Holiday Reading

Many of you may not read Vanity Fair or be aware that Joseph Stiglitz is a regular contributor.  In the current issue he gives his trenchant version of who is to blame for the mess the US economy is in at the start of 2009.  See

Anyone prepared to do an Irish edition?

Designing a Fiscal Response for the Crisis: The IMF View

The IMF has released a detailed study about the optimal design of fiscal policy to combat the crisis. A key feature of this report is that it accepts that the appropriate fiscal response varies across countries. In particular, this extract from an online interview with two of the report’s authors (Olivier Blanchard and Carlo Cottarelli) is relevant to the Irish situation:

Cottarelli: That said, it is critical that this fiscal stimulus isn’t seen by markets as undermining medium-term fiscal sustainability. That would be counterproductive, including in its effects on demand today. Indeed, we’ve said that not all countries can afford a fiscal expansion.

How the stimulus package is designed is also key: fiscal measures should be reversible, and governments may want to precommit to unwinding some of the policies. Also, any stimulus should be formulated within a robust medium-term fiscal framework, which could be made more credible by strengthening independent oversight of fiscal policy.

Wages and debt deflation

Alan made a comment in response to John Fitz that I think people need to think carefully about: wage cuts will be deflationary in that they will increase the real burden of debt. The Latvian piece Philip linked to talks about this, and Paul Krugman has been writing about this also.

I suppose that unlike in Latvia and other countries, most Irish household debt is owed to Irish financial institutions. As Krugman says, this implies that if we could adjust the real exchange rate by devaluation, that would be preferable to doing it through domestic deflation. However, devaluation is not an option for us. So, Alan is right: writing down the debt would seem like the best solution, assuming it were possible. Of course, you would like the banks rather than the taxpayer to take the consequent hit, and there is a fat chance of this with our current government.

If debts cannot be written down, then wage cuts will depress the economy still further through this mechanism. As will tax increases, and expenditure cuts, whether people like it or not. And thus the adjustment mechanism for our economy is most likely to be emigration. Which will of course further reduce economic activity, and asset prices, and increase the losses suffered in principle by banks, and in practice, one fears, by taxpayers. (And reduce GDP and the number of taxpayers, thus increasing the tax rates required to service a given level of debt.)

None of this is to disagree with John, but to point out how bad our options are right now.

Speaking personally, I would really appreciate a detailed debate in the next few weeks about two issues. First, what is the optimal timing of a return to 3% deficits? I am completely convinced by the argument that we are once again living in a Keynesian world, which on its own suggests doing this over a number of years, especially since we are starting with a low stock of government debt. (What else is a low stock of government debt for, one might ask.) The key questions then are: how rapidly will the stock of debt escalate to levels that are unacceptable? What are unacceptable levels of debt? How binding are the constraints which we will face due to increasing demands by governments for loans on world markets? How worried should we be about possible linkages between increments to and the stock of public debt, on the one hand, and the credibility of the government’s bank guarantee scheme on the other?

Second, what does the real exchange rate or labour market evidence suggest about the size of wage cuts required to get the real exchange rate back to some sort of sustainable non-bubble level? Can we do better than picking numbers out of the air?

A Path to Recovery

So far the bulk of the population have been insulated from the recession and, on present forecasts, this could continue through 2009. The latest ESRI QEC suggests that over the two years 2008 and 2009 output per head will fall by around 9% while real wage rates will actually increase. The insulation being provided for the bulk of the population comes from two sources: government borrowing, which will exceed 10% of GNP in 2009, and a dramatic collapse in the profitability of the company sector. A consequence of the loss of profitability, arising from the cumulative loss of competitiveness, will be that the rate of unemployment will exceed 10% before the end of next year. It is clearly unsustainable that the only people who will suffer a dramatic drop in their living standard will be those losing their jobs while those who continue in employment actually see an improvement in their living standards.

