Where is the demand?

It is one thing for little Ireland to assume that she will recover through exports. It is more alarming when bigger countries assume the same thing, since then one has to ask: where will the demand come from? If we all wait for others to provide it, we may wait a long time.

Martin Wolf has been arguing for a while that the collapse of private demand in high-spending economies such as the UK and US has left a hole in the world economy that has to be filled somehow, and that those countries’ governments will only be able to do so much to fill it. Those limits may be reached in the British case sooner than he may have initially anticipated. As he points out today, the collapse of the German and Japanese economies is the logical flipside of this same coin. It seems that the Germans are finally waking up to the scale of the crisis; how depressing then to read that Berlin is as resolute as ever in its refusal to do what is necessary (HT Eurointelligence):

Auch wenn es immer weiter abwärts geht – weiteres Geld zur Stützung der Konjunktur will die Bundesregierung derzeit nicht bereitstellen. Gleich zu Beginn des Gipfels habe die Kanzlerin klargemacht, dass man nicht zusammengekommen sei, um über ein drittes Konjunkturpaket zu reden, heißt es später. Die Koalition ist sich darüber einig und lässt die Gewerkschaften, die entsprechendes fordern, abblitzen. “Kontraproduktiv” nennt Steinbrück deren Rufe nach zusätzlichen hundert Milliarden Euro.

On the contrary: Steinbrück’s obstinacy is what is counterproductive. One supposes they will eventually change their tune, but how many workers must lose their jobs before that happens?

Ahearne on Nationalisation

The government has been trying out a series of arguments against nationalisation.  However, while one can make cogent arguments against nationalisation (and we have had a wide-ranging discussion about these arguments on this blog) the latest arguments from government seem particularly weak.  My old friend Alan Ahearne, now special adviser to the Minister for Finance, roled out the latest arguments today:

“Nationalization has lots of downsides for a banking system like Ireland which relies on international funds,” Mr Ahearne, a former Federal Reserve economist, said at an event in Tullamore, Co Offaly today.  “Nationalization is often viewed from wholesale markets as a sign that the banking systems have completely failed.   That’s a message the Government would not want to give out,” he said.

Let’s recall, however, that the only reason the Irish banks are currently able to borrow international funds is because the government has issued a blanket guarantee on their liabilities.  In effect, the banks’ debts are also government debts.  So, there is no reason to think that nationalised banks would have any less access to international funds than the current propped-up outfits.

As for not wanting to send out messages about the poor state of our banking system, I think that’s a ship that’s already sailed.  We should not let wishful thinking substitute for a rational assessment of the scale of our problems.

IMF on Costs of Financial Stabilisation

The Irish Times lead story cites the IMF’s Global Financial Stability report as having the following sentence: “The United States, United Kingdom and Ireland face some of the largest potential costs of financial stabilisation (12 to 13 per cent of GDP) given the scale of mortgage defaults.” It turns out, however, that the IT was a little behind on a (fairly silly) controversy about this sentence.

It turns out that the IMF’s cost estimates are not new at all but actually first appeared on page 17 of this report released on March 6, which was written as a companion to this report on the outlook for public finances around the world.  The March 6 paper reports a cost figure of 13.9 percent of Irish GDP, which amounts to €24 billion.  Table 4 also reports the cost for the UK at 9.1 percent of GDP.

For this reason, there was a bit of a flap over this when the BBC reported the 12-13 percent figure, with the UK Treasury pointing out correctly that the sentence and its accompanying table were wrong.  The version of the report on the website no long contains the parenthetical “(12 to 13 per cent of GDP)” that the Irish Times had quoted and the table has been altered—I think Ireland may have been listed in the original Table 1.8 but we are not now.  In any case, you can find the original source of the calculations from the above link.

So, not the IMF’s finest hour.  However, beyond the silliness, it is clear that the IMF’s assessment of the likely costs of financial sector support measures to the Irish taxpayer does not fit well with the government’s current stance that “under extreme stress scenarios” BOI only need €3.5 billion in additional capital, while AIB only need €5 billion.

The Fed’s Exit Strategy

The Fed is using an impressive range of firepower to counter the greatest deflationary threat since the Great Depression.   With such massive injections of liquidity, however, it is not surprising that leading figures are already debating exit strategies and the extent of the longer-term inflationary threat.   It is a fascinating debate to watch. 

John Taylor worried in the FT last month that “extraordinary measures have the potential to change permanently the role of the Fed in harmful ways.”   He said, “The success of monetary policy during the great moderation period of long expansions and mild recessions was not due to discretionary interventions, but to following predictable policies and guidelines that worked.” 

Writing this week in the FT, Martin Feldstein is also anxiously looking ahead:  “[W]hen the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.  This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.”

