David Begg on Fiscal Policy and Deflation

One of the great unanswered questions of our time is why the ICTU dudes are regarded by the media as credible macroeconomic commentators, rather than as just another set of problematic vested interests fighting their corner. David Begg is as objective as Tom Parlon or the boss of the ICMSA.

As to the standard arguments advanced by the unions (cutting our members’ wages will deflate the economy, etc), we’re already spending half a billion a week that we don’t have. If running up huge debts was the solution to the problem, we wouldn’t have a problem in the first place.

While some of the proposals have merit the idea of extending the adjustment out to 2017 is crazy.

By even the most optimistic assumptions that would push our debt to GNP to well over 100%. And put us on par with the worst countries in the would.

In the unions document, they only look at debt ratios out to 2011 which is meaning less if you plan to borrow for another 6 years. If they want people to believe we can borrow until 2017 then they need to spell out what it will look like at that time.

@Dreaded_Estate

Putting any date to the adjustment is crazy IMHO. It doesn’t make sense to say, “Okay, no matter what happens, this is what we will do, and damn the numbers and the consequences.” The adjustment should happen when the economic indicators say that it’s doable without screwing the pooch: the big indicator being job creation, because it’s a lagging indicator that represents investment and growth on the one hand, all of which will lead to increased revenue on the other hand. Then cuts in spending do not have to be so deep and you don’t kill the patient. I know that Maastricht says budgets should never be more than x% of GDP in deficit. That treaty did not foresee this, and realistically should be held in abeyance, for this is an unprecedented situation in modern economic history, in regards to its global reach and scope. I do notice that when the EU really wants to get around parts of their treaties, they usually find a way.

I can’t help but feel that there are forces trying to use the crisis to cut wages and benefits, just cuz that’s been on the agenda for a while. Competitiveness is a code word for lowering our living standards and expectations (Boots, I’m looking at you). Who are we directly competing with here, China? Not gonna happen, we can’t compete with them. Eastern Europe? People worked hard in order to improve the living standards here in Ireland, and now you want Latvia? Why then did we bother?
So they set the stage for the private sector workers to blame the public sector workers, and those nasty welfare kings and queens. Being from the States, I’ve heard that one before. The reason the politicos want to cut now must be that they know it will make the exchequer worse, so then they can cut even more. They can see the downward spiral very well, and are happy enough, at least as long as they feel that they will be able to use their clout to protect themselves from it. NAMA to protect asset prices, deflation to keep the value of debt high. Leave capital and corporate wealth alone in all the cuts — because that’s the side their bread is buttered on.
It’s class war. I know we’re not allowed to say it, but what else could it be?

@ Marise

“People worked hard in order to improve the living standards here in Ireland, and now you want Latvia? Why then did we bother?”

Eh, are public servants earning €51k or so in Latvia? Sorry, €46k after a suggested 10% pay cut? No they are not. Even after a 10% pay cut our public sector would remain one of the most highly paid in the world. In the UK average earnings in the public sector are just under €30k. We pay our public sector 66% more than our nearest neighbour! The upward-only pay reviews which seem to exist in the public sector need to have at least some connection with the economic cycle and the budget deficit.

We’re running a huge structural deficit, circa 7-8% of GDP, and we have been building this up for the last 5 years or so. It was just hidden by enourmous one-off transaction tax receipts and a debt fuelled economic cycle. Neither of those is, nor should, return in the next 10-15 years. Tax receipts could take a decade to return to the peak levels, so to suggest that we keep expenditure levels relatively unchecked is economic lunacy.

@ Ernie

i agree, comparisons with Latvia are ridiculous, but so to is trying to suggest that thats where our standard of living is heading.

Ireland vs UK, public sector wages in light of PPP. Discuss.

Good that David Begg has taken some time out from his many jobs to inform the masses as to the dangers of deflation by trying to balance the books.

Why, ask anyone in the Central Bank, where David is a director. Were it not for Davids timely preaching of countercyclical policies, which caused the bank to rein in the baking speculators, we would be facing into a very difficult 2010.
Or ask those working at Aer Lingus, thanks to Davids unique knowledge of aviation policy which meant he was a logical choice for a directorship; the company which was struggling under the ineffective leadership from Mr Walsh, has now been turned around almost completely.
Or perhaps those at the Irish Times Trust might vouch for his business insight; they have gotten a real bargain buying myhome.ie at a time when property related investments were deeply unfashionable.

