One of the things that we now know is that across Europe as a whole austerity is not working.
Co-ordinated deflation of a continent, or the refusal to reflate where such is possible, is not a route to economic growth.
In Ireland, we have had to engage in some degree of austerity. Countries can pay for the goods and services they wish to consume from the government sector in one of two ways; they provide the Government with sufficient tax revenue to allow this to happen or they borrow the money from others.
Borrowing money is not a bad thing, if the return on the borrowed money is larger than the cost of the money.
It is reasonable to argue that what resulted in Ireland becoming locked out of the borrowing markets (remember we can pay tax or borrow) was the lunatic decision to take on the banking debt.
Debt is not additive — it is multiplicative. We found ourselves wards of the troika and what would have been a fiscal crisis became an existential crisis.
Across Europe it is reasonable to see that in an effort to avoid the problems of the 1920s hyperinflation, we allowed ourselves to repeat the mistakes of the 1930s depression with coordinated fiscal and monetary stringency. The creditor nations engage in a morality play with the debtors and the ECB wasted crucial years pretending to be the Bundesbank.
The result is a Europe which is arguably in a balance sheet recession. Corporate, state and household balance sheets have too much debt and there is not enough growth to allow these to be repaired. Indeed, rather than focus on growth, the continent has focused on cutting the debt so hard that it has damaged the prospects for growth.
If we cannot deal with the growth issues in the short term, then we have to deal with the debt. We have been doing this one way and it’s not working. Insanity is doing the same thing time and again and expecting a different answer.
There are ways we can deal with the fractured balance sheets of households. If we can get households back on an even keel, then they can begin to drag economic growth forward. For ideological and philosophical reasons, people are uneasy about writing off debt.
The argument is that there is moral hazard: why would I be prudent in the future when I have had my debts of the past resolved at no cost? It’s funny how this argument has not prevented us, collectively, from doing exactly that with banks…
Moral hazard is that — a hazard and therefore one that is not inevitable. In any case, even if it is realised later, it’s a trade-off. If we do X now it will cost Y and might with a particular probability cost Z in the future, but will gain us amount A. It’s a trade-off.
We can avoid moral hazard to some extent by focusing on how we deal with debt. Across Europe, even the most upright countries have increased the loans on the household balance sheet over the last decade (Germany apart).
While it is the case that the net household financial asset position is positive in every country, in other words the households have more assets than liabilities, the composition matters. First, it is a well known and ineradicable human condition that people engage in mental accounting.
They separate assets and liabilities, and we worry more and are more sensitive to liabilities than assets. Second, the assets held tend to be insurance and pension assets which are longer term and more illiquid than the loans. In other words, even people with net financial assets can and do act to constrain spending and to reduce economic activity
So what can be done? One old concept floating about is that of helicopter money. This is direct money creation by the Central Bank which is given to people. The argument against this is that it is inflationary.
That is only the case if it is a permanent increase in the monetary base. With banks deleveraging and shrinking it is highly probable that we are looking in the longer term at lower money supply than higher. Ally to that the fact that money created now can be uncreated later.
Perhaps its time for the ECB to consider thinking outside the box — helicopter money to households that can only be used for paying down bank debt would not be direct monetary financing and thus not illegal for the ECB. It would relieve households of the actual burden and allow them restore their balance sheets. It is reversible.
It can be at a fixed amount, which would be of greater value to those on lower incomes who have the greatest propensity to spend additional money. Now, if only I had lots of loans…
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