Return to austerity would be bonkers, but so is idea deficits do not matter

The exchequer returns this week presented a grim picture of the public finances a year into the pandemic. Public spending in the first two months of this year is running more than €2 billion ahead of last year, as the lockdown forces the Government to burn through cash at a quicker-than-expected rate. Tax returns are way down on last year. The country is borrowing money at a staggering rate to make up the difference.

So what? Everyone’s borrowing like crazy. Joe Biden is starting his presidency with a gargantuan $1.9 trillion stimulus package. The European Union, which is providing €750 billion through grants and loans, suggested this week that its fiscal rules will remain in abeyance for next year. The European Central Bank meanwhile, continues to directly finance EU governments through buying their bonds.

Two things need to be said: firstly, huge deficit spending now is essential. Our society and economy – and everyone else’s – is being preserved, albeit in deep freeze, by the Government stepping in to maintain incomes and services with tens of billions of borrowed euro. The social and economic consequences of an alternative, where governments cut their cloth according to their measure, would not just be extraordinarily painful, they would be profoundly destabilising. It would destroy the society we know.

Now, maybe you think that’s a good thing. We could go on to rebuild a more just, sustainable and equitable society. It’s a coherent view to hold.

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But I’d say there are two important concerns about that. The first is that the process of society and the economy disintegrating would be pretty unpleasant for everyone. The second is there is no guarantee that the new society and economy would turn out to be quite the nirvana you might hope for.

There are those who think that it’s worth the risk. But most people, I think, would prefer to preserve the society and economy we have while seeking to improve it. Which means they should pay attention to the second point: this can’t go on forever.

Limits

No stimulus package, however large, is infinite. The drearily law-based, tight-assed EU will suspend its fiscal rules for 2022, but expects their reintroduction in 2023. And the bond market, where most government debt is raised, has its own limits.

In recent weeks, the bond markets have semaphored that their appetite for public debt is not endless, sending interest rates upward and spooking investors. Last week, the Financial Times called it a “disconcertingly swift and powerful bond market rout”.

In The Irish Times, Chris Johns observed, “Bond markets are signalling trouble . . . Their prices are falling, which means that yields and interest rates are rising. One traditional role of those yields and rates is to exert fiscal discipline on finance ministers: bonds tell governments when they are borrowing too much.”

Readers with memories that stretch back more than a decade will remember what it’s like to become acquainted with the bond markets. You can argue all you want that the world should be organised in a different way, that financial markets should not wield the power that they do, that government budgets should not be subject to the forces of financial capitalism – but until you get around to changing it (and, sincerely, good luck with that), you will have to deal with the world as it is.

It is true that whatever Donohoe does to reduce the deficit will be labelled as austerity by his political opponents

It is one of the Government’s principal responsibilities that it executes a prudent economic policy and maintains control of the public finances. This not an abstract debate – the consequences are very real for an awful lot of people. Because those who will suffer most when a government loses control of its finances are the people who depend the most on the state for help. Pensioners. People who need healthcare. Children in education. People with special needs. Those who have lost their jobs.

There is nothing right-wing or left-wing about this. The arguments between right and left are on the size of the state and how it should be funded, where to tax and where to spend. These are the age-old, fundamental questions of politics. But what is not arguable is the need for the public finances to be sustainable.

In fact, it is even more important for centre-left governments to run prudent fiscal policies because they are the people who believe in the power of government to improve society and to help people in their daily lives. They believe in public services, welfare, public housing, climate action and all the rest of it. The dominant political philosophy in the West for a long time was shrinking the state. That era is long gone. Fine. But a bigger state is a more expensive state, and it must be paid for.

Sustainable budgets

That is why the bond markets matter, and why a return to sustainable budgets in the next couple of years is imperative, no matter who is in government. That will mean reducing the deficit when the economy reopens, and that process will become central to our politics soon enough.

In a speech to the ESRI on Thursday, Paschal Donohoe gave notice enough about what’s coming. “The idea that ‘deficits don’t matter’ – especially for a small economy without the possibility to print its own currency – is so far wide of the mark as to be dangerous,” he said. He cautioned that the deficit would be reduced “at the appropriate pace and time”, but insisted it would have to be done.

Donohoe may underestimate how difficult this is going to be. It is true that a return to austerity would be politically and economically bonkers; it is also true that whatever Donohoe does to reduce the deficit will be labelled as austerity by his political opponents. That is why he will have to begin making the case for a gradual return to sustainable budgets this year. He will have to make that case inside and outside government. He has his work cut out.