We should listen to this man very carefully. I, for one, shall sleep much more soundly tonight knowing our plight has captured the great mans attention.

Begg says we shouldn’t be crippled by an overly ambitious deadline of 2013. But let’s face it, who really believes we can make our 2013 deadline anyway? Our government is already hinting that instead of tackling our vastly inflated public sector pay we should make savings by reform. Come on, pull the other one. Reform: We’ve heard that one before. So all indications are that we are never going to make the 2013 target anyway.

At the top end of public sector pay we know our pathetic little would-be republic didn’t merely get carried away a bit, it completely showed us up to be crass, vulgar, greedy, and pitifully deluded. Our elite, and I take in here the ruling class of politicians and also the so-called social partners, and boards and execs of the endless list of government quangos and agencies, now, when the glaring spotlight of economic and political reality beams in their eyes, look like a bunch of swine lifting their stiff dribbling faces from the trough of national treasure.

Our Taoiseach and ministers paid more than equivalents almost anywhere. Head of HSE paid more than head of NHS. Execs of any and every petty, nobody-knows-what-they-do, quango paid six figures sums. It is as if a strain of madness just ran rampant through our system of economic and political governance.

The shameful, pathetic, and unsustainable delusion that took root at the top is no less evident all the way down – only on a lesser scale. Here we see public servants paid far, oh yea far, more than their private sector counterparts with conditions that are now anachronistic – wholly of another era with the real world.

And union leaders on six figure salaries – who campaigned hard to gut our income tax base and were sitting on the boards of many of the organisations that screwed us – are now denying they were social ‘partners’. They are denying their own legacy, seeking to unhitch the mad, errant, trailor of partnership that has led us to the precipice of destruction.

Union leaders deserve our contempt in a way that others don’t because they would have us believe – in arrogant, mock-aggrieved tones – that they have a monopoly of compassion and that their members are a special case. All of which is the purest material that every emerged behind any bull.

The picture emerging is depressing : a weak, supine, and spent government is going to capitulate to vested interests on all sides. At the very moment when our nation needs leadership, we get more mealy mouthed capitulations and postponements by an FF-Green government that is the embodiment of cowardice.

At the moment of truth not a single figure – from any side of the national elite – managed to step up to the plate and assume real responsibility, take real risk, put party or lobby interests second to those of the nation.

Partnership was great during the boom, but now, instead, its whole edifice has collapsed into a fracas of competing interests.

Dreaded_Estate – I would point out that we have €30 billion in free cash balances which we are already paying interest on. The recent ESRI Quarterly Review projected a gross debt/GDP ratio of 76% by end of next year but when the exchequer cash deposit are included, our net debt will be only 62%. This compares with an average 84% in the Eurozone (though this no doubt overstates the net situation for other countries as they, too, will have cash balances for cushion). Historical cash cushions in Ireland has been 4%. So assuming this is the case for Eurozone countries, there is still a gap of between €25 and €30 billion. That’s the amount the NTMA has pre-borrowed already.

Going forward, if the Bruges Group’s estimate is correct – 90% EU debt average in 2013, then Ireland is on course – even with the Government currently missing its fiscal target by a wide amount – to undershoot that level by a wide margin. The April budget projections are for an Irish debt ratio of 77%. It will be higher, but no where near 90%. Still, benchmarking the Eurozone average in the medium term would be neither extravagant nor imprudent – but the wise course would be to create a convergence nearer 2017 rather than earlier.

There are still considerable fiscal strengths to be played to – strengths that are being whittled away by the Government’s deflationary policies. This isn’t a recipe for going on some kind of spending spree. But it does suggest that we can look at more sophisticated strategies that seek to combine the two imperatives: boosting economic investment and repairing the public finances. In fiscal policy, it is possible to walk and chew bubble-gum at the same time.

All comparisons are lame; of course it is easy to highlight differences between Japan and Ireland regarding inflation. In fact the Irish situation is worse in this regard; most macroeconomic models assume a monetary easing in response to fiscal tghtening. But this is not open to Ireland because of monetary union and a soaring Euro. Interest rates have already been slashed (but, because of domestic delfation, remai high in real terms). There will be no offset to a deflatinary fiscal policy here.
However, the central point is correct, namely deflation is counterproductive, leading to both lower growth and (therefore) a deterioration in govt. finances, not the sought-after improvement. Or put another way, there is no example of a deflationary course being set in simiar circumstances to our own where the authoriities achieved the type of rapid improvement in government fnances currently being targeted by the government, not in Japan, not in the UK from 1976 onwards, not in US in the Great Depression, where, it is widely accepted, the attempts to balance the budget were a decisive cause (amongst others) of turning a recession into a Depression.

