Limiting the Fall Out from Fiscal Adjustment

Ben Broadbent and Kevin Daly at Goldman Sachs have released a new study examining how the composition of fiscal adjustment packages affects the overall economic impact of fiscal tightening: you can read it here.

28 replies on “Limiting the Fall Out from Fiscal Adjustment”


Thanks for drawing our attention to this important paper. It is impressively clear and convincing.

One finding that might be missed based on a quick read of the introduction is the dramatic difference between cutting current and capital expenditure. This comes out clearly in Table 1 (p. 12). This finding is also present in the earlier work from the 1990s on which this paper builds. I have been arguing this for some time, but I think it gets far too little attention in the debate about Irish fiscal policy. The government deserves credit for its switch to expenditure-based adjustment in the December budget. But as the ESRI pointed out in its last but one QEC, the adjustment was heavily tilted to cutting captial expenditure when looked at in inflation-adjusted terms. By taking the politically easier route of cutting capital spending, our adjustment has slowed the economy more than necessary to attain any given level international creditworthiness. It is troubling that the plans for the next phase of adjustment again fall heavily on the capital side. This is not good economics.

Well, the folks at Goldman Sachs know all about “fiscal adjustment packages”, don’t they? How much taxpayer money did those two get in year-end bonuses, eh?

Funny I see nothing in the article by the Goldman Sachs economiests about Goldman Sachs’ preferred way of dealing with fiscal deficits: disguising loans as currency trades.

Of course the main reasons for cutting expenditure rather than increasing taxes are all political: it is more popular to victimise 1/6 of the workforce (especially after you’ve spent many months vilifying them) than it is to make everyone pay their share.

@Ernie Ball
It seems there is a direct correlation between the establishment stuffing money into the banks and then vilifying public sector workers:

“Am I alone in feeling puzzled as to why revelations about the scale of our banking crisis seem to be followed so swiftly by outpourings of rancour towards the public service? (The chart shows how interest in the public sector, measured by number of web searches from Ireland, surged after the first anouncement of the bank guarantee scheme in September 2008, and again after the publication of the NAMA legislation in September 2009. The current surge, following the fallout from Minister Lenihan’s speech and the conclusion of talks on the proposed public sector agreement on March 30th is too recent to appear clearly on the chart).”

I would not lend much credence to any advice coming out of the US and Goldman Sachs has little credibility to my eyes. The number of references to Ireland makes me uncomfortable. Is it possible that Central Bank-FSA and the gov’t are being lobbied.

Ask the Icelanders what they think of GS spivs.

Max Keiser met a couple of them in Reykjavík in 2006. He used to be a GS analyst himself. They told him over drinks that they would bust the Icelanders just because they could do it. And make a packet in the process. I would not believe a word out of their mouths.


Well spotted. Smoozed more like.

Just how much debt did the Greeks hide off balance sheet, courtesy of GS?

Good stuff, but hardly new. Ireland’s taxes are already very low. Squandering fiscal possibilities has gotten us into this mess. Further expenditure reductions are possible but at the risk of civil disturbance.

Public investment was left out to some degree and the authors suggest it should be protected. Why? If anything, governments are worse at directing these moneys than the current expenditure. Particularly if we take spen on software and comms moneys! “The more money spent, the more wasted”, is a refrain that all governments should add to their mandate seeking.

The other posters are just envious of the superiority of Gold in Sacks’ advices. That we all grow rich together as banks, of all colours, blow bubbles is a given, surely!

The Wall Street Journal is reporting that a GS board member is under investigation in connenction with the Galleon hedge fund insider trading case. He is suspected of giving billionaire Raj Rajaratnam tips on GS.

An ECB paper published yesterday warns that government debt in the Eurozone may top 100% of GDP in the next few years, and high public-sector borrowing could have “severe consequences” for growth and stability.

@MH / Others

This report is relevant to immediate Government policy. (Good to see the banks and the bond market exercising effective regulation over the democratic institutions 🙂 ?.

Any thoughts on what would be your top 10 reports/document and 2/3 books which TDs should read?

@ John McHale

Last week, four Ministers, about thirty councillors, and some clerical gentlemen gathered before the cameras in Limerick to celebrate the opening of the new railway line to Galway. The service offers five frequencies per day, at an average journey time of two hours. It cost €106m in capex, plus undisclosed operating losses.

