The CSO released the latest Quarterly National Accounts covering the first quarter of 2010. While seasonally adjusted GDP is up by 2.7% on the previous quarter, GNP is down by 0.5% (net factor outflows were up 11%on the previous quarter) . Compared to the same quarter in 2009 GDP was down by 0.7% and GNP was 4.2% lower. Exports are up compared both to the previous quarter and the same quarter a year ago. Building and construction has continued to contract significantly (-16.3%) while other industry has done very well (+11.6% for Industry including Building and Construction).
Yesterday Eurostat released their annual comparison of food prices. It shows that the prices in Ireland are the second highest in the EU after Denmark. What is more worrying is that instead of coming down faster in Ireland than in other countries food prices were actually relatively higher in 2009 than in 2008 or 2007. Irish consumers pay 29.2% more than the EU average. While Italy and Finland improved their relative price levels all other Euro members disimproved. The biggest relative improvement was recorded by Iceland, followed by Sweden and Poland.
The New York Times carries a lengthy article (plus plenty of photos in a slideshow format) on the Irish situation: you can read it here.
A more accurate and comprehensive headline might have been: “Ireland paying a high price for boom-bust cycle in property sector and attendant banking crisis, amplified and abetted by procyclical fiscal policy and now requiring a sustained fiscal correction” – but that is probably too long!
Update: Paul Krugman adds his view in this post.
Athlone is the target of a major Chinese investment initiative, according to this Guardian report: you can read it here.
According to the Volkskrant, each World Cup match of Oranje costs the Netherlands economy 130 mln euro — essentially because people sit around watching telly instead of working. Oranje has yet to sparkle, so there was limited joy to offset the loss in productivity.
Thanks to Henry, Ireland’s economy was spared a similar fate — although the Boys in Green certainly would have put in a better performance than les Bleus.
In today’s Business Post, Colm argues that “smart” should be defined broadly if it is to stimulate economic growth, rather than the narrow focus on gadgets that the government is currently following
Others and I have argued roughly the same, in different words, but without much traction
I guess that in ten years time, when an independent expert will evaluate the lack of return on investment in the smart economy, politicians will argue no one had warned them at the time
The ESRI macro-economic forecast record has attracted some attention this week.
The Indo is unfair to Frances Ruane. The ESRI has long tried and failed to fill the gap in its expertise in finance. In 2006 and 2007, it was nigh impossible to hire an economist. Part of the problem was/is that the data on the financial sector were/are so murky.
The Irish Times is fair in its critique.
For the record, the ESRI did predict the end of the housing boom (as did most others because it was fairly obvious) but we did not foresee that this would coincide with a major international crisis in finance (again, we were not alone).
Stephen Collins writes about further delays with the Poolbeg incinerator in today’s Irish Times.
The promised review of waste projections is now overdue.
Towards the end of a recent essay in The New York Review of Books (‘The Time We Have Is Growing Short’) Paul Volcker has some interesting remarks to make about the Irish economic situation.
The IMF has posted the concluding statement on its recent mission to Ireland: you can read it here.
Scaling back capital spending has been a central plank of the Government’s fiscal adjustment strategy. Nominal voted capital spending is set to fall from €7.2 bl. in 2009, to €6.5 bl. this year, to a planned €5.5 bl. in 2011. However, based on an examination of the project pipeline, the Construction Industry Federation believes that the procyclical cutback in spending will be considerably more severe, and conclude that “the Government’s ability to achieve its own spending targets in 2011 and 2012 is now in serious question”.
The Taoiseach defended his Government’s capital spending plans at the IBEC President’s Dinner last evening. In response, it is interesting to see both Lee Crawford, the incoming IBEC president, and David Begg argue vigorously for more protection of capital spending in side–by-side opinion pieces in today’s Irish Times. Unfortunately, in arguing for investment to support domestic demand, neither addresses the likelihood of a national creditworthiness/domestic demand trade off. This is just as limited a view as held by those who focus only on bond market constraints and ignore the demand implications of austerity plans.
I hope there will be more debate on the appropriate current-capital mix of adjustment measures in the coming months — though I can’t say I’m optimistic. It would be a pity if we end up following the path of least political resistance.
This guest blog is by Mick Moran, WJM MacKenzie Professor of Government, University of Manchester and is an edited text of the keynote address to the Biennial Conference of the European Consortium for Political Research Standing Group on Regulatory Governance, and was presented at University College Dublin, 18 June 2010.
Regulation and the Financial Crisis
The mess we are in.
Four quotations aptly summarise the mess we are in, and the way we got there.