@ DE

did some back of the envelope maths on the debt/gdp ratio in 2017 if we go with a slow fiscal adjustment.

Assumed 12/11/9/8/6/5/4/3% budget deficits each year from 2010-2017, and 2.5% economic growth each year, and starting with a 59% end-2009 debt/gdp ratio.

Spat out a figure of 101% for 2017, and this actually ignores the impact that bigger debt issuance/interest payments would have on the budget deficit itself. Would also lead to a situation where around €11bn per year would go on interest costs alone, and so would be north of 20% of all expenditure. Assuming GDP is 10% more than GNP, it’d put our debt/gnp ratio at 112%.

This is the forecast debt ratio that David Beggs does not want you to know about…

Philip,
Trade unionists always seem to use the term “deflationary” when they mean “contractionary”.

@Eoin
And Italy has 1 of the 5 worst debt to income ratios in the world!

Eoin and Dreaded_Estate – your projections are helpful in trying to take the debate away from the realm of mere assertion. Eoin – I note that you may be using the Government’s macro-economic projections from the April budget. Unfortunately, all those numbers have gone south. Therefore, in calculating the proposal to extend the target date, you’d have to start at a higher point than 12% (the ESRI projects the deficit to be 12.8% factoring in the €4 billion fiscal contraction).

However, as a comparative exercise it can shed some light. By 2013 – using the NTMA’s write-down schedule – the GCD/ratio would increase to 88% (from the Government’s projected 77%) with a new net ratio of 84% (as compared to 83%). If the Bruges Report projection is accurate, then Ireland would still be below the EU-15 average.

But it’s more than just revising all these deficit numbers higher (with an additional €10 billion in Exchequer cash balances). We have to revise the GDP upwards. The ESRI – calling the proposed €4 billion fiscal contraction planned for this budget ‘significantly deflationary’, stated that if this did not proceed, then the economy would emerge from the recession earlier and that growth next year would be positive (as it is, they are predicting it to be -1.1% GDP). Therefore, the higher debt level under a target postponement is not a % of the Government’s projection, but rather a % of a higher GDP – and consequently lowers the ratio than would appear using the Government’s projections going forward. As it is the Government is projecting 4%+ growth in 2012 and 2013.

And that’s the point of David Begg’s proposal – by removing the deflationary pressures that adherence to a premature target date creates, we can generate more growth and, hopefully and importantly, more jobs. I’ve never thought, though, that postponing the target date is sufficient, however necessary. What are needed are fiscally active policies to start reducing the cyclical debt. It is only in that context will consolidation measures have more traction and not unduly depress the economy.

However, you have set up a challenge which those of us who agree with David must rise to. I’ll do some more detailed work and put it up on my own blog.

Also, I would just point out that its’ not only trade unionists who believe 2013 is achievable. The recent Goodbody Stockbrokers’ Economic Review also believes it won’t be achieved.

@ Michael

i suppose i’m somewhat in agreement with you about 2013 possibly not being acheivable, but thats also sorta the problem. If we aim for 2013, at least we might hit it in 2014 or 2015. The fear would be that by aiming for 2017, we’d end up overrunning to 2020 or beyond, especially given the effects that a debt spiral could have on public finances. Think about it – we’re essentially looking to run up huge deficits for around a decade or more. This is especially important at the front end of this process, as we have to convince the markets that we’re serious about reform process we’re about to undertake. Stepping back from what have been perceived to be big, bold and real adjustments would send exactly the wrong message to the rest of the world right from the get go. The feeling i get from Beggs is that he would prefer if actual reforms never really arrived, and that we just inflated our way out of the problem with government borrowing.

Governments generally talk big and deliver small. At least by trying to keep the fiscal adjustment to a relatively small and forecastable time frame (3-4 years), we shouldn’t miss it by that much. Pushing it out to a 8-9 year time frame, with lots of puff pieces on reforms, productivity gains and transformation, would likely end up with nothing material actually changing. The risk therefore is of the us overshooting by twice as much, both in nominal as well as timeframe terms.

But i have a question for you – would you be in favour of significant increases in expenditure aimed at supporting the private sector and creating new private sector employment, but only if there was a significant reduction in public sector expenditure? Do you think David Beggs would be?