 Up to the summer the developing recession was a home-grown affair due to the mismanagement of domestic fiscal policy. The housing bubble was inflated by public policy and it crowded out the tradable sector of the economy by promoting a major slide in competitiveness. However, over the course of the Autumn the world financial crisis, and the particularly noxious form that it has taken in Ireland, has more than doubled the prospective fall in output.

 To get out of this mess a number of things need to happen. Firstly, the world economy needs to recover, including a restoration of order to the world financial system. Secondly, competitiveness needs to be restored. Thirdly, the imbalance in the public finances needs to be tackled. Fourthly the banking mess needs to be sorted out – properly.

Clearly the restoration of order to the world economy is outside the control of the Irish authorities. It remains unclear when the world economy will return to growth. Current hopes/expectations are for a turnaround by the end of 2009. The longer it is delayed the bigger the mountain that will have to be climbed in restoring the Irish economy to sustainable growth. However, when it does take place there is likely to be somewhat more rapid growth than normal in the world economy during a prolonged recovery phase.

If the world economy were to turn the corner before the end of 2009 it would have a very significant impact on the Irish economy because of its “gearing” through trade. It could be enough to undertake a significant part of the heavy lifting. It would probably eventually bring the rate of unemployment below 10% and the deficit in the public finances could fall substantially from its 2009 level. Nonetheless, the legacy effects of past policy mean that there is still likely to be a government deficit of well over 5 percentage points of GNP to be eliminated. It could well be larger than this if the world recovery is much delayed. Also, it would not address the competitiveness crisis so that unemployment would remain very high and it would not return the public finances to a sustainable path.

In the private sector wage rates are generally set on the market rather than by the “partnership process”. In the past they have shown themselves to be flexible in an upward direction. At the time of the bursting of the dotcom bubble wage rates actually fell in a few exposed sectors that were particularly badly affected, as employers and employees worked to stay in business and protect jobs. With a likely very low rate of inflation in the Euro zone next year, and a consequential moderate increases in wage rates among our competitors, tackling the competitiveness problem will be difficult. If, for example, Ireland needed to improve its competitiveness by 5% relative to its partners this could be done in two ways. A pay freeze in Ireland with wage inflation in our partners of 1% to 2% a year would mean that the process could take 3 or 4 years. Alternatively, a 5% fall in nominal wages in 2009 would achieve it all in one year with major beneficial effects on unemployment and growth in the medium term. We don’t know yet how much ground we have to make up, only that the competitiveness hurdle is high. It does seem likely that the market will deliver at least a wage freeze in the private sector and, very possibly, a small fall in nominal wage rates. This would still leave a lot of work for future years, with a high cost in terms of prolonged unemployment.

Given the problems with the public finances and the prospect of at least a standstill in private sector wage rates, if not a much-needed fall, it will be essential that the public sector at the very least follows suit. Given that public sector workers are generally better remunerated than comparable workers in the private sector it would make sense for there to be a significant cut in nominal wage rates in the public sector in 2009.

Even with a world recovery and a major gain in competitiveness this will still not be enough to sort out the public finances. Over four or five budgets from 2010 governments will have to either raise taxes or cut expenditure to restore order to the accounts. Initially, by improving efficiency in public services, some savings on expenditure are possible. However, if the public continue to want at least the current level of public services then increases in taxation will be the order of the day. As Ireland today has one of the lowest tax burdens in the OECD a significant increase in tax rates over the years of economic recovery would be feasible. However, it will mean that government will have to pre-empt an unusually large share of the fruits of the recovery in its early years in the form of additional taxes, such as a carbon tax, a property tax, and higher excise taxes.

The area where the government faces the possibility of another important “surprise” in the forecast is with regard to the price level. If sterling were to remain where it is today it could result in a much more dramatic fall in the CPI than currently forecast. If, in turn, employees in the private sector bargained in terms of real after tax wage rates (as they have in the past), this could greatly help the process of cutting nominal wage rates to improve competitiveness. A fall in nominal wage rates of 5% would, in turn, cut the CPI by a further percentage point. Such a “surprise” fall in the price level could thus be very good for competitiveness. It could also be achieved without a major drop in real incomes for employees (due to the implied terms of trade gain). However, unless the government acts rapidly, it could also dramatically worsen the public finance problem.