‘Complex financial instruments have been especial contributors, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter-century ago.’ (Alan Greenspan 2002)
‘In addressing the challenges and risks that financial innovation may create, we should also always keep in view the enormous economic benefits that flow from a healthy and innovative financial sector. The increasing sophistication and depth of financial markets promote economic growth by allocating capital where it is most productive. And the dispersion of risk more broadly across the financial system has, thus far, increased the resilience of the system and the economy to shocks’ (Ben Bernanke May 2007)
‘the current economic situation is better than what we have experienced in years. Our central forecast remains quite benign: In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.’ (OECD Economic Outlook 2007)
These first three quotations sum up ‘the Great Complacency’ – the delusion that led so many economists and economic policy makers to announce that the last bubble was ‘the Great Moderation’ – a new utopian age when all the fundamental problems of a market economy had been solved.
And the fourth quotation sums up the sort of intellectual mess that the financial crash left behind. Buiter puts it with characteristic Dutch bluntness:
‘The Bank of England in 2007 faced the onset of the credit crunch with too much Robert Lucas, Michael Woodford and Robert Merton in its intellectual cupboard. A drastic but chaotic re-education took place and is continuing.’ (Wilhem Buiter 2009).
What went wrong with economic understanding?
The problems with the discipline of economics are surely threefold:
· It became corporatised: both as to education (especially in the Business Schools) and in practice (economists in financial institutions). The economist in the study was transformed into the economist broadcasting from the dealing room, laying down the law about what markets would and would not tolerate.
· It became organised into a conventional academic hierarchy. What we can learn from the recent fate of economics is that the worst thing that can happen to a social science discipline is that it gets access to a Nobel Prize
· It became professionalized: it developed a recursive world of professional economics that heightened the danger of succumbing to groupthink. Algebra is not substitute for observation.
But while economists were cheerleaders during the ‘Great Complacency’ they were not the only culprits. Hardly anybody – not policy makers, not academic students of regulation – foresaw what was coming. We all have lessons to learn. Here are three that we must urgently take on board.
Democracy matters: the end of the ‘Great Moderation’ was also the end of a ‘Great Experiment’ lasting more than 30 years: the experiment was designed to insulate regulation from democratic politics. Hence the rise of central bank independence and the spread of independent regulatory agencies. We saw the realisation of Majone’s theory of the regulatory state: a theory that asserted that majoritarian democracy could not cope with the complexity of modern market management. The Great Experiment proved to be a disaster. It led us to the catastrophe of 2008; and rescuing the financial system was only possible by turning to those despised figures, elected politicians, who it turned out were the only ones able to mobilise the cash and legitimacy to put the financial system on something like an even keel.
Ideology matters: the core of the crisis was due to the naturalisation of markets: an exercise in ideological hegemony that pictured them as subject to quasi-scientific determined laws. They need to be denaturalised both to understand the crisis and to avert future disaster. Markets are social institutions to be understood by observation not algebra.
Interests matter: Many of our standard notions in explaining regulatory catastrophe – Groupthink, coordination problems – work contingently to explain things – see my opening three quotes. But why was something like groupthink so prevalent? It was linked to three developments
1. The astonishing rise of a new Anglo-American plutocracy in the markets: the era of the Great Moderation was also the greatest era of plutocratic enrichment since the age of the Robber Barons. But unlike the Robber Barons these new plutocrats did not practice the engineering of steel of railways; they practised the smoke and mirrors of financial engineering.
2. The fantastic wealth of the financial sector on both sides of the Atlantic bought an equally fantastic amount of lobbying muscle.
3. This converted into the kind of hegemony that lay behind my opening quotes: the stories of regulation before the crisis – in the UK, in the US, even in a smaller case like Ireland –are of timidity and subordination on the part of public regulators.
We have to fashion a new ideology of public interest regulation, and a new confidence in that regulation: it existed when the American New Deal institutions found their feet; it must be rediscovered. And, as the forces of financial power might regroup, it must be rediscovered in the face of the lobbying machines of the financial markets.
The government likes to see Ireland as a hotbed of all things green and techie. It must have been a bit of a disappointment then that the Economist’s briefing on Europe’s tech entrepreneurs (June 12) does not mention the Emerald Isle at all. The only Irish connection is the European Commissioner, Maire Geoghegan-Quinn.
The Intergovernmental Panel on Climate Change has just announced the authors of its Fifth Assessment Report. The list is, to a large degree, a list of the international, academic establishment on all things climate. Ireland is not represented.
The list of authors for Working Group 3 is impressive (scheduled for release at 8 am this morning). WG3 deals with greenhouse gas emission reduction and hence has a lot of economics in it. The list is a mix of world leaders and upcoming talent; expertise and topics match; and there are a few heavy weights with the authority to stand up to anyone who attempts censorship.
