Current policies set to exacerbate economic crisis

Jim Stewart: The Government's main stated current economic policies (Budget April, 2009) are (1) to stabilise the public finances and (2) provide finance to banks in order that they will resume lending. Both policies will exacerbate the economic crisis rather than solve it. This is because raising taxes and cutting government expenditure will result in further reductions in demand and incomes, increase unemployment and reduce taxes. The private sector has experienced an enormous fall in wealth (€150 billion according to National Irish Bank, 2009). This fall in wealth has been accompanied by an increase in private sector saving. What is needed is a fiscal stimulus to increase demand. Fiscal stabilisation policies are not enough. Some possible measures to stimulate spending could be vouchers which must be spent within a limited time period, or vouchers which can only be spent in hotels/guesthouses (accredited by Bord Failte). This latter policy has the advantage of minimising leakage, and most likely stimulating spending of a multiple of the value of the voucher.

The second main policy objective is also unlikely to succeed in ensuring “credit flows to businesses and consumers”. Policy should focus on the real economy, not the banking sector. The overall policy emphasis on ensuring the banking sector is commercially viable will not result in credit flows to the real economy. Rather, it damages the real economy because so much of Government borrowing and future tax revenues is used in support of the banking sector. There is a danger that the banking sector will survive but many firms in the real economy will fail. In my next post I will describe what banks should do, why current policy will fail, and what can be done to correct the situation.

Posted in: Banking and finance • Economics • Fiscal policy

Tagged with: stimulus • banking • budget

Prof Jim Stewart

Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.

He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).