Martin Wolf on Macroeoncomic Policy

Martin Wolf writes on “unorthodox” fiscal and monetary policy responses to the recession in this morning’s FT.    The article highlights the work of Agustin Benetrix, Kevin O’Rourke and co-authors (IIIS Discussion Paper version here).

25 replies on “Martin Wolf on Macroeoncomic Policy”

One policy option that both sides in this debate ought to be able to agree on is pensions reforms, and other ways of making states’ fiscal positions more sustainable in the long run that do not actually take purchasing power out of the economy in the short run.

The debate about the role of aggregate demand in the short run has never taken off in Ireland since we are very small and open, and since the bank guarantee placed the state under enormous pressure in the bond markets. But here is a question that might flush out peoples’ real positions: do we think that austerity in the rest of Europe helps Ireland by making space for us to sell our bonds in; or do we think it hurts Ireland by slowing growth in our major markets?

Pensions ‘reform’, cuts to entitlements and/or increased contributions, are not neutral even in the short run. Clearly, if contibutions are increased this removes purchasing power immediately, as is the case in Ireland. But even if only entitlements are cut this will induce a greater propensity to save, and dramatically so in the case of those nearing pension eligibility/retirement.

Ireland is no smaller and no more open than when it adopted the NDPs, which had immensely positive contributions to both short run demand and crucially to long-run productivity and competitiveness.

The borrowing constraint has been increased by current policy – doubling the deficit to over 14% of GDP, and pushing real yields substantally higher. It could be reduced by reversing it.

Neither is borrowing the sole source of funding, the NPRF, NTMA’s foreign holdings and taxation could all play their part. The corporate income tax rate would be the place to start. Mr Lenihan is fond of calling 12.5% tax ‘our international brand’. Given that Ireland and Iceland have the two lowest corp. tax rates in the OECD (Japan and the US have 39%), there’s not much equity in the brand.

Nice way to put it Kevin. But there are three impacts, not just two. For a given Irish policy, overall Euro-area interest rates fall with others’ austerity, so do Irish net exports, but the Irish premium over Euro average interest rates presumably worsens.

If the question is ‘What policy should we urge on others?’, the answer may not be the obvious Expand, Expand, if that pushes the rate we must pay over the too-close-for-comfort edge. If the question is ‘What should we do ourselves?’, the pay-offs are very assymetric, given the closeness of marginal borrowing costs right now to the knife-edge, and the state of sovdebt markets. Unless you don’t care about the loss of policy autonomy experienced by the Greeks. How bad is it for the Greeks, incidentally?

If others expand, how sure can we be that Ireland’s borrowing costs would narrow to reward unilateral austerity, or would we really get a free ride in the sovdebt market if others chose to tighten? Do the interest effects swamp the routine demand effects given the scale of Irish indebtedness?

It’s probably a case of damned if you, damned if you don’t. Imo, the bond markets are not convinced by the EZ stabilisation fund and the opacity of bank “stress-testing”. They seem to see mechanisms and procedures that allow for too much political discretion and backroom deals. The EU and its national governments are a long way from the sort of transparency that is accepted as standard in the US and, like barbers of yore, are being required to bleed their economies to demonstrate the seriousness of their intent. But this bleeding raises even more doubt about their medium to longer term debt servicing capability.

Martin Wolf makes a convincing case that the EU will have to lift itself out of the mire largely on its own via some form of QE. China, alone, is not the main reason that the EU will have to do a lot of the heavy-lifting itself, but it has the lion’s share of the relevant ASEAN economies GDP. It seems clear that China has not fully appreciated the extent to which it is integrated in the global economy and that taking some short-term pain (e.g., allowing further upward movement in the RMB and re-balancing its economy away from exports and towards private consumption) is in its own longer-term interests and those of the global economy.

In this context Germany is pursuing its own agenda and Ireland is on one of the hind tits – second from last. Germany has the strength, determination and resilience to play in the big league. Ireland, weighed down by insolvent banks and gross inefficiencies in the sheltered and non-traded sectors, will struggle to play at all.

…do we think that austerity in the rest of Europe helps Ireland by making space for us to sell our bonds in; or do we think it hurts Ireland by slowing growth in our major markets?

The latter, surely. If Euro interest rates were higher then we might hope that German austerity would reduce them significantly. As things stand that’s not possible, so we’re stuck with a shrinking export market. I’m surprised that anyone could imagine that there is a silver lining to Merkel’s hairshirt. Have any Irish economists really fallen for Ricardian DSGE models? That’s not a rhetorical question: I don’t socialise with economists so I really wouldn’t know. But I tend to assume people use these models for mental exercise rather than as guides to the real world.

Isnt the cost of Ireland (land) relative to other EU’ers one of the main problems here?
As in each effort to reduce costs, be it rents or welfare comes into friction with it!
Not exactly a win win situation, but if we could reduce the value of land, possibly through taxation, it would give more freedom to choose…

Not that it would help my mortgage costs…

Hi Colm, yes, the premium we have to pay is a third factor. *Given our policies* it ought depend on average interest rates and our growth prospects, and so the premium could I suppose move in either direction, although I share your presumption that it would worsen (esp since average interest rates are already low). It certainly has been worsening in recent weeks.

