The Irish Economy

Writing in today’s Irish Times, Ashoka Mody argues for the need to introduce a special resolution regime for banks as well as “fiscal benchmarks and supporting rules, along with a technical voice in the form of “fiscal councils” to evaluate budgetary risks.”

Mr. Mody is assistant director in the European department of the International Monetary Fund and has lead the IMF’s article for team that has visited Ireland in recent years. While Mody’s senior IMF status makes him worth listening to, it’s also worth noting that he has a considerable research record as an economist including this interesting work on the effects of budgetary institutions.

With the publication of the heads of the promised climate change bill now imminent, it is interesting to note that two Oireachtas Comittees, the Joint Committee on Climate Change and Energy Security and the Joint Committee on Agriculture, Fisheries and Food, have just published a report on the role of forests in future EU climate policy. The paper was written in the context of the Committees’ role in responding to EU proposals, in this case an EU Commission Green Paper on Protecting Forests against Climate Change.

The report raises some important issues on the treatment of carbon sequestration by forests in the context of EU climate policy, where arguably Irish interests differ from the rest of the EU. Although its conclusions need further discussion, the report is a good example of how the Oireachtas can contribute to public debate and for this reason alone it should be welcomed. For the record, Andrew Doyle T.D. (FG)  was the rapporteur for both committees and he was assisted in preparing the report by EPS Consulting (formerly A&L Goodbody Consulting).

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One by-product of Paul Krugman’s latest intervention on Ireland is that it will provide further ammunition for the many people who believe the government should abandon fiscal austerity and provide a stimulus package of new spending to boost the economy. Stimulus advocates believe that budget cuts are self-defeating and that, by contrast, a stimulus package will pay for itself and actually improve our budgetary situation.

I know that the majority of Irish economists don’t agree with this idea but perhaps we’re not doing a very good job at communicating why, so here’s a brief explanation.

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Paul Krugman criticises the ESRI’s Recovery Scenarios paper:

What the careless reader might miss, however, is the fact that the policy conclusions are not, in fact, derived from the analysis — they come out of thin air. The authors simply assert that more austerity now would lead to a lower risk premium and hence higher growth, based on no evidence I can see.

This criticism appears to relate to the paragraph on page 41 of the report starting with “Recent experience ..”

Two aspects of this criticism strike me as unfair.

First, the assertion that Krugman refers to appears to be the following concluding sentence:

It also raises the question as to whether a more rapid fiscal adjustment than currently planned would have a more beneficial outcome for the economy. 

This seems to be pretty far from an assertion. Rather it flags this idea as something to consider. Krugman seems to be jumping on the ESRI for what it is little more than a speculative remark.

Second, in relation to the “based on no evidence that I can see” comment, I’d note that the relevant paragraph contains the following sentence:

This means that action to reduce borrowing, which would otherwise still be deflationary, could actually increase domestic activity if it produced a sufficient reduction in the risk premium (Alesina, 2010).

Now I’m guessing that Krugman has no time for the analysis in Alesina, 2010 (and he may be correct in this assessment) but it’s still worth noting that the ESRI did cite evidence from a Harvard economist when making the supposed assertion.

What seems to be happening here is that the ESRI-bashing is just a small element in Krugman’s greater campaign of opposing austerity in the US and Germany (with which I’m sympathetic.)  However, it’s worth recalling that last year, Krugman noted about Ireland that “there isn’t much disagreement about the need for fiscal austerity. As far as responding to the recession goes, Ireland appears to be really, truly without options” and referred to an “Irish-type fiscal straitjacket.”

I’d be surprised if Krugman’s assessment of the bond market’s attitude to Ireland has changed much since then: The spread over bunds of the Irish ten-year bond was 282 basis points yesterday versus 293 the day Krugman’s Erin go Broke column was published.

So while kicking around a little research institute his readers have never heard of may seem to provide a nice example-de-jour of crazy people advocating Herbert Hoover economics, in truth it’s likely that even Paul Krugman doesn’t really believe Ireland is in a position to abandon austerity.

My prediction earlier this week is now supported by the Times (and again in more detail) and Independent.

I would agree that the focus should be spending cuts rather than tax increases.

However, I would also argue that taxes need to be reformed too. Particularly, I would use the revenues of property taxes and water charges to reduce income taxes — as that would help to price Ireland back into the export and FDI markets.