Robert Hall and Susan Woodward strike a more optimistic note in a piece on the VOX site:  “[T]he Fed can control inflation by varying the interest rate it pays (or charges) banks on their reserve holding. Consequently, the Fed’s exit strategy need not be constrained by concerns about inflation – reserve interest-rate policy can take care of inflation, but the Fed should publically announce this policy.”

AIB Re-Cap Announcements

So where does the substance of the AIB announcement leave us?  As has often been the case with the government’s approach to the banking crisis, this pushes us one step closer to some kind of resolution, while still maintaining lots of uncertainty as to what that resolution will look like. 

Continue reading “AIB Re-Cap Announcements”

Goodwill Hunting at AIB

I’ll write a bit more later on the substance of the announcements today from AIB and the Department of Finance. However, I thought I’d first discuss an aspect of today’s developments that hasn’t been discussed in most of the press reports. Together with the Minister for Finance (with whom they have good reason not to disagree) AIB have “formed a view” that they need to have an extra €1.5 billion in Tier 1 capital.

Those who followed AIB and BOI’s fruitless attempts to raise equity in recent months were probably surprised to hear that rather than just announce that AIB was taking an extra €1.5 billion from the government, the bank stated that it was planning to raise these funds itself.  Most media stories have focused on how AIB can achieve this by selling its minority stake in M&T, an American bank, and perhaps also selling its stake in a Polish bank.

Now here’s where it gets tricky. RTE and other media outlets have reported this as a simple story of “bank short of funds raises funds by selling assets.” The problem is folks, that plausible as this may sound, that’s not the story at all.

Continue reading “Goodwill Hunting at AIB”

Voting with their feet

Not literally, of course, as no one since Fionn mac Cumhail has left the island on foot. Most people fly. While reliable and timely data on migration are hard to get, we do know how many people fly out of country, and how many fly in. This data can be had from the CSO for every month since January 2006. Unfortunately, the data are released with a six-month delay (courtesy of Dublin Airport Authority). They are instructive nonetheless.

Between Jan 2006 and Oct 2008, 30,282 more people arrived at one of the seven airports than left. This trend has reversed however. While 35,453 entered the Republic of Ireland between Jan 06 and Oct 06, and 72,936 between Nov 06 and Oct 07, 78,106 people left between Nov 07 and Oct 08.

That is, eighty thousand people took a one-way flight, before the scale of the recession was clear.

Of those 78,106 people, 58,980 left for Great Britain, 11,018 for Germany, 6,750 for Poland, 6,409 for the Czech Republic, and 4,161 for the Baltic countries. Between Nov 07 and Oct 08, 4,164 people came from Italy, 3,966 from France, and 2,456 from Hungary.

A NAMA for Germany?

From today’s Eurointelligence

There is some movement in the debate on bank resolution policies in Germany. FT Deutschland has the details, according to which the government is currently favouring a model proposed by investment bank Lazard. According to one variant of this model, the government takes the toxic assets from the banks, in return for government debt obligtation, which carry ultra-low interest rates, and which the banks promise to keep on their books for a long time. The idea is that such a construction prevents spillovers into the general bond market. Another construction is a bad bank, which holds the bad assets, and which issues government-guranteed debt obligations to the good bank.

On Nationalisation

The debate on bank nationalisation on this site and elsewhere has been taking place at an impressively high level.    Owing to the efforts of Karl and others, we stand a much better chance of having a rational banking policy.   Yet I can’t help being puzzled at the depth and breadth of the support for nationalisation from so many leading economists.    I have no doubt that this support for the state ownership of such a critical sector of the economy is not a position easily come to.   What has led so many liberal-leaning economists to support nationalisation? 

As best I can read it, there is a huge fear of government failure at one level, and a relatively relaxed attitude to failure at another.   The driving fear – indeed prediction – is NAMA will significantly overpay for bank assets, imposing a potentially huge cost on taxpayers.    On the other hand, while advocates of nationalisation are well aware of the dangers of politicised credit allocation, I think it is fair to say they believe we can devise institutions that would allow arms-length control and speedy re-privatisation. 

I weigh the risks of these two forms of potential government failure differently.    On the overpayment risk, a critical achievement of the debate so far is to shine a searchlight on the danger.   With this danger firmly in mind, it should be possible to devise effective and transparent mechanisms for determining and paying expected value.   Innovative mechanisms – such as Patrick Honohan’s idea to combine lower direct payments with shares in NAMA – can help attenuate overpayment bias and reduce risk to the taxpayer.   Bottom line: I think this risk is manageable with due attention. 

