step towards further fiscal integration in Europe, but that amount does not begin to balance the books either.

Looking beyond the current turbulence, the Government needs to plan for taxation consistent with the sustained spending needs that will persist when the turbulence has settled. That includes a reasoned approach not only to how much, but in what form the extra tax revenue should come.

Yes, as a society we can afford anything we can actually make. But, as a society, we have to be prepared to pay for it.

Patrick Honohan was governor of the Central Bank of Ireland from 2009-15