By the by – i have 2.5% economic growth figures pencilled into those projections, starting with 2010. I think i’m being fairly decently on the optimistic side of the column there!

It seems that your points Philip are a difference of degree, rather a difference of opinion when contrasted to David Beggs article. What the latter prioritises is ‘political’ economy, an area that Michael Taft has now championed to great effect. Recognising that economic decisions have political effects that benefit some and not others results in two different economic analysis. In Europe, both Begg and Taft would be considered run of the mill social democrats with an recessionary economic analysis that fist neatly into any undergraduate economics textbook. In Ireland, anyone who questions the consensus on public sector cuts, keeping low taxes and letting the market self correct (except for the banks) is considered an economic illiterate. And we wonder why the country is in a mess?

@ Eamonn

the costs of leaving the Euro would be far greater than anything even the biggest NAMA skeptics can dream up arising from it. You’d have an immediate capital flight from the country, never mind the fact that exiting the Euro would technically count as a default on our sovereign debt. The Euro was the only thing that got us through the financial crisis in even remotely decent health. The impending deflation and deleveraging over the next few years are the unfortunate medicine we have to take, and would be required regardless of NAMA.

@ Tomaltach

Thanks, for saving me having to write a post!

@ James Conran and Mick Costigan

I thought that’s what Germany did recently (whether the correction took place completely within the Euro or not I can’t recall, but it certainly came about without currency devaluation)

Essentially their rate of inflation, including wage inflation, was below that of other EU members for a protracted period thereby making them more competitive over time.

@Michael

Generous public sector pay as a form of stimulus seems akin to dropping the money from helicopters and hoping for the best. You can’t control where its spent and on what, if at all.

@ Eamonn

“I don’t think the owners of our existing debt would care so long as we kept them in euros, in every sense.”

Ok, so forgetting the sovereign, how does this work at a household level? Lets say a 20% nominal devaluation in terms of the New Punt vs the Euro – wouldn’t this increase personal indebtedness by a further 20%? I would call this far beyond ‘drastic’ action, i would call it the outright nuclear option only to be considered when unemployment reached 20%+ or so.

@Eoin
When Nama goes wrong the anger against our banks will be immense.
I could see all domestic loans of the guaranteed banks being summarily converted to punts with the banks international borrowings being left in Euros. Now that’s what I’d call levying them. Will this be against EU rules, highly unorthodox, have costs etc, of course. But in a crisis situation drastic measures become necessary. The ECB wil have clean hands on Nama but not the Commission and Eurostat.
The more Nama loses, the more disgraced our elite and their orthodoxies become.
In that situation long-run mass unemployment will grow increasingly intolerable, and leaving the EUro increasingly attractive.

@Eoin
But at least Iceland’s economy is showing real signs of recovery.

@ DE and E76

“They are heading up from a lower base while we are heading down from a higher base”

“But at least Iceland’s economy is showing real signs of recovery.”

I’m sorry, but this is like saying ‘Country A fell by 30% last year and rose by 5% this year, while Country B fell by 10% last year and will fall by another 5% this year. Therefore Country A is in better shape than country B’.

Iceland has a free floating currency and suffered hugely as a result of the global instability and credit crunch, culminating in an entire run on the national currency. What do you think the effect would be of us leaving a common currency union, the same union that shielded us from the most severe effects of the credit crisis? To say very blandly that “it’d be unorthodox and have costs” is rather underplaying the risks by just a tad. We’d be looking at an entire run on all capital within the country, followed by a huge jump in the effective interest rate charged on the country by foreign lenders. We’d also likely see a crash in foreign trade due to the exchange rate volatility and a massive jump in import-led inflation.

Iceland didn’t choose a devaluation, it was enforced on them from the international markets, and only after a complete freezing up of capital flows and a massive ECB and IMF bailout (does anyone see the ECB helping us to exit the Euro?). Why do you think Latvia is pretty much unwilling to do it anytime soon despite coming under huge pressure from the IMF and being in a far worse situation than us?

As regards the ECB, i would argue that their allowing us to use NAMA to avail of the discount window on such a huge scale is a form of qualitative credit easing (not quantitative), but yes, i agree, more needs to be done, and i would expect any major problems in Spain to see this happen. To be honest, many in the markets find it highly unlikely that the ECB will raise rates if the Euro remains strong, as it would only exasperate the problem, so we could be looking at another 12-18 months before any decent move by them.

