Ireland's Budget Cuts: A Case Study on the rewards of Austerity

For those who don't know, austerity is "a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided. Austerity policies are often used by governments to reduce their deficit spending while sometimes coupled with increases in taxes to pay back creditors to reduce debt".

In the United States, our government is now beginning to understand the importance of Austerity and how its the responsible thing to do when in hard economic times.  Therefore, I though I'd review all the good things that happened to Ireland as it pursued its own austerity.

In late 2008, as the world financial markets were crashing and burning, Ireland, like other nations, saw tax revenues dip, money disappear overnight, and the economy quickly contract.  As you can imagine it caused huge budget deficits and it's debt started rising.  Unlike most other nations in the EU, it did the responsible thing and declared that Ireland would not take part in EU stimulus plans.  Ireland continue to reap the rewards of it's responsible actions.

September, 2008.  Ireland cuts spending by another 1.5% or a total of 4% less from the year before.

With September tax returns expected to be very bad and the economic climate rapidly deteriorating, a further 1.5% reduction in 2009 spending is now up for debate. This would bring planned cutbacks in current expenditure for next year to more than €2bn.

April, 2009.  Ireland announces more emergency budget cuts and this time, income tax increases as well.

From May 1, a 2 percent “income levy”—effectively a pay cut—is to be imposed on all those earning between €15,028 and €75, 036. This doubles a levy first introduced last October and reduces the tax threshold to incorporate large numbers of low paid workers. Those on higher incomes will be levied at 4 percent and 9 percent of their income.
A health levy is also to be increased to 5 percent. This, as with other levies, is to be taken directly from the pay packets of workers whose tax payments are collected by their employers. This will be added to the pension “levy” also extracted from public sector workers in February.
The government also announced there will be no Christmas welfare payment for social security claimants in 2009. More damningly, childcare allowances for pre-school children are to be halved immediately and abolished by the end of 2009. Child benefit, currently paid to all parents, is to be means tested.
Payments to unemployed workers under 20 are also to be halved and rent support payments reduced, while new punitive measures will be introduced against welfare claimants. Mortgage interest relief will now only apply to the first seven years of its commencement.

December, 2009.  More drastic budget cuts are announced.  This time an additional 4 billion euros were being cut out of their budget.  All the cuts came out of wage cuts on public workers, reduced benefits for the unemployed, other reduced social welfare programs, and less spending on infrastructure

Public sector workers bore the brunt of cutbacks in Lenihan’s Budget with €1 billion in pay cuts ranging from 5 per cent for those on average pay to 15 per cent for those at senior level.
The rest of the €4 billion in savings will come from a €760 million reduction in the social welfare, a €980 million cut in day-to-day spending programmes and €960 million in savings on capital investment projects.
Cuts to Child Benefit will see a €16 euro per month reduction with the lower and higher rates now €150 and €187 per month respectively. Families on social welfare will be compensated with an increase of €3.80 a week in qualified child allowance.

At the same time, unlike previous budgets, taxes were heroically kept the same or lower.

VAT will be cut by half a percentage point from January for 12 months, while the corporation tax rate will not change from 12.5 per cent.

In February 2010, a levy(tax) was placed on the generous pension plans of government workers to save the government even more money.

In March 2010 , public sector wages were cut again, despite freak out from the greedy public sector unions.

Tax revenues have collapsed, the government has run out of money, we can't afford to pay state workers as much as they have been getting.
In fact tax revenues here have now fallen to the 2002 level. But since then, the payroll for state workers has increased by 35%.
So far the government has cut them back by an average of 12% over two budgets. But the state workers won't accept it.

By April 2010, Ireland's bold moves were rewarded by the financial industry, praised by the EU Central Bankers, and declared a model for Greece.

As a result, the country's government and taxpayers have been rewarded. The "spread" the bond markets charge to hold Irish 10-year debt over the German "bund" equivalent is now 139 basis points, less than half as wide as this time last year. The Greek spread over the bund, meanwhile, is 316 basis points – more than twice as high as that of the Irish – with Athens now paying far, far more than Dublin to service government debt.
"Greece has a role model and that role model is Ireland," said Jean-Claude Trichet last week, the European Central Bank president singling out the Emerald Isle for praise. "Ireland had extremely difficult problems and took them very seriously – and that's now been recognised by all."

