Does Fiscal Austerity Reassure Markets?

Paul Krugman takes the cases of Ireland and Spain to address this question here.

13 replies on “Does Fiscal Austerity Reassure Markets?”

Link doesnt work Kevin!

Far be it for me to kick Prof. Krugmans Nobel in the shins, but, comparing Ireland and Spain to prove his point on austerity ignores important issues like critical mass, etc.

I seriously doubt we would be better off if we were slower in doning the sackcloth and ashes!!!

But then again, he’s got a Nobel
All I have is a doorbell

He still assumes that markets have a brain! Markets are an abstract mechanism to explain why goods and services trade and prices fluctuate. That is all!

We have a market failure because we have too much of everything and cannot afford to borrow amounts that will enable continuing mal investment. We now need to find what actually is the non bubble and post bubble economic demand supply status.

In the meantime, assuming that it is far less than heretofore is sensible and conservative of capital. Prices after all, cannot fall too far! They merely meet the level of demand, don’t they Paul? These so called economists who fear for the economic system are really fearing for the bubble rentier madness that has ceased. The market in fine, invisible clothing for all our emperors seems to have peaked for some time.

There is always the complaint that X (Ireland) is not the same as Y (A N Other) country. Of course they are not the same, X is a different entity to Y, but comparisons are valid once differences are taken into account.

Cross-country comparisions: Ireland adopted fiscal contraction in 2008. Nearly everyone else adopted some sort of stimulus. For most of 2009 Irish 10yr bond yields were the highest in the Euro Area, including Greece.

Time-series comparison. At the beginning of 2008, Irish 10yr bond yields were 4.13%. Fiscal contraction began in late 2008 shortly after the bank bail-out was announced. At end-2008 those yields were higher 4.44%. At end 2009 they were 4.88%, after fiscal contraction had begun to take effect. Core European yields had moved in the opposite direction meanwhile, ranging from Germany’s drop of 73bps to Belgium’s decline of 56bps.

They are rising once more, towards 5.5%.

Given that Ireland almost uniquely has experienced deflation, the real debt burden, and real yields have increased in a way that is not true elsewhere in the Euro Area. The price level (GDP deflator) has dropped by 5% or more in 2008-09, so that the rise in real yields has ben in the order of 6%.

As Krugman points out Irish credit default swap rates are above Spain’s.

None of this can be advanced as evidence that government policy has ‘reassured the fiancial markets’.

Hang on a second guys. Roll back a year and Irish CDS were the highest in the Eurozone, higher even than Greece. As Michael points out a much fairer comparison is the change in credit spreads over time. i.e. Compare the change in credit spreads for Ireland from 2008 to 2010 and the the change in the credit spreads of Spain from 2008 to 2010. Luckily you can find a nice chart here

Clearly Ireland has done well relative to Spain

Far away hills are green and Krugman may not have delved too deeply into this issue.

Looking a spreads levels surely does not tell the full story and in Ireland, as a small country like Greece, perceptions can vary.

Earlier in June, it cost more to insure $10 million of French government bonds against default for five years ($104,000 a year) than a British default – – despite a better fiscal position.

France’s debt-default insurance cost has more than tripled since January while similar costs for Britain have remained largely between $80,000 and $90,000 over that period, though Britain went above $100,000 on Friday June 4th.

By comparison with Italy at $290,000 a year, the cost of insuring Irish debt against default was slightly higher at $340,000 even though Ireland has a budget deficit much larger than Italy’s.

Italy has a higher debt to GDP ratio.

bond rates are relative not absolute, Krugman and every trader knows that so the comparison is perhaps not totally fair. Austerity in a small island economy with few natural resources doesn’t mean you suddenly get a better price versus a larger more diversified economy that isn’t as fast to make the changes.

The guardian article Krugman links to states that the debt to GDP ratio is 77.3% for Ireland and 64.9% for Spain. The budget deficits are 14.7% and 10.1% respectively. So we’re in a worse fiscal position than Spain. Maybe not too surprising, then, that CDS and bond rates are higher for us than for the Spaniards.

As Michael says above, comparisons are valid once differences are taken into account. But he doesn’t seem to have taken any differences, other than austerity measures, into account – not even the ones in the article he links to.

@ All,

I’ll copy this post here also, as it seems somewhat appropriate to this thread.