To deal with a fall in the CPI of much more that 2% in 2009 the government would have to ensure that wage rates fell by a similar amount in the public sector. However, that would not be enough. With welfare rates scheduled to rise in nominal terms by 3% in 2009, real welfare rates could end up rising by the largest amount experienced since 1982. Such a dramatic increase, coming on top of an already very high replacement rate could have a major impact on the long-term unemployment rate well out into the next decade.

Very clever game theorists needed, or perhaps not

Was I the only one to find the following snippet from the Irish Times astonishing?

It has emerged that the Government increased the size of its planned investment in Anglo by half in the final hours of talks. Mr Lenihan was offering €1 billion up to lunchtime on Sunday but raised the offer to €1.5 billion in the face of tough negotiation by the bank.

Calmfors Driffill revisited

Everyone agrees that the Irish economy needs to restore competitiveness. Absent the possibility of devaluation, this either requires freezing nominal wages, and letting inflation erode their real value; or reducing nominal wages. The former course of action seems insufficient, since it will take too long, and we may even be heading for deflation.

So, the old Calmford Driffill literature from the 1980s may be relevant. (I couldn’t find their 1988 Economic Policy article online, but a survey article is here.)

Remember the basic point: if labour markets are very competitive, then wages will fall by themselves. If there are strong sectoral unions, on the other hand, then they may all play a game of ‘after you, my dear Alphonse’, and wages may not be cut. In that case, moving to central bargaining can help in coordinating wage cuts, in that no-one feels that they are falling behind in relative terms. Some would say that the introduction of social partnership in the late 1980s is a good illustration of that mechanism in practice. (OK, it involved wage restraint, not wage cuts, but that was useful in itself at the time, especially in the context of devaluation.)

The question for you all is: how flexible are private sector labour markets in Ireland today? We have all read about particular firms cutting wages, but how common is that? Are there studies on this? Will private sector wages fall sufficiently on their own, or is there a role for government coordination here?

Some unpalatable pension arithmetic

There are so many fronts in the Armageddon in which the Irish economy is now engaged that some have received less attention than they deserve. The pensions’ crisis is an example. As most of the contributors to this Blog can look forwarding to drawing public service pensions – or like are already doing so – they might not be personally too concerned about the situation facing members of defined benefits schemes that have to rely on employer and employee contributions to meet their liabilities.

The collapse of equity prices has devastated the asset side of pension schemes’ balance sheets. In line with the conventional belief in a long-run “equity premium”, most schemes had between two thirds and three quarters of their assets in equities a few years ago. To make matters worse, the “home bias” of most Irish schemes led to an overconcentration in Irish equities, whose recent performance has been among the worst in the world. As a result, over the last eighteen months the assets of typical Irish pension funds have declined up to forty per cent. All the gains of the bull market of the 1990s have been erased, and in many cases asset values are back to where they were ten years ago but liabilities have continued to grow. Ominously, the annual average return to diversified portfolios over the past ten years has been less than the annual rate of inflation.

To this equity shock should be added a “longevity shock” –the good news on the demographic front has added more years to life expectancy over the past ten years than over the previous twenty and Ireland in particular has been enjoying a catch up with the most advanced countries on this front. Actuaries have to take account of the impact of this on pension schemes’ liabilities. About two years have been added to life expectancy at age 65 since the start of the century – equal to an increase of about twenty per cent in the life span of a pensioner.

And if this were not enough, there is the prospect of lower term “risk free” interest and annuity rates, which will inflate the present value of pension fund liabilities.

So there has been a perfect storm in this area too.

The legislation governing defined benefits schemes stipulates that pensioners have a priority claim on the scheme’s assets. Contributing members take second place in the queue. As a result, the developments outlined above have devastating implications for contributing members.

