The writer is Chief Economist at the European Bank for Reconstruction and Development
Myopia is a by-product of democracy. Politicians facing short election cycles do well to focus on what they can do to please voters ahead of the next election. But bandaging a gunshot wound can make the problem worse in the long run.
Voters are hurt 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.
Support for precarious households should be a priority for every government, with means-tested transfers for those most in need. Instead, the governments of Canada, Germany, Italy and the United Kingdom are resorting to widespread temporary suspensions or reductions of fuel taxes and energy VAT. Such measures are also popular in Central and Eastern Europe, where rising heating costs have hit households hard. An average household in Romania spends a quarter of its budget on utility bills, compared to 7% in Germany and 12% in Italy.
General measures are popular with voters and can help incumbent governments in upcoming elections, but they have many drawbacks. They add to the existing pressure on public finances due to post-Covid pressure. They dampen price signals and provide little incentive for wealthier households with larger properties to save energy. Such price signals, leading to lower energy consumption, are urgently needed if Europe is to wean itself off energy dependence on Russia and slow climate change.
Once introduced, temporary measures often persist. Futures markets expect the price of Brent crude to be $97 per barrel in December 2023. This is 18% higher than the spot price at the start of January. So the pressure to extend the tax relief isn’t going away anytime soon.
Similarly, it can be argued that the poorest households need help with debt servicing in an environment of rapidly rising interest rates. But then again, governments are tempted to help everyone, not just those affected by job losses or temporarily unable to repay their debts. This option is politically attractive if many beneficiaries tend to vote for opposition parties. Governments can use debt relief to attract these voters in the next election.
From August 1, a general moratorium on mortgage debt 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 the free extension of mortgages.
Assistance is available to all borrowers, but only one mortgage contract per person is authorized and must relate to real estate “for own use”. If all eligible borrowers join the program, the cost will exceed 20 billion zlotys ($4.5 billion), according to the National Bank of Poland. The Polish Banking Association, using somewhat different assumptions, estimates it at 23–27 billion zlotys. Whatever the cost, the banking sector will indeed finance it.
Romania is working on a similar scheme, which is also due to start this summer, but the legislative process is less advanced. It also appears that Romania’s moratorium will at least theoretically be limited to households hard hit by inflation. Nevertheless, all of these measurements 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 gives the impression that banks are now unfairly raising interest rates on mortgages and other loans.
Moratoriums cost banks dearly and disproportionately benefit large property owners. They can weaken a central bank’s monetary policy transmission mechanism and necessitate even larger rate hikes in the future. They create incentives for unwary borrowers by raising expectations that when the next shock hits, the government will rush in to help again. Finally, they may induce banks to increase lending costs because they too expect more debt relief measures in the future. The Central Bank of Poland and the Polish Banking Association criticized the moratorium.
A cheaper and smarter system in Poland is a borrower support fund for people who lose their jobs or whose mortgage payments exceed 50% of monthly household income. This fund, financed by bank contributions, should be extended to 2 billion zlotys. Extending it to a larger number of households in need would limit the expected costs of the general moratorium. But perhaps the government would receive less electoral momentum.
The choices that policy makers make today matter. Bad policies will make the already devastating impact of the pandemic and the war in Ukraine last much longer than necessary.