The long-established Citylink bus connection between these two cities offers six frequencies per day with an average journey time of 90 minutes. It is unsubsidised. The government has spent €106m. to create a public transport option which offers worse frequency and slower transit times than an existing (free to the Exchequer) alternative.

It is irresponsible to laud public investment, as you and others insist on doing, without due care and attention to the economics of the specific projects.

We have a large public investment programme at present. Can you argue (project by project) that all of it makes sense? Is it possible that long-run economic welfare would be enhanced by cutting this programme in December’s budget? We have a responsibility to at least contemplate the possibility that State capex is too high.

We should be cautious about the findings contained in this report – at least in regards to the Irish example. The driver in fiscal adjustment in the late 1980s was not expenditure cuts but rather increased tax revenue which accounted for over 80 percent of the turnaround. This arose, not due to tax increases, but increased growth – not only here but throughout the industrialised economies. Current expenditure increased in nominal terms with increases in social welfare rates and public sector pay (of course, expenditure levels were helped by the reduction in unemployment owing, not to increased job creation, but emigration which accelerated during this period). What spending was cut was in capital spend combined with economic services (primarily, agriculture).

We were also assisted by two other factors that do not pertain today. First, taxation levels were much higher which meant the Government was able to benefit from increased GDP by a greater extent than today with our low-tax base. Second, back in the late 1980s we benefited from a substantial stimulus programme – courtesy of the EU. In today’s terms it would amount to a stimulus of over €5 over a three year period. Throughout the 1990s this stimulus increased substantially in nominal terms.

I can’t comment on the experience of the other countries but our own history suggests that it is much more nuanced than the authors of this report suggests.


I hold my hands up to lack of expertise on specific projects. But I am sure there will be substantial capital investment requirements for the Irish economy over the next decade or so, even if a rexamination of priorities under the current NDP is required. The key question is one of timing. Being in a deep recession can dramatically change the cost-benefit calculations for investment projects from an overall social point of view. I don’t need to tell you that even relatively small multipliers alter the case for postponing needed investments.

I think we are in agreement about the precariousness of Ireland’s creditworthiness, and I take the need for fiscal adjustment very seriously. Where I find your position exasperating, is that you write and talk as if there are no consequences for domestic demand, and thus you evade the central tradeoff that should be preoccupying us all. This brings us back to the well-worn topic of expansionary fiscal contractions. If we are in such a world, then there is no tradeoff: we can then stimulate the economy and improve creditworthiness at the same time. The evidence from the Broadbent and Daly paper is consistent with such a view holding for current expenditure. My point in the original comment is that their evidence shows that this is not the case for capital spending. Cutting spending across the board is too crude a policy given the macro evidence we have available to us. It will cost jobs and do little to help our creditworthiness. It involves a first order welfare loss. Even if we conclude that we must maintain current deficit reduction targets overall, then surely the available evidence warrants that responsible economists push for the burden of cuts to fall on the current spending side, however politically difficult that might be.

@ John McHale

I agree that current rather than capital spending should bear the greater adjustment burden, and capital spend was cut too severely during the 1980s consolidation. Even after the December cuts, we still have a very big capital programme, much bigger than it was in the late 1980s. But it just cannot be presumed that because something is classified (often arbitrarily) as capital, it is ‘good’, or ‘productive’. This is a vade mecum for chancers and lobbyists, and I know whereof I speak.

Shadow-price labour at 80% (or 60% if you wish) and re-evaluate every single project in the NDP. Do you think they would all survive?

A good way to screw up a macroeconomic adjustment is to abandon microeconomic analysis.

We should keep our eye on the ball and keep in mind that the ball is bouncing between Brussels and Frankfurt. Commissioner Rehn will be tabling proposals to the EU Commission within 30 days along the folowing lines.
1) Tighten the 2005 Stability Pact.
2) Early intervention in the budgeting process of members who are showing signs of profligacy.
3) Establish a EU monetary fund.
4) Remove politics from technical decision making (Bank Anlysts, Economists and Accountants to the fore).
5) Make the rescue terms unattractive and known in the policy.

Angela shook the Frankfurt Bankers to the core, her behaviour during the Greece decision making process was irresponsible in the extreme. Politicians have to be pushed back into the dark corners where they belong. Ireland and Portugal amount to rounding errors in EU terms so the alacrity with which new policies are being developed have to be with a view to dealing with Spain and Portugal. Ireland could become collateral damage as the process develops.

