Thursday, February 10, 2011

On not predicting economic fortunes

One of the main criticisms of Ireland's present government is that they blew a decade of economic growth, leaving Ireland in debt through extravagant spending with apparently little thought of preparing for the inevitable rainy day.

Yet the government did plan for an economic decline, with the Special Saving Incentive Account (SSIA) launched in May 2001. The SSIA was a state-funded scheme to encourage saving with very high interest rates (25%), planned to prevent the economy over-heating during the boom years. It was popular, with around €14 billion put back into the economy when the scheme matured in 2006-07.

So here was a scheme designed specifically to counter the business cycle, to keep savings high during boom times so that there would be money to spend for the inevitable recession. Yet the SSIA ran into problems immediately, as the global economy was already slowing due to the popping of the IT bubble and later the 9/11 attacks, just as the SSIAs came on stream. Here is Ireland's inflation rate over the period:

And here is Ireland's quarterly economic growth for the period:

At the time there was some derision for the government's SSIA plans, since they seemed to be sucking money out of the economy just as it was going into decline. Nonetheless growth (albeit unsustainable, construction-based growth) continued in the early 2000s, and when the SSIAs finally did mature between May 2006 and April 2007 we were at the height of an economic bubble:

The SSIAs were mistimed. Instead of increasing savings during the boom and releasing them during the bust almost the opposite happened. Ireland's household saving rate collapsed after 2004 so that when the crisis hit in 2007 savings were exceptionally low. As the recession gathered pace, household savings soared, slowing the economy even further as consumption dried up:

Perhaps if this scheme had been over a different timescale the maturing SSIAs could have been released onto a credit-starved recession economy, instead of a construction-fuelled bubble. Yet the government could not know when the decline would kick in. For a group criticised for being too optimistic about Ireland's economic future, in this case they were too pessimistic, expecting decline before it happened.

So it is extremely difficult to predict and manipulate the market. Confident claims by politicans that they can "create" jobs and boost the economy with top-down interventions need to be viewed with deep scepticism.

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