The writer is chief economist at the European Bank for Reconstruction and Development
Myopia is a byproduct of democracy. Politicians facing short electoral cycles have every incentive to focus on what they can deliver to please voters before the next election. But applying a band-aid to a bullet wound can make a problem worse in the long run.
Voters are wounded by high energy prices and rising interest rates. Predictably, many governments are responding with band-aid solutions of temporarily suspending fuel taxes and introducing mortgage moratoriums.
Assisting insecure households should be a priority for every government, with means-tested transfers for those in greatest need. Instead, governments in Canada, Germany, Italy and the UK are resorting to across-the-board temporary suspensions or cuts to fuel taxes and VAT on energy. Such measures are also popular in central and eastern Europe where rising heating costs have hit households harder. An average household in Romania spends a quarter of its budget on utility bills, compared with 7 per cent in Germany and 12 per cent in Italy.
Across-the-board measures are popular with voters and may help incumbent governments in the next election, but they have many downsides. They add to existing pressure on public finances from post-Covid strain. They damp price signals and give wealthier households with larger properties little incentive to save energy. Such price signals, leading to lower energy consumption, are urgently needed if Europe wants to wean itself off energy dependence on Russia and slow down climate change.
Once introduced, temporary measures often stick around. Futures markets expect the price of Brent crude to be $97 a barrel in December 2023. That is 18 per cent higher than the spot price in early January. Thus, the pressure to extend tax relief will not go away soon.
Similarly, a case can be made that poorer households need assistance with debt servicing in an environment of rapidly increasing interest rates. But here again governments are tempted to help everyone, not just those affected by job losses or temporarily unable to service their debts. This option is politically attractive if many beneficiaries tend to vote for opposition parties. Governments can use debt relief to lure these voters at the next elections.
From August 1, an across-the-board mortgage debt moratorium will be launched in Poland. It involves “debt service holidays” of up to four months in the second half of 2022 and an additional four months in 2023. This essentially means extending mortgage loans for free.
The help is available to all borrowers, but only one mortgage contract per person is allowed and it must cover “own use” real estate. If all eligible borrowers join the scheme, the cost will exceed 20bn zlotys ($4.5bn), according to the National Bank of Poland. The Polish Banking Association, using somewhat different assumptions, estimates it at 23bn-27bn zlotys. Whatever the cost, the banking sector will in effect finance it.
Romania is working on a similar scheme, also to start this summer, but the legislative process is less advanced. It appears, moreover, that Romania’s moratorium will be at least notionally restricted to households severely hit by inflation. Nevertheless, all such measures are distortions that use a different distortion as an excuse. The problem is that excess liquidity in the banking system has kept deposit rates very low. This creates an impression that banks are now unfairly raising interest rates on mortgages and other loans.
Moratoriums are expensive for banks and disproportionately benefit large property owners. They may weaken a central bank’s monetary policy transmission mechanism and require even higher rate hikes in the future. They create incentives for reckless borrowers by raising expectations that, when the next shock comes, the government will again rush to help. Finally, they may induce banks to increase loan costs as they, too, expect more debt relief measures in the future. Both Poland’s central bank and the Polish Banking Association have criticised the moratorium.
A cheaper, more sensible scheme in Poland is a Borrowers’ Support Fund for people who lose their jobs or whose mortgage payments exceed 50 per cent of monthly household income. This fund, financed from bank contributions, is set to expand to 2bn zlotys. Extending it to cover more households in need would limit the costs expected to arise from the across-the-board moratorium. But perhaps the government would receive less of an election boost.
The choices policymakers make today matter. Bad policies will make the already devastating impact of the pandemic and the Ukraine war last for much longer than necessary.
Source: Economy - ft.com