So, more cuts and trebles all round then? A well written paper though.

I wonder how far you can push ‘the little people’, the lower salary scale public servants (which I guess are the majority) and the vast number of unemployed with more cuts? I guess we could soon be finding out.

On the subject of pain, I was just reading that 1 in every 138 households (932,234 ) were served with a foreclosure notice in the USA during Q1 2010 – another record (and a lot who should have been, haven’t yet). Does anyone have any equivalent figures for Ireland? My guess is that it’s very low at the moment with banks etc. agreeing not to take any action for 12 months but that it could be starting to ramp up some time later this year? Can anyone please remind me when that 12 month period started?

I guess that could be a future problem to come with banks and join up with Nama to put more downward pressure on house prices….. which leads to more negative equity…… which leads to more unemployment…… which leads to more repossessions…… sorry, I seem to be stuck in a loop.

I expect they will also be finding out a bit more about spending cuts in Greece soon too. I see there’s an IMF team flying out there on Monday.

The scouts ahead of the cavalry??

@ colm mccarthy

Bus transport has relatively low entry costs, resulting in razor sharp competition. No contest with the public sector on a busy, profitable route.
As you know,the argument for public sector transport revolves around social as well as economic considerations. We opted for the automobile and we are paying the price. But that’s for another thread.

The point about chancers is well taken.

Given that our banks are systemic, is it reasonable to categorise the Anglo takeover and NAMA bound commerical property development as having given rise to signficant unplanned capex, with dubious return ?

Speaking of fallout, what is the likely opportunity cost of that ‘investment’ in terms of planned capital investment over the medium term ?

I know this is off topic but, I was glad to see James Kwak point out, around minute 28.00 of the interview, that it was in the banks short term financial interests to underestimate their risks, because if they had to estimate their risks acurrately, they would have to set more capital aside, they would have been less profitable. There was an incentive behind the mistake. I think James Kwak has indeed identified a common link between 1990s hedge fund failures and 2000s banking failures, which I had not seen before.

If anyone reads Roger Lowenstein’s excellent book, When Genius Failed, you will notice that LTCM gave back money to investors, as they struggled to find more ways to invest it in arbitrage. The management of the hedge fund made that conscious decision, in order to combat the dilution of their own stake in the operation. Sure, it resulted in the management taking away more profits from LTCM in the short term. But very shortly afterwards, when markets turned against the huge positions of LTCM, when LTCM needed the capital to ride through the storm, they didn’t have it. Chances are, if LTCM had the capital to get through the rough period they would have made good on their positions (which were all fairly well positioned risks given normally market conditions).

Getting back to the point of Philip Lane’s original blog entry, the Michael Spence podcast on growth, linked by Steven Kinsella recently, does contain some useful points about the Washington consensus, having the right set of ingredients – though, that often is not enough. BOH.

Ireland wants to create a smart economy, but is cutting back on teacher employment. How do taxes raised and paid out for teacher training, support the smart economy? Easy!

This is an extract from new migration requirements to Australia:

1. English language proficiency

All applicants are required to provide evidence of a standard of English language proficiency required for teaching in Australia by meeting one of the following criteria:

• completed at least one year full-time higher education level study for an initial teacher education qualification in Australia, Canada, Ireland, New Zealand, the United Kingdom or the United States of America; or

• obtained a score of seven (7.0) or more in each component of the Academic version of the International English Language Testing System (IELTS) examination.

English language proficiency is now attracting more points for entry than ever before. Ireland is now a third world country, providing capital, in human form, for Australia?

Incidentally, by teasing out the definition of systemic, we might just find out that not all the banks and not everything in those banks, needs to be in place.

We might even save money?

colm mccarthy

Thank you! You are exposing waste.

Why are these worthies not apologizing for their wasteful destruction of capital? They spread money around like it was magic manure, growing jobs, when all it does is buy votes at a loss to the entire population.

Thanks gain for exposing this. Perhaps a weekly expose on this site would encourage the msm to do some probing? It would build up support?

@Pat Donnelly – “How do taxes raised and paid out for teacher training, support the smart economy?”

My understanding is that, where taxpayer money is actually used to pay for teacher training, it’s only about 10k per teacher (St. Pat’s). Quite a large % of teachers in training actually pay for it themselves (e.g. Hibernia).

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