Despite all these spending cuts and increased taxes on the public sector employees and middle class, Ireland still found itself facing another deep budget hole in October 2010.

DEEP welfare cuts loomed last night as ministers began a marathon session thrashing out how to bridge a €5 billion black hole in the budget.

A property tax and specific projects like the Dublin Metro North line were under discussion, as was cutting welfare which is set to take a hit of some €2bn. The Greens are keen to save Metro north and some ministers fear cutting the capital building programme too far will damage the economy in the medium term.
Education is also expected to be a big loser.

Last week, the outcome of the cuts were announced to be another 6 billion Euros cut from spending.

Irish Finance Minister Brian Lenihan plans to slash the budget deficit by 6 billion euros (US$8.5-billion) in 2011 as he fights to save the nation's economic independence.

How did the financial markets respond to these even more drastic budget cuts?  It rewarded them with higher interest rates.

Brian Lenihan, Ireland's Finance Minister, described the country's borrowing problems as "very serious", as the yields on its bonds hit yet another all-time high. The yield on 10-year bonds peaked at 9.26 per cent yesterday, almost four times the yield that is demanded by investors in equivalent German bonds.

The ultimate outcome of 2 years of fiscal austerity?

Senior officials in Ireland and the European Union yesterday moved closer than ever to conceding that the indebted country may now have no choice but to seek a bail-out.

Queue the Trombone:

What's the Big Deal with the Fed Buying Treasury Debt?

Last week the Fed announced that it was going to Buy $600 Billion in Debt, Hoping to Spur Growth.  The idea is to increase the amount of bank reserves so that it'll lower interest rates which will spur more borrowing to fund real economic activity(i.e. buying stuff and starting new businesses).  This move by the Fed was quickly followed by a lot of people freaking out about it (see here, here, here, and here).  The basic criticism that I see is that the Fed is "monetizing debt" which will - at some point - cause inflation.  Not being an economist, I feel that I must be missing something because I don't understand the logic of the Fed's actions nor the logic of its critics.

First, here's why I don't understand the Fed's actions.  Banks already have a record high level of cash reserves.  What that means is that the banks are already sitting on a pile of cash in their vaults(Okay, I know most of it is just numbers in a computer, but the physical metaphor makes it easier for me to comprehend).  The banks are already not loaning out this money.  What makes the Fed think that making them have bigger piles of cash will suddenly induce them to start making loans?  Will making already historically low interest rates go even lower get the economy going again?  My point is that I don't think monetary policy alone is going to get us out of our depression.

Now, onto the critics of the federal reserve.  The argument is that for the Fed to buy these treasury securities is that it will increase inflation either now or in the long-term.  To see the ridiculousness of this argument let's first review what treasury securities are:

A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries.

So, by law, every time the Treasury spends money that hasn't been collected in taxes, it must issue some type of treasury security to "finance" that spending.  For those who purchase this treasury securities(mostly domestic commercial banks and foreign central banks) they get to earn interest on the debt.  So if the United States spends $1,000 that it doesn't have and Chase Bank purchases the security, it will make $1,000 plus interest.  At 3% over 10 years, that will be 1,300 dollars.  When 10 years is up, the U.S. treasury pays Chase 1,300 dollars.  When all is said and done, Chase makes 300 dollars and the U.S. Treasury is out another 300$ on top of the original debt.  (This, BTW, is why people are worried about the growing debt)

Now let's look at what happens when the Federal Reserve buys the debt instead of Chase Bank.  The Federal Reserve gives the U.S. treasury a thousand dollars.  At the end of 10 years the U.S. Treasury gives the Federal Reserve 1,300 dollars.  The Federal Reserve just made 300 dollars.  Now, here's the kicker.  By law, any money that the federal reserve makes must go to the U.S. Treasury at the end of the year.  So that 300 dollars the Fed just made by loaning to the U.S. Treasury... goes back to the U.S. Treasury.  (addressing the absolute absurdity of this system is beyond the scope of this post, I will address it some other time)

Whether Chase Bank or the Federal Reserve purchases the original treasury security, neither scenario causes long term inflation as long as the Federal Government brings it's budget back into balance at the end of the 10 years. This is true because no money is "created".  The government eventually pays off its debt by collecting more tax dollars than it spends and that goes to paying its debt.