The list of authors for Working Group 2, on the impacts of climate change, is good too. There is less economics here, but what is there is well covered.
For completeness, here’s the list for Working Group 1 on the physics, chemistry and biology of climate change.
UPDATE: The (correct) WG3 list is now available.
The Institute of International and European Affairs recently held an event on the European sovereign debt crisis. The event featured Dietmar Hornung of Moody’s Sovereign Risk Group, Lee C. Buchheit, a legal expert on sovereign debt issues and Ann Pettifor of Advocacy International who is known for work on sovereign debt and international finance such as the Jubilee 2000 (Drop the Debt) campaign. Podcasts of the presentations and slides are available here.
The Central Bank has published a strategy document outlining a new approach to banking supervision. The document as well as two speeches from senior staff in this area are available here.
The idea of establishing some kind of fiscal council seems to be gaining momentum. Minister Lenihan expressed interest in this idea last week; it featured in speeches by Eamon Gilmore and Joan Burton last week; it is also Fine Gael policy. An editorial in today’s Irish Times also endorses the idea – you can read it here.
This new IMF working paper by Luc Laeven and Fabian Valencia compares the current banking crisis to previous episodes across a range of dimensions – it is especially interesting on the fiscal and output costs of banking crises. You can download the paper here.
Summary: This paper presents a new database of systemic banking crises for the period 1970-2009. While there are many commonalities between recent and past crises, both in terms of underlying causes and policy responses, there are some important differences in terms of the scale and scope of interventions. Direct fiscal costs to support the financial sector were smaller this time as a consequence of swift policy action and significant indirect support from expansionary monetary and fiscal policy, the widespread use of guarantees on liabilities, and direct purchases of assets. While these policies have reduced the real impact of the current crisis, they have increased the burden of public debt and the size of government contingent liabilities, raising concerns about fiscal sustainability in some countries.
Economic policy advice on reducing the risks to macroeconomic and financial stability from the housing market, restoring competitiveness and preparing to adjust in a downturn was available to the Government prior to the financial crisis.
In a research paper which I presented in the plenary session of the Annual Economic Policy Conference in Kenmare on 13 October 2006 (attended by a good number of senior civil servants), after discussing the adjustment mechanisms available to Ireland as a member of the European Economic and Monetary Union, I pointed out four main challenges facing the Irish economy and suggested a combination of policy measures to respond to these challenges. The four challenges that I identified were as follows:
a) maintaining a high potential output growth rate
b) restoring competitiveness
c) managing potential risks to macroeconomic and financial stability from the housing market
d) adjustment to a slowdown in the United States and an expected appreciation of the euro against the dollar
The policy measures suggested to respond to these challenges included the following:
a) fiscal tightening to reduce domestic demand pressures
b) a wage restraint in the public sector
c) fiscal measures to reduce the risks to macroeconomic and financial stability such as phasing out the tax relief on mortgage interest payments, a tax on imputed rents, a broader capital gains tax, or a property tax on vacant of secondary dwellings (as options available to the Government)
d) limits on the use of real estate as collateral to protect the banking system against over lending and bad loans
e) running a large fiscal surplus during the current boom to prepare for a downturn in the world economy
The Irish Times of 14 October 2006 covered extensively my main points. The paper was published in the Quarterly Economic Commentary in March 2007.
Paul Krugman continues his campaign against the expansionary fiscal contraction hypothesis here. In making his case, he links to a 2007 paper by UCC’s John Considine and University of Portsmouth’s David Duffy. I don’t think the paper provides the slam-dunk evidence Krugman contends, but it is a very interesting read.
It is ironic that the potential expansionary effects of fiscal contractions have become known as non-Keynesian effects. This paper highlights the fact that Keynes and his contemporaries were aware of such potential perverse effects. It is clear that the important indirect effects of budgetary policy via expectation were known in the 1930s. Moreover, the economists of the time recognised the possibilities before they occurred. This paper supplements the existing research on the Expansionary Fiscal Contraction hypothesis by comparing two periods in economic history, Britain in 1930/1 and Ireland 1986/7, and the accompanying economic thought.
Here‘s the transcript of Governor Patrick Honohan’s appearance before the Oireachtas Finance committee on Tuesday.
University of Chicago economist Raghuram Rajan made news recently for his perplexing call on major central banks to raise interest rates (see here and a response from Paul Krugman here). While his monetary policy advice might be a bit unorthodox, his recent book on the financial crisis stands out from the recent crop of titles as an important read. The book is Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton University Press). The introduction is available for free download from the publisher’s website.
