Debt deflation to force Irish transformation from Boston to Berlin?

This weeks budget raised the marginal tax rates in Ireland to 28% and 53% sharply up from 22% and 42.5% this time last year.

The government largely favoured tax rises over spending cuts to bridge a budget deficit due to projected revenues of €34bn and spending of between €55-60bn. However as Michael Taft and Constantin Grudgiev have both suggested these may not actually ensure the government makes their deficit reduction targets. Irish households are among the most indebted in the world, with household debt prior to these budgetary changes standing at 178% of disposable income. Such violent tax rises will dramatically reduce householders’ disposable incomes, these rises will often be accompanied with pay cuts in the private sector and the public service facing a pension levy.

Unfortunately there may be many more tax rises to come. Most of this debt is variable rate mortgage debt, and householders will be relieved that the ECB has cut rates significantly over the last year. For many, despite these cuts the burden of repaying that debt will have grown substantially. With CPI running at a negative annual rate of 2.7% (CPI deflation), real interest rates in Ireland are sky high. A lurking danger for households, however, is the threat that if core European economies recover faster workers may find their disposable incomes decimated by interest rate rises, tax rises and pay cuts in a deflationary Ireland.

Over at the Telegraph Eurosceptic Ambrose Evans-Pritchard succinctly details much of the bind Ireland finds herself in. As a small nation within the Eurozone we simply don’t have our hands on the monetary levers to fight deflation in our own economy (and to create the inflation we need to inflate away our household debt).

While I disagree with the argument that the credit bubble in Ireland was unavoidable, huge policy errors were made and no attempt to talk the public out of their mass delusion – he does make valid points about our current position. A concern of mine, which Ambrose highlights, is that with this weeks budget – the government seems to have abandoned the low tax policy, that created and drove the Celtic Tiger (Corporation tax notwithstanding), and appears to be forced into replicating the high tax structures present in the rest of Europe (without the same value for money in services). Does this crises represent the transition of the Irish economy permanently from Boston to Berlin?

No bio, some books worth reading – The Rational Optimist: How Prosperity Evolves – Matt Ridley .

Crisis Economics: A Crash Course in the Future of Finance -Nouriel Roubini, Stephen Mihm