At the end of the second World War, Britain faced a crippling debt burden. It had been unable to win the war without large-scale material assistance, especially from the US. The debts that had been accumulated were not only vis-à-vis the US; indeed, among others, Ireland had become a substantial creditor as a result of the export of foodstuffs.
But the US was the major creditor, and it fell to Britain's foremost and flashiest economic and financial expert, Maynard Keynes, to devise a negotiating strategy with the Americans that could allow his country to recover its position as the world's leading financial centre.
Ever the eloquent optimist, Lord Keynes presented three options for dealing with the debt crisis. The first was to try to pay all the debts promptly; the second to accept a long-term low-interest loan from the Americans, thereby spreading the burden over a protracted period of time; the third, advocated by Keynes, was to insist that the Americans and the dominions (presumably including Ireland) should cancel debt on the grounds that these countries had either incurred moral debts to Britain or had extracted “windfall profits” during the war.
Seduced by Keynes’s rhetorical repudiation both of the “austerity” implied by the first option and the “temptation” of accepting a loan, the British shipped Keynes to Washington in September 1945 to seek “justice”, to wit, the third option.
In his recent history of the period, Benn Steil * deftly paints what ensued. Unsurprisingly, the creditors were both unimpressed and irritated by the line adopted by the British negotiators. Far from accepting the “justice” of the third option, the American side “immediately began stabbing through the fog of Keynes’s wispy words”.
Within two weeks Keynes was reduced to asking a shocked Whitehall for permission to reverse course and negotiate that tempting long-term loan. It took a further two months before even that was agreed – and on terms which were less favourable than had been hoped for.
Historical parallels
It is not just the historical parallels – imperfect though they are – with more recent debt negotiations that made reading the history of the postwar financial talks interesting. There is also the rhetorical element: Keynes's use of the term "austerity" may well have been one of the first instances this term was used in the context of fiscal adjustments.
Thus from the start “austerity” was already being used as a pejorative term and applied to what would have been a self-destructive policy of ignoring available opportunities to defer and spread out debt repayments. “Austerity” in Keynes’s usage meant cutting back for its own sake.
The modern macroeconomy does not thrive on such masochism. But a return to stable economic growth does require a disciplined and realistic approach to balancing the national books over a credible time horizon – the policy which was eventually employed by Britain when Keynes’s somewhat naive appeals for debt cancellation were dismissed out of hand.
In the current global debate, advocates of less fiscal restraint have portrayed their opponents as advocates of “austerity”. True, there are some ideologues who find virtue in a frugal approach to economic policy on the national level, but for the most part, the real policy debate is more technical. The question for economies such as the US, UK and Germany really is whether spending a little more now will boost economic activity now by enough to compensate for the drag that additional debt could impose in the future.
For Ireland today, working (as Britain was in 1945) close to the limits of available borrowing, the question is a bit different again. By accessing long-term low interest loans from foreign official sources, Ireland has managed to maintain a higher level of domestic spending over the past three years than would otherwise have been possible.
This is not the “austerity” Keynes was castigating, but mirrors the middle-ground solution that he fell back on, when his appeals for charity fell on deaf ears. Rather than to any ideology of austerity, it is to pragmatism that we should look in planning the pace of spending and tax adjustments. There is a limited margin of manoeuvre with regard to overall borrowing (I do not speak here about the balance of different spending programme and tax choices within the overall adjustment).
Scale of adjustment
But within that margin, should the adjustment be slowed? This question needs to be answered by reference to the likely impact on both the level of future private spending and on the available volume and cost of future government borrowing.
Private consumer spending has been deterred not only by the compression in household disposable incomes, but also by uncertainty about the duration of the fiscal contraction and about where it will hit. The sooner the fiscal adjustment is completed, the sooner these elements of uncertainty will be removed, paving the way for reduced private saving and increased consumer demand flowing into the local economy.
Likewise, the steady course charted both by Irish governments since 2008 in sticking to their budgetary adjustment plans has been the key to restoring international lender credibility, allowing the adjustment to be accomplished more gradually than has been required of other stressed countries.
Current budgetary policy should not be seen as reflecting pursuit of an ideological agenda of “austerity” externally imposed. On the contrary, Ireland has shown pragmatically that it can regain full autonomy and control over its public finances. The faster this is done, the sooner we can get back to steady growth in employment and output. It makes sense.
* Benn Steil, The Battle of Bretton Woods, Princeton University Press, 2013.
Patrick Honohan is governor of the Central Bank