To give a very simplified example, consider a scheme that roughly balanced its assets and liabilities at €1 billion in early 2007. The scheme was mature in the sense that roughly half of its liabilities were in respect of pensioners.



Total €1 billion

To pensioners

€0.5 billion

To contributing members

€0.5 billion

Focussing exclusively on the decline in asset values – leaving aside the impact of increased longevity and falling interest rates – the situation at end-2008 would be:



Total €0.6 billion

To pensioners

€0.5 billion

To contributing members

€0.5 billion

The priority claim of pensioners on the assets will absorb €0.5 billion, leaving a residual of only €0.1 billion to cover the entitlements of contributing members. This represents only 20 per cent of their accrued benefits.

Long-serving members of a scheme like this should be very worried indeed. Their plight is a time bomb ticking away that has been somewhat ignored in light of all the other economic concerns we are facing. While there are as yet no precise estimates of the size of the aggregate deficit in these schemes, the total certainly exceeds the amounts being used to recapitalise the banking system.

What can be done? If pension schemes fail to meet a statutory minimum funding standard (MFS) each year, they must prepare a funding proposal to employers and members that will address the deficit over a medium term horizon. In the course of 2009 the Pensions Board will be receiving a steady flow of reports from schemes that do not meet the MFS and hence are technically insolvent. Short of a sustained and massive stock market recovery in the New Year, the scale of the contributions increases that would be required to redress the deficits is enormous and unlikely to be acceptable to hard-pressed employers and employees. This raises the spectre of large scale closures of defined benefits schemes, which would have serious social repercussions.

The issue of the potential inequity in the treatment of contributing members relative to pensioners will come to the fore as schemes are being wound up. It is hardly acceptable that someone with twenty or thirty years’ membership of a scheme should be entitled to a mere fraction of what they believed they had accumulated as pension entitlements.

Happy Christmas and a better 2009!

2008 CSO agricultural output and income data disappoint

The CSO recently published its advance estimate for output, input and income in agriculture. Despite world prices for food hitting record highs in the early part of this year, the CSO estimates that GVA at basic prices fell by 17 per cent and that the operating surplus generated in the sector fell by 13 per cent in 2008.

The main reason is that, although agricultural output prices have risen by 20 per cent since the beginning of 2007, input prices driven by higher energy prices have risen even faster. As a result, Irish farmers have experienced a sharp deterioration in their terms of trade from its recent peak in September 2007. Output prices relative to input prices fell by 20 per cent between September 2007 and October 2008.


Gross value added at basic prices in primary agriculture is estimated to amount to €1,579.6 million in 2008. When interest on borrowing, wages to farm workers, land rental payments and capital depreciation are netted out, the amount left to remunerate farmers for their own labour, land and capital input is the princely sum of … -€186 million! (if you want to do the calculation yourselves, the raw data is provided in the CSO release).

Fortunately, farmers don’t depend on the market for their income (even the supported EU market in which , thanks to the Common Agricultural Policy, they can sell beef and dairy products for up to 75 per cent higher than third country competitors). Thanks to direct payments (which amounted to €1,995 million last year and will top the €2 billion mark this year because of the introduction of a new Suckler Cow Welfare Scheme), farm incomes will remain in positive territory. While some of these payments reflect the role of farming in producing valued public goods, their distribution across farmers is hardly equitable and their future in the light of the 2013 EU budget debate is hardly secure.

Dealing with a problem bank

This post draws attention to two recent examples of best current practice for dealing with a problem bank that is not indispensable to the economy.

Key lessons: no need for capital injections if the bank is not going to survive; no protection for unguaranteed subordinated debt holders.  In a nutshell, the problem bank is wound up; the guaranteed depositors transferred to a strong bank.

While it is now clear that Lehman Brothers was too large and complex a bank to be wound up, this is not true of many other banks. Indeed, even since Lehmans a number of quite large banks have been intervened.  The cases of Washington Mutual and Bradford and Bingley are instructive for any authorities faced with a problem bank whose continued operation is not vital to the economy.