I have also called for privatisation of particular state companies and agencies (ESB, CIE, DAA, Bord Bia, RTE, etc). This would only improve the public balance sheet if the market would pay a higher price than the current book value — that is, if a private operator thinks she can improve efficiency. However, privatisation would, in the longer run, improve domestic competition and reduce the costs of energy and transport.

These things will not happen soon as the necessary preparations are slow at best. Some have taken this as me criticising the civil service, particularly the DoF. That would be incorrect. Reform is complex and requires careful consideration — and DoF has its own budget cuts and hiring ban; endless complaints from other departments; the EU and IMF; and NAMA to cope with.

Nevertheless, you should never let a good crisis go to waste — and the public sector should be reformed as well as cut in size.

Agustín Bénétrix, Barry Eichengreen and I have a piece over at Vox looking at the end of house price collapses. Historical patterns don’t suggest that Irish residential prices will stop falling any time soon; the best way to ensure that they do is to let them adjust downwards as speedily as possible.

Update: in light of a recent article in the Sunday Tribune, I should clarify that nowhere in the Vox piece do we present estimates of the extent to which house prices will decline in Ireland. When asked by the journalist in question how far they would have to fall, I replied that I agreed with Morgan Kelly’s analysis, or words to that effect. When pressed as to what that meant, I gave the figure mentioned in the Sunday Tribune. I am always happy to cite and give credit to Morgan’s work in this area, but I am not happy to be presented as an independent source of analysis on the subject, much less to be described as a “leading housing researcher”.

There. That feels better.

For those who are interested, our article on the above topic is available here.

On RTE radio this morning (on Today with Pat Kenny with, em, Myles Dungan) Fianna Fail TD Frank Fahey said:

I stand by what I said about NAMA from the very beginning. NAMA is being funded … the bonds are being funded by the European Central Bank.

Now I know that language is a flexible thing and perhaps philosophy graduates could spend all night debating what the meaning of “being funded” is. But, I would suggest that the only reasonable interpretation of this statement is that it implies NAMA are receiving funds from the ECB.

This is not at all true. The ECB has no direct relationship with NAMA at all. NAMA bonds can be used by the banks that have received them as collateral for loans from the ECB but that’s it, that’s the full extent of the ECB’s involvement in relation to NAMA. Furthermore, AIB and BoI executives told the Oireachtas last year that they had no particular plans to use the bonds in this fashion.

The NAMA bonds are fully backed by the Irish government. They are a liability of the Irish state, albeit one entered into at the same time that it acquired some property assets that may or may not yield enough to pay off the bonds.

It is long past time for government politicians to stop misleading the Irish public that NAMA somehow involves the state getting money from the ECB. I would plead with any journalist interviewing Deputy Fahey or any other commentator making this claim in the future to point out to them that it has no grounding in fact.

I have heard various RTE reporters state in three different reports that despite yesterday’s ratings downgrade, the good news is that Moody’s changed their “outlook for the Irish economy” from “negative to stable”. I know the vast majority of our readers know that this is incorrect. But, just in case anyone has been mislead by this, here’s where Moody’s use the phrase stable:

On 19 July 2010, Moody’s announced its decision to downgrade Ireland’s government bond ratings by one notch to Aa2 from Aa1. Moody’s has changed the outlook on the ratings to stable from negative as we view the upside and downside risks as evenly balanced at the current rating level.

So, you can see that it is the outlook for the rating that has been changed from negative to stable. Having downgraded the debt, they’re saying they’re not anticipating further downgrades now. In relation to the economy, Moody’s said the following:

The Department of Finance has based its debt projections in the SPU on the expectation of growth rates exceeding 4% in the period 2012 to 2014. For the reasons mentioned above, we believe these forecasts to be optimistic and instead expect real growth to range from 2% to 3% from 2011 onwards.

So, for what it’s worth, Moody’s are more pessimistic on growth in the Irish economy than the government.

In an earlier post, I wrote about postponement of water charges and property taxes — partly because proper preparations started too late and have not progressed fast enough. The same is true for privatisation and, it emerged today, for child benefits. It looks increasingly likely that there will be €3 bln worth of spending cuts in the 2011 budget.