I have written before on these pages that one of the most interesting and important political dynamics of the age is the ongoing conflict between the Irish Government and those in the Irish and European Central Banks who are responsible for managing inflation.
Because inflation is elevated – and, per the Irish Central Bank’s report yesterday, likely to continue until at least the end of 2024 – the experts in the ECB and its Dublin Office are determined to reduce the amount of money in the economy. This is accomplished by hiking interest rates, driving up mortgage repayments, and making bank lending a daunting prospect for borrowers. The objective, even if it is not stated openly, is to bring down inflation by making a lot of people poorer.
This is, of course, perfectly economically correct. It is also perfectly politically unpopular.
To combat the effects of interest rate hikes and inflation, which hurt people’s pockets, politicians are instinctively keen to open the national wallet and hand out extra cash to the public, especially with one eye on the ever-nearing date of the next General Election. And this is the basic conflict: The central bankers want you to be poorer in the short term, to drive down inflation. The politicians want you to be richer in the short term, to drive up their vote numbers.
As usual, whomever wins, the public is likely to lose. But it’s worth keeping an eye on the battle, in which the latest shot was fired yesterday by the Central Bank in Dublin:
The government has been warned, however, to not go above its 5 per cent spending rule which would would “add significantly” to inflation.
“Given the current cyclical position of the economy, discretionary government spending increases or tax reductions outside the bounds of the Government’s net 5 per cent spending rule would add significantly to demand and inflation in the coming years,” the latest bulletin warned.
The regulator said that if the risks of overheating become more pronounced this year and next, it may even be appropriate “to adopt a tighter fiscal stance by the middle of the decade.”
“A tighter fiscal stance” is a fancy word for an older, and less popular phrase: Austerity. And “the middle of the decade” is, at this point, just two years away. If you want the Central Bank’s warning translated into normal-person speak, it is as follows: “If you guys think you can buy the next election with public money, you’d better hope you lose that election – because whoever wins is going to have to deal with big problems.”
The problem, of course, is that there are very few politicians who would not trade a recession tomorrow for an election win today. And the other problem, without wishing to sound like an elitist, is that very few people understand monetary economics and the driving causes of inflation. Because of that, the political pressure, and political imperatives, for giveaway budgets in the run in to the election are likely to be steep. Sinn Fein and the left, after all, are not likely to praise the Government for abiding by the advice of wealthy central bankers about how much extra should go onto the state pension or child benefit.
The risk we all run, unfortunately, is that a tussle between the Government and the Central Bankers over inflation becomes a tit for tat: Spending increases will heat up the economy, so the bankers will try to pull it back with interest rate increases, causing pressure for more spending.
This is not solely an Irish problem: Every country over which the European Central Bank reigns will face the same competing pressures, with the added problem that a blanket EU wide policy simply doesn’t suit everyone. In Greece, for example, the inflation rate is a mere 2.8% – a relatively healthy figure. The Greeks – victims of the European Central Bank once before, arguably – are presently living with interest rates that are high in order to solve a problem that Greece does not really have.
To combat that problem, the Greeks will likely end up spending more and more cash to buffer their citizens from the effects of high interest rates. We have seen once before how that story can end.
Overall, it is difficult to look at the medium term economic situation with anything but pessimism: The tension between politicians, and central bankers, is creating a structural problem that requires politicians to constantly act against their instincts, and the instincts of their voters. If and when we elect a Government that simply refuses to act against its instincts, real problems will emerge. The polls say there is a reasonable chance that we will elect such a Government soon.
Oh well.