What makes the book stand out is his attempt to look beyond the usual proximate causes to deeper determinants – or what he calls “fault lines”. One may not always agree, but he is always provocative. His fault lines include: the use of expansionary macro policies to (cheaply) ease distributional tensions in response to rising income inequality; an export-driven growth model in emerging economies that made it hard to absorb capital in non-traded sectors; and the legacy of the Asian crisis that convinced emerging-economy governments to build war chests of foreign reserves. He also puts great emphasis on the role of implicit government guarantees in incentivising the taking of “tail risks”.
I think the book is a good complement to the Honohan and Regling & Watson reports. With differing emphases, the reports rightly point to the failures of key agents – bank managements, regulators and government. But while the reports are good at describing what happened, the why was largely beyond their briefs.
Rajan’s book is helpful in part because it makes us look beyond the more obvious agency failures to the failures of key principals – bank shareholders, politicians and voters (including their fourth-estate watchdogs). What would the shareholders of the big two banks have done if management had refused to get involved in highly profitable development lending in the lead up to 2007? What would politicians – government and opposition – have done if regulators had moved to curb credit expansion and prick a suspected property bubble? What would voters have done if the government had moved to tighten fiscal policy while running budget surpluses? There is a bit too much wisdom after the fact.
A couple of extracts from the introduction give a flavour of the argument:
[T]he central problem of free- enterprise capitalism in a modern democracy has always been how to balance the role of the government and that of the market. While much intellectual energy has been focused on defining the appropriate activities of each, it is the interaction between the two that is a central source of fragility. In a democracy, the government (or central bank) simply cannot allow ordinary people to suffer collateral damage as the harsh logic of the market is allowed to play out. A modern, sophisticated financial sector understands this and therefore seeks ways to exploit government decency, whether it is the government’s concern about inequality, unemployment, or the stability of the country’s banks. The problem stems from the fundamental incompatibility between the goals of capitalism and those of democracy. And yet the two go together, because each of these systems softens the deficiencies of the other. (p.18)
We also have to recognize that good economics cannot be divorced from good politics: this is perhaps a reason why the field of economics was known as political economy. The mistake economists made was to believe that once countries had developed a steel frame of institutions, political influences would be tempered: countries would graduate permanently from developing-country status. We should now recognize that institutions such as regulators have influence only so long as politics is reasonably well balanced. Deep imbalances such as inequality can create the political groundswell that can overcome any constraining institutions. Countries can return to developing-country status if their politics become imbalanced, no matter how well developed their institutions. (p.19)
The literature on the Great Depression throws up some curious parallels and contrasts to today.
From Kindleberger (The World in Depression, 1929-1939, p. 194):
“In the electoral campaign, Roosevelt charged Hoover with total responsibility for the depression. It’s origin, he said, was entirely within the United States… Hoover, in reply, insisted that the depression had originated abroad.”
Also from Kindleberger, p. 139:
“The Unemployment Insurance Fund, being in deficit, had to be made up by the German government, which thereby suffered a budget deficit. The Socialist Party proposed raising contributions to the fund by a 4 per cent levy largely on government officials, whose contracts provided protection from unemployment.”
In Ireland, the first Fianna Fáil budget of 11 May 1932 included a tax amnesty for those with undeclared overseas accounts.
The settlement would enable them to resolve any outstanding liabilities by paying 75 per cent of the amount owed in outstanding taxes on foreign holdings from 1914 to the present, with no penalties or interest charges.
(Dáil Éireann – Volume 41 – 11 May, 1932 – In Committee on Finance. – Financial Resolutions—Minister’s Statement.)
Ronan Fanning’s book on the Department of Finance, pps. 233-4, reveals that the same government hoped to but failed to cut public service pay.
“This proved a difficult process and the reductions were widely resisted by public servants, including the senior civil servants that the government relied on to implement its policies – some , whose tenure predated the state were threatening to take early retirement under a clause in the 1921 Treaty. The proposed cuts were targeted at higher-paid public servants – including Government ministers. This dispute suggests a strong division of opinion, with the farming community very much in favour of cutting the cost of public services. One minority report to the report on this topic concluded that:
‘Even at the reduced rate there are many competent people who would gladly exchange places with public servants for the next ten years. The discontented State Servant would derive much benefit from a sojourn in the beet fields of Leinster, the cow pasture of the Kerry hills, or turf banks of the Bog of Allen for £1 a week’.”
Paul Krugman takes the cases of Ireland and Spain to address this question here.
Here‘s the transcript of Klaus Regling and Max Watson’s appearance before the Oireachtas Finance committee last Friday.