Worth noting that Krugman said today in Buenos Aires that Spain has to take the same deflationary course that Philip and others are recommending Ireland take. He also sheds light on the question
James Conran asked earlier
(News in Spanish here, I expect it will filter through to the English-speaking media soon. http://www.cotizalia.com/noticias/krugman-recomienda-espana-devaluacion-ajustes-salarios-20091028.html )

Here’s a quick Google translation plus some editing:

“The economist said in a presentation to business executives, that the euro as a single currency, “poses serious problems for depressed regions of Europe such as Spain that have no real way to adjust”. “Spain was building this monstrous bubble that collapsed and now has a 17% unemployment and needs, either that workers move to other parts of Europe, or a relative decline in wages,” he said.

“But workers do not move as freely within Europe. It is very difficult that costs and wages are aligned (with the EU). 20 years ago Spain would have devalued the peseta but today there is no peseta, there is the euro, and it seems that they find themselves in a straitjacket, “he added.

When asked about whether Spain should receive any special assistance from the EU, Krugman said “In brief yes, but that’s not going to happen.” “Life would be much easier if there was a fiscal federalism in Europe. In the U.S., states like Florida and California that were severely affected by the housing bubble, immediately received help because social security is being financed by Washington. That is not going to happen in Europe, ” he told journalists.

The Nobel Prize winner considered that at this “very difficult” situation, “Spain will have to make salary cuts, price cuts. “I don’t like this, it is not a good way to adjust, but is the only way available. I hate this: I do not like deflation, but the reality is that that’s what is going to happen. The question is whether to go for ten years of suffering or relatively quickly, “the economist pondered.

Hi all,
Very interesting forum. We need this type of rational debate and the importance of the need to address the likely borrowings (and repayments)must be communicated to the public at large.
Whether or not ‘payback time’ can be postponed to 2017 without impoverising the next generation or that it should be tackled quicker is an interesting discussion.
I can’t see how this is relevant to the debate about public sector pay. My view is that in the next budget they should cut pay in public sector by about 20 percent(distributed to hit higher earners more).the average pay would reduce from 50k to 40k so nobody would go hungery and would still be better paid than private sector equivalents. To me this is low hanging fruit(I support a family of 5 on 35k). This would raise over 4 billion. A further 2 billion could then be raised in tax measures and other public services cuts. This could be done without effecting anyone earning less than the average.
Assuming this was done the debate would be Whether not this 6 billion savings is used to service debt or to provide a job stimulus and the balance to be stuck. This balance is then decided upon based by the excellent 2013/2017 debate above.

@Eoin
Nama will waste all of our establishment’s scarce moral capital and cripple us with debt. Only swift, strong measures by the ECB IN ADDITION to controlling our deficit AND a new celtic export tiger would give us prosperity in the medium term. As all these together are unlikely Nama will make a bad slump much longer.

We will end up with a national government or a new post-election government with a new strong mandate. As all our main parties are in favour of the Euro it is unlikely we would leave but the most likely set of circumstances for our departure will be in place.
Prolonged 20% unemployment could result in many things. Leaving the Euro could well be the most benign. No one wants to see that but how do we avoid it? Not by making things worse with Nama.

For myself, I would like to see a Canadian Czar to reform our public services following on from the work of Colm McCarthy – make him a Czar too; a Swedish Czar to run any bad bank; a Competition Czar to make us competitive and a German Czar to persuade us to deflate wages. We may also need a Social Welfare Czar who will possibly be as hated as the mean old Czars were.

Our senior public servants and politicians are just not up to the job. And unless the Special Advisor is the world’s first bionic economist he is unlikely on his own to be able to do the work of all the Russian royalty we need to create. All of this should be done within a hundred days.

Hopefully Nama will be the dying sting of a deeply dysfunctional governing class.

We are in speeding car. There is a brick wall ahead. We need to (a) reduce our speed to 0 and (b) we need to do so _before_ we hit the brick wall. Time at the start spent looking for the brake-pedal is time spent approaching the wall at full speed. A little bit of braking early is worth a lot of braking later on.

David Begg is pretending that the only relevant goal is to stop eventually (reduce borrowing to < 3% of GDP) with no regard the final resting position (overall national debt).

Ignoring interest, the difference between reducing borrowing by 4 per year over 4 years (16, 12, 8, 4 then 0) and reducing by 2 per year over 8 years (16, 14, 12, 10, 8, 6, 4, 2, 0) is 40 vs 72.

I have yet to see any mainstream commentary to this effect.