These banks were seen by the authorities as having no viable future, and as not being indispensible to the economy.  Their continuing business was transferred to other banks.  Government only injected sufficient funds to cover insured depositors: no new capital was needed as the rump banks were gradually being wound up.  Holders of uninsured and unguaranteed subordinated debt and preference shares faced heavy losses (they had been earning higher interest in recognition of default risk).

More detail:

On September 25th, 2008, Washington Mutual, one of the largest banks in the US, was intervened by Federal Authorities.  Its insured deposits and mortgage book was sold to the bigger bank JP Morgan Chase.  Retail customers were able to continue access their accounts the following morning and in the same old branches, but now owned by JPM.  Little or nothing was left to pay WaMu’s $22.6bn in unsecured debt, let alone the shareholders.  See:

On September 29th, 2008, Bradford and Bingley, a large UK mortgage lender, was intervened by the British Authorities.  All of the deposits were transferred to Abbey National and depositors had continued access to their funds through the B&B branches, now operated by Abbey.  Mortgage holders continued to make debt service payments to B&B, now owned by the Government.  Subordinated debt holders will lose much of their investment.  See:

Banking Crises: An Equal Opportunity Menace

Carmen Reinhart and Ken Rogoff have released a new cross-country empirical study “Banking Crises: An Equal Opportunity Menace“.   Their analysis shows that the average fiscal impact of a banking crisis is to increase the level of public debt by 86 percent, such that the public debt nearly doubles.  They also show that the typical duration of a housing bust is 4-6 years.

Such cross-country averages are useful benchmarks and it is useful to think about the reasons why the current Irish crisis might deviate from such patterns.

Update: Reinhart and Rogoff have also just released a much shorter companion paper “The Aftermath of Financial Crises”  [to be presented at the January AEA meetings in San Francisco].

Building Ireland’s Smart Economy

The Irish government’s economic recovery plan can be found here. This report has a wide-ranging agenda.

For university-based economists, the following section is especially interesting, since it may represent an important shift in the government’s approach to funding research:

“The creation of more concentrated research-intensive excellence will enhance the country’s reputation internationally and its ability to attract top-level researchers and will underline Ireland’s intentions in terms of the development of the Smart Economy.  It will also enhance the international exposure of Irish
universities and institutes of technology.”
(page 75)

New Irish data releases

A busy day for CSO releases.   The quarterly national accounts are published here, while the BOP data are here. In addition, the CSO released the 2006-2007 data for services trade, which can found here.

A striking feature of the data is the wide divergence between GNP and GDP for Ireland, with the most worrying data point being the 0.9 percent decline in GNP during the 3rd quarter (corresponding to an approximately 3.6 percent contraction at an annualised rate).   The widening of the current account deficit, despite the slowdown, signals the external competitiveness problem.

Crisis containment: too little, too late

CES Ifo’s latest quarterly Forum has just appeared with a special issue on the financial crisis with articles by Hans Werner Sinn, Barry Eichengreen, Martin Hellwig, and yours truly, among others.

Download it free at

My piece develops the argument that containment and resolution policy started too slowly and emphasized liquidity rather than solvency issues.  True of Ireland as elsewhere.  Only now are some of us coming to terms with this.

Fiscal Policy and International Competitiveness

Two current policy problems for Ireland are to tackle the loss of external competitiveness and to determine the appropriate level and composition of government spending.  These issues are linked, since government spending affects the real exchange rate for Ireland, through its impact on the relative price of nontraded goods in terms of traded goods.

In a new paper  Fiscal Policy and International Competitiveness: Evidence from Ireland(joint with my TCD colleague Vahagn Galstyan), we show that the long-run behaviour of the real exchange rate and the relative price of nontradables is increasing in the long-run level of government consumption but decreasing in the long-run level of government investment.