@Colm McCarthy,

You raise important questions and it would be interesting to see some tentative quantification. However, “loss of political autonomy” is probably going a little too far. I think we need to accept that fiscal sovereignty now resides in Brussels and that the resolution of the banking sector will be decided in Brussels and Frankfurt (e.g., the latest Anglo resolution proposal is currently being considered in Brussels), but there is much the Government can do in the “micro” area to strip out unjustified costs and gross inefficiencies in the semi-state, sheltered and non-traded sectors.

Imo, there seems to be little sense in moidering about macro issues over which we have no control and ignoring micro issues where some hard graft will generate long-term sustainable benefits.

….”But here is a question that might flush out peoples’ real positions: do we think that austerity in the rest of Europe helps Ireland by making space for us to sell our bonds in; or do we think it hurts Ireland by slowing growth in our major markets?”…..

Definitely the latter. I would even question whether the former carries any logic in the current global economy. Post the UK’s austere budget yesterday, UK gilt yields have fallen, reflecting more appetite for UK debt and increased market confidence in the UK’s ability to rein in its deficit. Despite this, Irish yields have widened out today, probably reflecting concerns around lower growth in Ireland’s key export market. So no more space for Ireland to sell bonds into and widening of Irish risk premium.

Is there any conclusions as to how Ireland will refinance wall of bank debt in September? More Irish bank securitized debt and the ECB?

Those who advocate more stimulus spending tend to shy away from structural reform proposals and the argument goes that retrenchment measures can be introduced when economies are less fragile.

However, once a recovery, likely a tepid one, is underway, the pressure for reform dissipates.

The problem with many economies is that living standards were elevated on the back of asset and credit bubbles and with the exception of the UK, it’s private sector workers are taking the strain.

In Ireland, a private sector worker who is lucky to have a pension faces cuts in benefits and investment returns are expected to remain low for years to come.

France is planning some baby-steps by raising the retirement age to 62; men currently on average retire at 59.

So a 25 year old could have begun work, worked 24 years and lived another 24 years — two-thirds of his life as a dependent on the state.

Public debt in Europe as a ratio of GDP is currently at about 100% and is expected to rise to over 130% in just a decade.

It’s just not good enough to say public spending should be increased because there is compelling data from the 1930s.

Economists and newspaper columnists often put forward policy debating points but when it comes to prescriptions, they often come up short.

Germany and sustainable domestic demand

Carsten Brzeski of ING about the real effective exchange rate of EUR:

For the Eurozone as a whole, the real effective exchange rate dropped by slightly more than 11%. This drop masks a depreciation of more than 10% in Ireland and around 7% in Germany, the Netherlands and Finland. At the same time, the real effective exchange rate only depreciated by around 2% in Greece and Portugal and around 3% in Spain. Of course, real effective exchange rates are not the only determinants of export developments: think of product and regional specialisation, outsourcing or exporters’ hedging of exchange rate risks. Nevertheless, recent real effective exchange rate developments indicate that countries at the Eurozone periphery, except for Ireland, hardly benefit from the current euro weakness.
While exports account for more than 50% of GDP in Ireland and around 35% in Germany, they barely make up 20% of GDP in Portugal, 15% of GDP in Spain and only 5% of GDP in Greece. Same picture, different angle: while net exports have been an important growth driver in Ireland since the early 1990s, growth in Spain, Greece and Portugal has been driven almost exclusively by domestic demand.
To regain competitiveness a country needs to follow more deflationary policies than the rest of the Eurozone. Simply put, this means that countries such as Greece, Portugal and Spain would have to go through a protracted period with lower wage increases than in Germany. The German inclination for low wages clearly complicates such a task. In addition, historical evidence shows that the magnitude of the required adjustment is huge and almost unprecedented.
The current euro weakness will benefit the countries which are already running ahead in the recovery and not the countries which need it most. There will be no quantum of solace from the euro.

Unless I am missing something, the cut in Ireland’s effective index should be the biggest in the Eurozone. Where can I find Brzeski’s article?

@ colm/Michael

actually, that article appears to have been originally referencing the situation in Oct 2009 (though posted today on AV). EUR/USD was around $1.47-48, and EUR/GBP was around 92p then, so the real effective exchange rate depreciation must be much much bigger now, no?

Kenny is going to borrow for employment.

Well, that will get him elected, but what jobs? Why Ireland? How much more? Definitely more waste. Borrowing for anything?

Oh, I almost missed it, Prime Minister Cowen has told us that the money he took from our children’s future has gone! Wise investment! Many jobs will be created. People will dance at the crossroads! DoF is very happy! Want more money, borrowed of course, in order to make more jobs ……..

A back-of the-envelope estimate is that over the last seven months Ireland’s trade weighted exchange rate has depreciated by 11%, around twice the depreciation enjoyed by mainland Eurozone countries. Not sure how they derived the other figures.

Al and Eoin
I agree. Once we remove the 20% GNP deficit stimulus, we will be able to see what economy actually lives and what has been created by zombie banking.

