Saturday, 6 November 2010

Polish debt and FED's quantitative easing

As many countries in the world, Poland has to tackle a major problem - its public debt. Though it is not the biggest debt in EU neither in absolute nor relative terms, it is serious issue in public debate. Despite the fact the debt has been rising significantly in recent years, there is no policy change. The government keeps selling bonds (quite successfully) and assets, most of which are government owned companies, like PGE, WSE, Tauron, just to name few of them, in order to keep debt to GDP ratio under 55%. If they will not succeed, some constitutional constrains will have to be applied automatically.

The question is if we should feel concerned about the growing debt, or simply let it finance our current expenses, no matter the impact on future spending it will have. In the end those ideas will lead us to ultimate question: how big the country's budget should be. In my opinion low government spending and low taxes are the way to let the economy grow on its own in the long run, even if the price we have to pay is higher unemployment rate today. The only reason for that is the fact government will always be inefficient - it will never be able to judge the situation correctly and use appropriate measures at the right time.

Nevertheless, we can see there is a huge temptation to increase public spending. FED announced on Friday it will provide $600 billion of stimulus to make the recovery of the U.S. economy possible. According to monetary theory, giving away money has no effect on the economy in the long run, except the change in inflation. Quantitative easing will sooner or later make the inflation rate go up. Even some U.S. economists are aware of that fact, e.g. Paul Volcker thinks that 'Future Inflation Risk Limits Easing Effect' (http://www.cnbc.com//id/40023233).

Polish government is not allowed to use monetary policy to finance its own spending or stimulate growth, because the central bank is to some extent independent and its main goal is to keep inflation rate low. They could either decide to cut spending or increase taxes. The latter, obviously easier choice, has been made. At first, VAT will go up by one percentage point in January 2011. There are also several other ideas, but we do not know yet if they will be applied.

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