The intuition is that government consumption tends to drive up economy-wide wages and nontraded prices (since the public sector competes for scarce labour and non-traded inputs), while government investment in the long run improves productivity (especially in the non-traded sector) which is associated with a reduction in the relative price level.

The appropriate levels of government consumption and government investment depend on a range of socio-political factors, but these results are worth noting in any debate about the connections between fiscal policy and external competitiveness.

ECB Financial Stability Review: Property Decline worst in Ireland

The ECB has released its latest Financial Stability Review.  From a domestic perspective, the report highlights that Ireland has seen the sharpest decline in commercial property values, from the fastest-growing market in early 2007 to the greatest contraction in 2008, with the gap growing over the course of the last few months. Similarly, the Irish residential property market is the worst performing in the euro area.

SSISI Meeting, 20th January 2009, 6 pm at RIA

The next meeting of The Statistical & Social Inquiry Society of Ireland will take place on Tuesday, 20th January 2009, starting at 6 pm [SHARP], at the Royal Irish Academy, 19 Dawson Street, Dublin 2. The President, Dr Donal de Buitleir, will be in the chair when Mr Michael Moloney and Dr Shane Whelan (UCD) will present a paper titled Pension Insecurity in Ireland. The text of the paper is available at, and an abstract is set out below:

The annual amount of the state subsidy to occupational and private pensions in Ireland is double that previously believed and is of the same order as the total annual payments under the state flat-rate contributory and non-contributory pension schemes. We ask: does the state get value-for-money from these subsidies? To answer the question we introduce the fair value approach to value pension entitlements. The current regulatory regime is shown to be very weak, with the security of pension entitlements of those in employment below that of investment grade debt (so the pension promise if tradeable would have junk status). We suggest and analyse measures to improve members’ security and recommend that the fair value of pension entitlements be made a debt on the sponsoring employer and that there should be regular disclosure to members of the level of security backing their pension entitlement. The former only gives a minor increase in security in an Irish context but the latter incentivises members to make other provision for their retirement. We conclude by suggesting that the state has a larger role to play in pension provision in Ireland in the 21st century than it played in the last century.

Spanish Banks: Well Regulated but Still Suffering

Tuesday’s FT has a long piece on the Spanish banking system: you can read it here.   An interesting difference relative to Ireland is that the Bank of Spain insisted on banks building up reserves against general future risks. However, these provisions are not formally counted as part of its capital base and the general push towards higher measured capital ratios means that the Spanish banks are also looking to raise capital.  This may reduce the chances of these banks getting involved in acquisitions in Ireland, at least in the near term.

Tax increases are inevitable: discuss

Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.

So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.

Poznan and all that

The latest round of international negotiations under the United Nations Framework Convention on Climate Change in Poznan reached its conclusion last week. The parties to this convention meet twice a year. The latest talks were a preparation for the Copenhagen negotiations scheduled for late 2009. Nothing much happened in Poznan. These were talks about talks.  Should one pity the civil servant who attends these boring meetings, or envy her for all the foreign travel at the taxpayers’ expense?

By the way, the Irish taxpayer need not worry about such expense: The Irish delegation to the climate negotiations travels on account of official development aid. Poor foreigners foot the bill.

The irrelevance of Poznan is best illustrated with the fact that the European Council met during the “crucial” end-phase of the Poznan conference — and made decisions about European climate policy. The decisions are bizarre from an economic viewpoint.

The main target of European climate policy was unchanged. We will reduce greenhouse gas emissions in 2020 to 20% below their 2005 levels. A number of countries expressed concern about the costs of meeting such a strict target. These worries were placated by grandparenting more emission permits, and auctioning fewer. This is exactly wrong. Cap-and-trade with grandparented emission permits is roughly equivalent to a carbon tax with lump-sum recycling. Cap-and-trade with auctioned permits allows for a smarter recycling of revenue. In fact, almost any recycling scheme is smarter than lump-sum. In this particular case, the revenue is essentially a capital subsidy to energy-intensive industries (but long after credit will be uncrunched), although it can also be interpreted as a windfall profit. The agreed compromise is not bad for the environment as some environmentalists have claimed because emission targets are the same. The agreed compromise is not good for the economy either, contrary to the claims of the politicians involved. It is bad for the economy, but good for shareholders in energy-intensive industries.