I am more worried about the danger of a politicised credit system – even with politicians having the best of intentions going into their new roles.   On my reading, the international evidence on bank ownership and performance raises a huge cautionary flag.   (A good survey is:  William Megginson (2005), “The Economics of Bank Privatization,” Journal of Banking and Finance, 29, 1931-80; working paper version here).   While recognising that selective quotations do not prove a point, I think the following from another paper by Andrei Shleifer and co-authors gives a good sense of the danger:

A government can participate in the financing of firms in a variety of ways: it can provide subsidies directly, it can encourage private banks through regulation and suasion to lend to politically desirable projects, or it can own financial institutions, completely or partially, itself.   The advantage of owning banks–as opposed to regulating or owning all projects outright–is that ownership allows the government extensive control over the choice of projects bieng financed while leaving the implementation of these projects to the private sector. Ownership of banks thus promotes the government’s goals in both the “development” and “political” theories.

. . .

We find that higher government ownership of banks is associated with slower subsequent development of the finanical system, lower economic growth, and, in particular, lower growth of productivity.   These results, and particularly the finding of low productivity growth in countries with high government ownership of banks, are broadly supportive of the political view of the effects of government interference in markets (LaPorta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer (2002), “Government Ownership of Banks,” Journal of Finance, 57(1), 265-301).   

Perhaps paradoxically, the danger of politically directed lending is increased by the compelling rationale for a co-ordinated expansion in credit that nationalisation could facilitate.  Lucien Bebchuck and Itay Goldstein do a good job outlining the basic co-ordination failure and rationale for intervention.  The basic idea is that the creditworthiness of firms increases with a broad expansion in credit given interdependencies in the profitability of investment projects.   A coordinated credit expansion can then shift the economy from a bad (low creditworthiness, low credit) equilibrium to a good (high creditworthiness, high credit) equilibrium.   Nationalised banks would certainly be in a good position to solve the coordination problem.  But such directed lending is likely to be the thin end of the wedge to a more pervasive politician-directed credit allocation system.   I think the long-run costs would be lower with a coordinated expansion achieved through transparent fiscal instruments.  

The ease with which the government has come to direct the investment strategy of the National Pension Reserve Fund provides a useful warning.   As reported recently by the National Treasury Management Agency, investments “under the direction of the Minister for Finance” now account for 23.4 percent of the total fund (and that only includes investments in the preference shares of Bank of Ireland).  Here again there is a rationale for the government’s direction (though I believe it is a weak one given that international bond markets are still very much open for Irish debt).   But any semblance of arms-length governance is thoroughly shot – with as far as I can tell barely a whimper from economists. 

Two final brief points relating to majority government ownership (the most likely alternative to full nationalisation): 

First, in their Irish Times piece the proponents of nationalisation worry that the government would leave the banks undercapitalised under majority government ownership.    Under nationalisation, they see the government having a strong incentive to recapitalise the bank to maximise divestiture value.   However, given the government will eventually want to divest itself under both majority share ownership and nationalisation, I do not see why the incentive to recapitalise is weaker under the majority ownership option.  

Finally, it is reasonable to question whether the risk of politicisation is any less under majority government ownership than under full nationalisation.   However, a key focus of work on politicisation has been on cost to politicians in exercising control.    The transparency and governance institutions of a publicly traded company should make it more costly for politicians to direct the banks’ credit allocation for political ends.  

The concept of ‘legitimate expectations’

The Irish  Times reported in yesterday’s edition on the debate in government over whether to try to effect savings in child benefit expenditure (which currently costs almost €2.5 billion per annum) through means testing or through taxing benefit payments. The report concluded that “briefing notes released under the Freedom of Information Act show senior officials are concerned about the legal implications of major changes to benefit payments. Concern has been expressed that the State could be vulnerable to legal action where recipients may have had a legitimate expectation a welfare benefit would continue.”

It seems to me that to claim a legitimate expectation that a welfare payment (or, presumably, any government payment) would continue would make government decision-making, whether in fiscal policy or welfare policy, totally unmanageable. At face value, it would seem to make any change to a government expenditure scheme, once introduced, impossible (and why stop at expenditure – did we not also have a legitimate expectation that the government would refrain from introducing an income levy?).

It is interesting to contrast this with payments which were actually cut in the budget. In agriculture, for example, annual payments for those farmers enrolled in the Rural Environment Protection Scheme (REPS) were cut by 17% in 2009. There is a much stronger argument against cutting these payments as these are contractual payments – farmers enter into an agreeement to follow certain environmentally-sensitive farming practices for a five year period, in return for a payment from  the State. However, the State has inserted a clause into the Regulation (away towards the end under Paragraph 28) that “The Minister reserves the right to vary, where occasion so demands, the amount of financial aid wherever specified in the Scheme subject at all times to the provisions of any relevant European Union legislation.” Given that farmers incur costly obligations on entering REPS, this unilateral right  on the part of the State to vary the amount of payments may appear rather extraordinary. Particularly given that if a farmer were to decide to leave the  Scheme in response to a change in payments, then aid already paid must be re-imbursed. If these farmers had no legitimate expectation that payments would continue at the level agreed at the start of the 5-year scheme despite a contractual agreement with the Department of Agriculture Fisheries and Food, it seems extraordinary that officials are fearful that any change to welfare payments might be challenged on the basis of ‘what we have, we hold’.

