C: Wikimedia Commons (CC BY 2.0) https://bit.ly/3CfcPjk (L & R)

There’s no point blaming Irish banks for ECB policy

There is, according to the Irish Times, “mounting pressure” on the Government to do something in the forthcoming budget about the rising cost of mortgages, with the average mortgage interest rate in Ireland now heading north of 4%.

The regional independent group have set out their stall: They want mortgage interest tax relief increased to offset the costs. Paul Murphy and the gang are busy setting out their own demands as well: They want a windfall tax on the “profiteering” banks that are robbing the country’s homeowners blind.

But of course, the banks are not raising interest rates of their own volition. This is – every last decimal point of it – the explicit policy of the unelected (and largely unaccountable) independent European Central Bank, which is attempting to combat inflation through the mechanism of deliberately making as many people as possible poorer this year than they were last year.

I have written before here about one of the least understood conflicts in modern politics: The ongoing cold war between the ECB on one hand, and national politicians on the other. The conflict derives from the differing objectives that central bankers and politicians have.

Politicians exist, more or less, to be re-elected. The best way to get re-elected is to make people relatively better off than they were when they elected you the first time. The European Central Bank never has to worry about being re-elected, and it exists to combat inflation and keep the European Economy relatively stable. The best way to combat inflation is to stop people from getting too rich, too quickly.

One of the major reasons for the crisis in inflation which we now have is that for years, the ECB essentially bowed to political demands to increase economic growth in the face of a recession. It did this by reducing interest rates to nearly zero, allowing people to borrow money for very cheap prices, and encouraging them to spend more in the process. It also engaged in what was always obscurely referred to as “quantitative easing” – which is a fancy way of saying “printing money”. By putting more and more money into a depressed economy, the objective was to get people to spend more and encourage them to create demand, and therefore jobs.

The problem, in a nutshell, is that this policy of money printing worked too well. Now there is too much money chasing too few goods, which means prices rise and we have inflation. The ECB wants to fix it, and the easiest way to do that is to make people poorer by pushing up the cost of their loans, which forces them to cut back spending in other areas, thus reducing demand and causing prices to fall. That’s the basic theory of what is happening.

The problem is that while politicians had no problem whatsoever with all the money printing (more money means more votes can be bought with that money) they very much do have a problem with the ECB’s medicine – because struggling mortgage payers vote for the opposition.

Consequently, we are in a sort of internal economic cold war: The ECB wants to make you poorer to fix inflation. The politicians want to mitigate those efforts by the ECB by pumping more money into your pocket to compensate, thus undermining the effort to fix inflation.

This is further complicated by the European nature of the ECB: It has a one-size fits all policy for the continent at large, which means that Ireland (or another small country) is often lumbered with an unsuitable interest rate which has actually been enacted for the benefit of the larger economies like Germany, Italy, France, and Spain. An Irish Central Bank, working with the Government to set interest rates in accordance with Government policy, might well be making different choices. But the European Central bank is unlikely to worry itself unduly about the political impact of rising mortgage repayments in Ireland.

The other complicating factor is that the Irish Government is awash with money, meaning that it is perfectly capable of almost entirely negating the impact of ECB rate rises were it to choose to do so. About the only thing stopping it is a vague sense of responsibility – the knowledge that when it comes to the economy, the ECB’s policy is largely the correct one in the long term, in order to get inflation down.

Opposition politicians, by contrast, need not worry themselves about fancy-dan things like “responsibility”. Which is why one of the main issues at the next election will be about the cost of mortgages and what we can do to insulate people from the decisions made by the very Central Bank we have empowered to make decisions about the economy.

In all of this, the Irish banks for all their sins are simply piggy in the middle: Interest rates are not a matter of choice for them. They do not set them, the ECB does. But they will, I expect, get the blame anyway. Because blaming them is a lot easier than owning up in public to an embarrassing political conflict with the European Central Bank. This is a cold war, and it is in everyone’s interest that nobody really talks about it.

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