It will not be pretty. NAMA will be selling into a falling market, but we will find many court actions against these moves. Think of the Tribunals of Inquiry on steroids. I recommend that NAMA and the banks move for bankruptcy against the worst customers as it will mean that they will need the permission of their trustee in bankruptcy to sue anyone for anything. No libel actions!

But there will be new taxes! Misery will be sharfed but it will impact less on those who know what “fictional (sic) reserve banking” actually consists of.

The currency needs to fall. The Germans have no clothes. Ireland will be able to fund new borrowing. But should we?

Eoin, Michael, Ronnie:

Brzeski’s numbers are odd. The CB’s nominal Harmonised Competitiveness Index is the effective exchange rate index and they seem to do the weights thoroughly – there is a methodology article by Derry O’Brien in the Qtly Bulletin early 2010. (They can’t call it an effective exchange rate index ‘cos we don’t have an exchange rate, OK?).

The weights are not published, but the Euro has been sliding against about half of the weight, mainly Stg. and USD.

The index is based Q1 1999 = 100. It fell rapidly from the off, and fluctuated around 90 through 2000 and 2001, finishing 2002 in mid-90s. Happy days!

It breached 100 again in March 2003 and ran at about 104 through 2004, 2005 and 2006, and averaged 107.2, 112.0 and 113.2 for 2007, 2008 and 2009. The all-time low in the monthly average was 87 in Oct 2000, and the all-time high 115.5 in Oct 2009, so the Euro deal has’nt exactly delivered (effective) exchange rate stability as claimed on the tin.

The CB databank shows a monthly average down to 109.5 for April 2010, and I reckon (guessing the weights) that it would have been down further to 107.6 for May and will be maybe 107.3 for June, despite the recent Euro strength.

So the June fig will be down 5% on the 2009 average and 7% on the Ocober 2009 peak. The CB should publish the weights.

@ Kevin O’Rourke,

But here is a question that might flush out peoples’ real positions: do we think that austerity in the rest of Europe helps Ireland by making space for us to sell our bonds in; or do we think it hurts Ireland by slowing growth in our major markets?

There is another wrinkle to that I would like to add. To what extent did slow growth in other EU countries allow Ireland’s economy to benefit from influx of human resources over the past decade or two? To what extent will stronger economies of other EU member states mean those same human resources will be dragged away from Ireland towards other locations? The people who study taxation seem to be highly sensitive to this matter. I.e. The competition between regions for the best human resources. It all depends on your speciality. It dictates a large part of how you view the world. I became intensely aware of this phenomenon while working in project management in the construction industry. Where you would find practitioners who would focus very much in one or other area, or sell one or other product. The funniest I heard was a man who sold antique bricks for conservation work on older buildings. Apparently he walked around the city, and simply saw bricks everywhere. I once did a series of jobs for a restaurant chain for their signage. It was a strange thing. For about a fortnight afterwards, I couldn’t see anything else except shop signs when I walked around town. Eventually it wore off though. This was our trick we had in construction management – to find ways for our employees to move around a little bit between tasks, so as not to suffer from the tunnel vision factor.

It was interesting to listen to Brian Lucey speaking on Morning Ireland this morning. Because Brian described the various different sub-branches of economics. The various applications for it, in macro-, micro-, transportation, labour and so forth. Getting back to the taxation experts. Whenever I listen to them, I appreciate they are intensely aware of factors affecting movement of people based on incentives and conditions. The trick is to unlock that sort of knowledge and share it amongst people, who may not have an opportunity to focus in so much on an area. BOH.

@ K O’R,

I was thinking more about raising the retirement age, especially in countries where it is particularly low.

I believe a major attraction of Ireland in the past decade or two, as a location to come to, to gain employment – apart from availability of jobs, was also the challenges offered. A lot of people who came to Ireland were fit, able, smart people who liked to pursue a real challenge. Of course, the typical commentary in Ireland nowadays is about availability of employment. It doesn’t seem to matter to us what kind of employment. A portion of Irish society however didn’t get the opportunity to participate in the kinds of challenging employment positions that were available during the Celtic Tiger. I often think all of the conversation during the Celtic Tiger about pay levels was a smoke screen. When it boils to it, people very often opt for an employment which they find stimulating and challenging, even if its pay is moderate. I often wonder how few people from other EU states came here to find better salaries. I believe, in larger measure it was to do with vibrancy of workplaces and life in general. BOH.

The ECB provides some more up to date info on Ireland’s real HCI(deflated by consumer prices). It fell by a further 2.8% in May (versus April) and is now about 13% off its peak back in April 2008, though the major part of this fall has occurred since Oct’09…

Below is the change between Oct’09 and May’10 in real HCIs for the euro countries

Ireland -10.0
Germany -7.0
Malta -6.9
Finland -6.3
Italy -5.7
France -5.3
Spain -4.7
Belgium -4.5
Cyprus -4.1
Austria -3.9
Slovakia -3.9
Portugal -3.7
Slovenia -2.9
Greece -2.9

Comments are closed.