Lessons from Sweden

I linked last weekend to former Swedish Finance Minister’s Bo Lundgren’s appearance on the Marian Finucane show.

Lundgren also appeared recently before the TARP Congressional Oversight Committee, chaired by Harvard Law Professor Elizabeth Warren and his written testimony was the basis for the section on Sweden in the committee’s latest report. Here’s a webpage containing the written testimony of Lundgren and three other experts on other banking crises (Great Depression, 1980s S&L and 1990’s Japan) who all appeared before the committee at the same time.

The webpage also has full video of this meeting. The experts delivered short verbal testimony (Lundgren’s starts about 14 minutes in) and about 40 minutes in there is a question and answer session. Prof. Warren’s opening line of questioning about arguments against nationalisation was of particular interest to yours truly but the whole session is really useful.

Continue reading “Lessons from Sweden”

Irish Economic Association Conference


This year’s conference has a record number of submitted papers covering a wide variety of topics.

The conference Programme is now available http://www.iea.ie/conferences/iea2009programme.pdf: the booking form may be downloaded http://www.iea.ie/conferences/iea2009booking.doc.  There is now very limited accommodation at the conference hotel: further information from the local organisation: ieaconference@ucc.ie

There will be two plenary guest lectures:

The Edgeworth Lecture (sponsored by the Central Bank of Ireland and Financial Services Authority of Ireland): Professor Paul Collier (University of Oxford): The Political Economy of State Failure.

The DEW/ESR Lecture: Professor James Heckman (University of Chicago and UCD Geary Institute. The Economics and Psychology of Personality .

As can be seen from the programme, there are eight sessions on macroeconomics, money and finance. As usual the conference is strong on labour economics with three sessions on the topic. In all there will be 27 sessions with 80 papers. In most cases four sessions will run in parallel.


Distributional Impact of Budget(s) 2009

SWITCH, the ESRI tax-benefit model has been used to analyse the distributional impact of the tax and welfare measures in the October 2008 and April 2009 budgets. Results show a significant gain for the lowest income quintile, with losses for other quintiles increasing with income. For details see here for the Irish Times article of Friday 10 April.

Skills Deficits

One of the things underpinning a lot of posts, notably Karl’s last one, is that there is an elephant in the living room here around the human capital available to deal with economic issues within the core Government Departments.  We know the tales of how there are no economists in the civil service.   What is badly needed is something like the Government Economic Service in the UK. This ensures two things – the presence of a cadre of professional economists within the sector, but also the harmonisation of the training across Departments giving a unity of approach regardless of the topic. Of course the development of PhD capacity in Ireland will help but that takes time – wondering aloud, should we as a body of economists not begin to work with the Government to develop a GES model for Ireland and also develop the training structures?


Thanks folks, for the comments.  I am going to stay out of the debate around constitutional crisis this would cause…..and just pick up some threads.  Cormac’s comment hits it well and he would know well from working at IFS in London what I mean.   The GES is NOT an new body accountable or otherwise – it is a training infrastructure for the civil service that ensures that economists are trained in a way that is consistent across the service regardless of their posting.  It also ensures that economists can move between Departments, be redeployed etc very easily and that economics has a core platform within the service.   Secondly, the issue is not creating new degrees etc but rather to work with the civil service to ensure that platform is in place.  Thirdly, there is both an immediate need for a small, highly skilled cohort now – perhaps this is the 10 or so that Brian L discusses – but the idea that we can continue with the lamentable lack of economics as a core discipline across all government departments needs to be tackled.   In effect health, education, environment and employment have no structured economics unit and to revert briefly to constitutional issues, to be relying on external ministerial advisors is worrying.   Finally, for sure this would need a change in how things work – the economics unit in the UK looks at EVERY piece of policy and proofs it against standard metrics.

Thanks again, folks, for the comments.


Arguments Against Nationalisation, Part 5: Lack of Government Expertise

[Last in Series …. For Now]

Speaking with Myles Dungan on RTE radio on Thursday, Minister Eamon Ryan put forward the following argument against nationalisation:

You have to run the whole bank, the system, from Merrion Street … And there’s no ability, I believe, in the Department of Finance to run six banks at the one time … They [the Department of Finance] recognise that you don’t just suddenly start running six banks. And you can’t do it in a very transparent way.

I think the Minister raises a fair concern here, so I thought I’d throw this one out there as my final (for now) post on this.

Continue reading “Arguments Against Nationalisation, Part 5: Lack of Government Expertise”