However, since the federal budget has only been balanced about 7 times during it's entire existence(and each time it lasted only 2 years or less), it would be a dumb assumption to assume that the debt won't continue to go up over time as it always has.  What that means is that when the debt comes due, the federal government will invariably have to issue new debt to pay for the old debt.  If Chase bank owned the debt, the U.S. Treasury will have to create $1,300(the original 1,000 plus 300 in interestprofit) in new debt to pay for the old debt.   If the Federal Reserve owned the debt, the U.S. Treasury will only have to create only a $1,000 in new debt because the Federal Reserve had to give back it's profit.

So, if you assume that the U.S. debt will still be growing in 10 years, which scenario is more inflationary:  Chase owning the Treasury security, or the Federal Reserve?  Chase owning it is more inflationary.  Why?  Because to pay Chase, the U.S. Treasury will have to create $1,300 total in new money to pay for the debt(1,000 plus 300 in interest) where as if the Fed owns the debt, only $1,000 dollars in new money gets created.  In other words, in the long run, it's actually less inflationary for the Fed to own this debt than private banks.  So all these people yelping about this causing long-term inflation are arguing for policies that will increase long-term inflation.

Now, I'm not an economist, so I admit that I could be wrong.  I could be missing something here, but as far as I can tell, the Federal Reserve's latest move won't jump start the economy, and neither will it be more likely to cause long term inflation.  Right now, the only things that can hurt or save us will be what our congress does to address the economy.

Election "Day" is an Outdated concept

Why do we have an election "day"?  I was thinking about this today while I stood in line to vote.  In the age of on-demand rentals, super sonic jets, and email on our mobile phones... why does it take 2, 4, even 6 years to change our minds on who should be running our country?  If my representative votes differently than he or she promised, I should have the ability to instantly register my displeasure.

In my opinion, election "day" and "lame duck" sessions are a holdover from a time before phones, computers, and interstate highways.  Back then ballots had to be hand-counted, and the winners had to travel via horse & buggy to get to Washington.  Of course it would be impractical to have elections more than once every few years.  However, in the digital age, we are no longer under the same restrictions as our forefathers.

Here is what I'm thinking:  (As I only thought of this today, I haven't completely thought through all the problems, but everything I'm proposing is completely feasible with today's technology.)  Let's just take the house of representatives to start:  In each district, everybody votes for whoever they want to be their representative.  At the end of the month, the votes are tallied and whoever gets the most votes(even if it's not over 50%) gets to be in congress.  Now, let's say 15 days later that person breaks several campaign promises.  I just go down to my election headquarters (during any weekday) and change my vote to somebody else.  If enough people change their vote, then at the end of the month, there will be a new congressman from that district.  Now that's a responsive democracy.

This has ancillary benefits too.  It could severely weaken the two-party system we have in the United States.  If there's a viable third party candidate you will know at the end of each day.  Because there's no reason the tallies can't be updated every day and reported online.  Congressman could instantly be notified when they're losing support.  At that point they either have to try and change their constituents' minds, or change their own vote.

Some might decry this because it would mean politicians would be in constant "campaign" mode.  To that I say, GOOD!  With each and every vote, congressman would have to think long and hard about what the people of their district want.

Another problem some might have is so-called "continuity".  A constantly changing congress might mean nothing gets done.  I disagree, I think more would get done.  Because when you have only a month to prove yourself, you aren't going to wait around.

Some might argue the opposite.  Too many things would get done in an ever shifting congress.  Again, I disagree.  Only the things that voters want would get done because congressman would know they have to face the voters everyday.  If voters do something that congress doesn't like, it'll probably only be about a month or two before it gets repealed as congressman are replaced.

In the end, I think the consistency of the system would probably surprise most people.  As the best get in, they would stay and would likely only get voted out when they start taking their constituents for granted.  I'm willing to bet that month-to-month districts would be fairly stable with only a few getting voted out.

I'm not saying this would be the absolute best way, but give me a break.  It's only my first time completely re-inventing democracy for the digital age.  If you got a better idea, let me know in the comments.