Sunday, 11 April 2010

Deflationary blues

Michael Taft: An interesting article from Michael Casey (The Big Squeeze: Deflation a threat to Irish Economy), but as it appeared in the Irish Times Innovation supplement, some might have missed it. In particular, this procative observation:

‘We have not adopted a stimulus package and our banks are more zombified than most. What we have done is precisely the opposite to what the US has done. In the middle of the worst recession in our history we have brought in three of the most deflationary budgets ever conceived. We now realise to our cost that Nama and massive capital injections will not get the banks lending again any time soon. In fact when the banks cash in their IOUs for European Central Bank (ECB) funds they are likely to use them to buy safe Government bonds.

On top of that, the Central Bank is allowing banks to raise their lending interest rates to improve their profit margins without any signal from the ECB. This is the second de facto tightening of monetary policy. The chances are that it will be further tightened by the ECB sometime next year. We are also promised at least two more deflationary budgets, including carbon taxes and property taxes. Because of the massive re-capitalisations of the banks, tax-payers are facing a very bleak long-term future. How can consumer demand recover?

In the middle of the worst depression ever experienced, we are inflicting upon ourselves five deflationary budgets and at least three restrictive monetary policies. In the past, Irish economists have criticised former finance ministers for following pro-cyclical stances of policy. But that was nothing compared to what is happening now.

Admittedly the climate for foreign borrowing is less auspicious today, but it does not appear as if the Government even considered the implications of piling deflation upon deflation. There is a chance that, as a small open economy, the deflationary effects here can be mitigated. But, nevertheless, the Government has taken a huge risk with the economy, without analysing the downside implications.

Ministers keep on saying how the EU is pleased with our economic policies. Of course they are. That is because we have promised to keep to the EU fiscal guidelines. The financial markets are also pleased with us. But none of these institutions cares about the effects on the real Irish economy, on unemployment or emigration. Let us hope and pray that we have not deflated ourselves into the ground to satisfy Brussels mandarins, financial markets and Irish bankers.’


1 comment:

Fergus O'Rourke said...

IMHO the banks are at least as likely to have to use the funds raised by cashing in the IOUs to repay short- and medium-term creditors.

The idea that NAMA could "get the credit flowing again" was always a mirage.