More festive cheer

Another instalment of miserable analysis to help maintain the festive spirit! This time, on cross-border shopping, patriotism and the real exchange rate.

Also, a paper by Olivier Blanchard on Portugal that got me thinking along these lines:

It all suggests that, as far as public sector pay is concerned, the commentariat is focused on quite the wrong question. It’s not whether there should be a public sector pay freeze, it’s how big the pay cut should be.

Should Ireland Try a Fiscal Stimulus?

Responding to Labour leader Eamon Gilmore’s suggestion of a fiscal stimulus at his party’s recent conference in Kilkenny, Jim O’Leary argued in yesterday’s Irish Times that the option is unattractive. I would like to expand on some of Jim’s points and offer a few more.

The first is that the Government’s fiscal targets for 2008-2011 will in all likelihood be over-shot significantly in 2008 and 2009, and will be hard to hit in the terminal year of 2011. The targets are (as per the Budget Stability Update), GGB deficits for the years 2008 to 2011 at 5.5%, 6.5%, 4.7% and 2.9%. The gross debt grows from 36% through 43.4%, 47.5% to 47.8%, while net debt starts at 25% and grows through 31% to stabilise at 34% for both 2010 and 2011. 

To begin with, the out-turn for 2008 will be a GGB deficit of maybe 6.5%: the NPRF vauation was 10% of GDP at end-June, but can only be 9% at best now; and GDP for 2008 will probably come in under the figure assumed in this table. At end 2008, gross and net debt ratios will likely be 2 to 3 points higher for these reasons. But borrowing in 2009 could be in the 8 to 9% zone, rather than the 6.5% target, and the assumed growth in NPRF value in 2009 may not happen. There could be bank bail-out costs not included in the budgetary arithmetic. At end 2009, gross debt will likely breach 50% (of nominal GDP below the 2008 outcome), and the net debt ratio could approach 40%. These would be the numbers before the fiscal consolidation begins!

There is a casual assumption being made by some commentators, and possibly some Governments, that the sovereign debt markets will pony up whatever is required, at least for developed countries and certainly for Eurozone members. But Germany struggled with a bond issue during the week, secondary markets are illiquid, spreads have widened and the weakest Eurozone member (Greece) trades 1.65% above bunds at ten years. The second-weakest is Ireland at 1.35%, and some Eurozone countries with worse debt ratios are trading on narrower spreads than us.

Martin Wolf argued in the FT during the week that a weaker Eurozone member could, in principle, default. There cannot be a currency crisis, but there can be a credit crisis instead. Greece is the current bookie’s favourite, but Wolf described Ireland as ‘…a dramatic case’, noting the speed of the fiscal deterioration and the over-leveraged private sector. The system as a whole needs to de-leverage, and there is no point offsetting a necessary balance-sheet improvement in the private sector with a public borrowing explosion. Indeed, de-leveraging the public sector through liquidation of the NPRF at some stage, and crystalising the painful losses, will need to be addressed. If you can’t easily sell debt, you may have to sell equities, as many hedge fund managers have discovered.

Any attempt by Government to stimulate will run up against Ricardian Equivalence anyway, even more so in the UK version, where the tax reductions are accompanied by specific commitments to increase taxes later. If the private sector is determined to improve its balance sheet through cutting consumption and investment spending, fiscal easing will either fail, in which case it is pointless, or ‘succeed’ at the cost of frustrating the unavoidable private sector adjustment.

Finally, Mr. Gilmore proposed specific capital spending initiatives, such as school building. These may be better projects than some other components of the capital programme, but it is notoriously difficult to fine-tune with capital spending.