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The benefit of thrift
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In the background of our recent posts having gone to the same place as Brian Lenihan’s April revenue forecasts, consider this quote (page 11) from his pre-Budget report –
Next year, the investment-to-GDP ratio is projected to fall further so that higher private sector savings are expected to move the current account into surplus. Effectively, this means that the domestic private sector is providing a large part of the savings necessary to finance the public deficit, so that the need to borrow from abroad is lessened.
This needs to be put in the context of repeated statements from the Minister that the fairly low yields on Irish government debt mean that the markets approve of his stabilization measures, while at the same time we need to appease the bond market gods with more cuts and NAMA. Yet his own official economic analysis of the situation is that we’re cutting to compress private expenditure enough so that we can lend to ourselves. Maybe all that garlic chewing helps keep it straight in the Minister’s head, but it’s dizzying for the rest of us.
We are so dizzy from spin that we just close our eyes ,grit our teeth and hope it will be alright on the night, maybe that is BL’s plan.
P,
It’s not that dizzying really, not when you read yesterday’s Department of Finance statement anyway.
Increased levels of household savings are both an opportunity and a risk. The opportunity is as Lenihan stated in his pre-budget statement. The risk is that when growth resumes, households will continue to hold onto the savings they have accumulated rather than spending them on consumer goods and services, thus slowing down national economic recovery.
The “fall in consumption appears to be larger than the decline in disposable incomes,” the DOF points out, “suggesting that households are setting aside a greater portion of their incomes for savings purposes.”
There are two reasons why this may be happening – people are hoarding against a rainy day, what the DOF terms ‘precautionary savings’, or they are paying off credit card or other debts instead of running up new ones. Nobody seems to know, as yet, which predominates or how it may differ between ‘private sector’ households vs. ‘public sector’ households. Nor can anyone state definitively to what extent wages have been lowered throughout the private sector, although some surveys suggest that there have been cuts in nominal wages across a wide variety of private employments, according to the Department, who also expect that household incomes will fall again next year.
The ESRI’s John Fitzgerald suggested a while back that uncertainty about the future may also be pushing people to hoard money – if they don’t know what new taxes they may be hit with in the next year or two, people may be inclined to hold on to money they might otherwise have spent on consumer goods. Same applies to uncertainty about the country’s economic direction – if people think it’s going to get worse or if they have no sense of a viable ‘roadmap’ to get us out of our current difficulties, then they won’t spend money they don’t need to.
What everyone does acknowledge is that cutting wages will definitely have a deflationary effect, in the short-term anyway. The counterargument is that making the 4bn euro adjustment now is better than waiting around hoping for sunny days that may never dawn. The Department claim there is a “window of opportunity” to take action now to stabilise the deficit, when prices are falling and we still have low interest rates. Attempts to cut public spending at a time of price inflation or rising interest rates would be much more difficult and more painful for all concerned.
Personally I think that much of the current analysis ignores the ‘pent-up’ demand issue. Sooner or later, the car has to be replaced (though I’m told there’s a greater demand for used cars in the 2-5K price range at the present time than there has been for quite a while) furniture wears out; new clothes and shoes become a necessity; and so on. People will start spending again, but they’re more likely to start when uncertainty about the economic survival of the country, among other things, has been removed.
Cuts in nominal wages in the private or public sectors certainly have a dampening effect on consumer spending, but they’re not by any means the only factor that influence people to spend or save.
People are saving because we all now know that as far as Ireland is concerned this recession will continue indefinitely. Our private debt is also one of the highest. And now the Minister want to squander savings on servicing public debt (back to the eighties). Anything but tax the rich?
The ESRI’s John Fitzgerald suggested a while back that uncertainty about the future may also be pushing people to hoard money – if they don’t know what new taxes they may be hit with in the next year or two
They may also suspect that their gross pay will be reduced in the next year or two – difficult to suspect otherwise given the clamour in the media for reduced wages, both in the public sector and (in today’s news) for reductions in the minimum wage.
And they may also be afraid that their jobs may not be there in the next year or two in any case and may be worried as to just how far their income will fall as a result given the similar media clamour for reduced unemployment and welfare benefits.
Or they may be afraid that cutbacks may mean that they will have to pay extra for public services such as medical or education expenses, and that other outgoings such as mortgage payments will remain the same or even increase.
All of those things can reduce people’s disposable income, and all of these fears increase people’s propensity to save. It’s not just taxes.
Paddy,
I think you’ve pretty much nailed it – there is widespread expectation that we will have to pay more for public services, particularly health and education.
The Minister for Health’s recent kite-flying about introducing a 50 cent charge for prescription items is indicative of where the government is heading; the increase to €1,500 in the College Registration Fee amounts to the reintroduction of third level fees by another name, and in an ad hoc way that is hardly desirable.
The root of the problem though is that, even at the height of the boom, we were not contributing enough in taxes to fund spiralling public service costs, especially in health and education, which were financed by the bubble taxes from property transactions while at the same time taking more and more people out of the income tax net and refusing to expand the range of taxes into non-labour areas like a carbon tax or property taxes, water charges etc. There was a consensus across all the main political parties on this approach to the national finances and anyone from those parties who now claims they were advocating anything different is simply telling barefaced lies.
I also think you’re right in identifying fears of increased interest rates as a major concern for most people, especially anyone who bought a house at the height of the boom and find their asset is worth a lot less than what they borrowed for it. Or who took out one of those terrible ‘interest only’ mortgages and now find that the lending institution wants to convert their loan into an ordinary mortgage, which will cripple them financially if they can afford it at all. Again, everyone expects that interest rates will rise, especially if the rest of the eurozone continues to pull out of recession. The only question is, how much?
The common factor in all this is uncertainty. Whatever else is in December’s budget it must also give a clear indication of what new taxes will be introduced in the following year and the year after that as well. The Opposition have to be very clear about their prescriptions too. Nothing less is acceptable.