The Sunday Business Post featured an article by Richard Curran, entitled The tax breaks that broke us, which I got around to reading properly this afternoon. I had assumed in the past the concern over tax breaks to those people earning rental incomes, was a bit overdone by the press and media. But after reading Richard Curran’s article, there is much substance in what he has to say. The reason I am skeptical of the media’s coverage of ‘tax breaks’, is the reporting is often sloppy. It is a lazy way out for reporters who really do not want to delve too deeply into issues affecting the Irish economy, and resort to a bit of FF/Cowen bashing. That is why I think Curran’s article is a very worthwhile contribution to debate. He has taken the time to study the Regling Watson report and consider the issues in depth and dimension. Of course, Curran’s article The tax breaks that broke us, does fit in neatly with some of my examples above. The oil tank that the state refills for the next door neighbour, if/when the cold winter comes and oil prices shoot up. Curran concentrates on the idea of a transfer of wealth. But I prefer to concentrate on the idea, that potential risks are being transferred to the state’s citizens from private enterprise. In fairness, if one has to quantify it, Curran is correct in his assertion, the tax breaks did break us, to the tune of billions. What is harder to quantify is risk. I.e. In my example above, the transfer of risk is (a) the possibility of a very cold winter and, (b) the possibility in the rise of price of fuel. I am sure there is a ‘risk transfer’ as well as a ‘wealth transfer’ at work, if one were to analyse the property tax breaks fully. Something which Curran’s article could not have elaborated on, in the thousand or so words in a newspaper. BOH.

The tax benefit to a group of people of around €2.2 billion was a major transfer of wealth and it could have been used to make investments of several times that amount. Property developer beneficiaries of tax incentives could have used the extra cash from their incentives to borrow tens of billions of euro.


Good point. Well made.

But in the time series analysis refered to, nothing material has changed, or to take Karl Deeter’s points, Ireland isn’t suddenly smaller or lacking in natural resources from 2008 to end 2009.

The policy measures adopted here were designed to

a. reduce the deficit
b. reassure the markets.

The deficit has doubled and bond yields have risen, both relatively and in absolute terms – in real terms the rise in yields has been disastrous.

The policy has failed. And, after Einstein, repeating the same experiment and expecting to get a different result is madness.

@ Michael Burke

Yes the policy has failed but it is unlikely the alternative would have worked either, ie. borrow more and invest in a stimulus package. Its possible that Ireland has no way out of its debt dynamics.

Ireland is in a more difficult place than Spain, because we had a larger credit, property and construction bubble.
Thus the Spanish banking system is much stronger than the Irish, with the big banks looking,remarkably, as if they will come thro the crisis without experiencing an unprofitable year. There are issues in the savings bank sector, but these are much less in scale than ours.
The Bank of Spain adopted anti-cyclical provisioning policies during the bubble, which undoubtedly helped.
Not only did we not adopt anti-cyclical policies during the bubble, but now, following the crash, we are adopting strongly pro-cyclical policies, which is an error.
In addition to the banking system difference we also have a much deeper recession, as our construction output contracts from 23% of GNP to, it looks like, 4% of GNP!
So far from the market punishing Ireland for the austerity measures taken, the reality is that our position wd have been impossible, if we hadn’t taken those measures.
We need to make substantial further expenditure cuts in 2011 and 2012, but unfortunately, there is no evidence that we have the intention to do this, as well as to take the least cost approach to the banking and property sector resolution. Unfortunately we don’t appear to be doing this either as we don’t appear to be accessing the 2.3bn of Ango sub debt, we don’t intend to wind down Anglo or Nationwide, and substantially all our property sector is being managed by a single State entity, which is creating huge inflexibility in the sector, where restarting some activity is vital to final economic demand, as well as being the greatest socio economic challenge we face.

Krugman is a very effective communicator and this debate around the importance of the sustained growth in aggregate global demand, in the aftermath of the crisis is an important one. (A sustained global recovery will also be the most important positive influence on whether Ireland can manage it’s adjustment in any form of minimally acceptable manner.)
It is largely thanks to him that we are having the debate.
However, in the discussion, I think he is paying insufficient attention to the role of record low interest rates in supporting a recovery. Despite a lot of noise and volatility, the evidence appears to suggest that a recovery is underway and record government deficits, some of which are clearly unsustainable in the context of being capable of being financed in the medium term, and historically low rates, may combine to transform a sustainable recovery into growth which becomes too rapid.
It is better that this is counterbalanced by fiscal measures, than by central banks increasing interest rates by more than a de minimis amount, given the aggregate levels of debt which global economies are grappling with.

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