Month: September 2010

Debt Reduction After Crises

The new issue of the BIS Quarterly Review carries some interesting empirical work on debt reduction after crises.  The paper is here and the summary is:

Financial crises tend to be followed by a protracted period of debt reduction in the nonfinancial private sector. We find that a period of debt reduction followed 17 out of 20 systemic banking crises that were preceded by surges in credit. Debt/GDP ratios fell by an average of 38 percentage points, returning to approximately the levels seen before the increase. If history is any guide, we should expect to see a much more significant reduction in private sector debt, particularly of households, than has so far taken place after the recent crisis. The costs of this process in forgone output are difficult to pin down, but there are reasons to believe that they need not be high provided that the banking sector problems that led to the crisis are fixed.

The Costs of Default

Panizza, Sturzenegger, and Zettelmeyer’s influential 2009 Journal of Economic Literature survey on the economics of debt and default has been referenced on different threads over the last few days.   The message has been that the costs of sovereign default in terms debt market access and borrowing costs are relatively low.   While I know that those referencing the paper know these findings provide only part of the picture, I am concerned that some blog readers will come away with too strong a conclusion. 

The puzzle of sovereign debt markets is that they should only be possible if there are costs to default – and especially to voluntary default.   In contrast to corporate borrowers, legal sanctions do not provide much of a deterrent for sovereign governments.   The traditional explanation has instead focused on the value of reputation and thus on future access.   But the finding of low direct capital market punishments for defaulters has put that explanation in doubt. 

Yet sovereign debt markets are alive and well.   From this we can infer that there must be costs of some sort.   Recent attention has focused on domestic costs, such as the costs of severe output losses that have accompanied a number of recent debt crises. 

Here is what Panizza et al. (cautiously) conclude:

If anything, defaults appear to be deterred by the domestic “collateral damage” that tends to accompany debt crises, rather than punishments from outside.   While it is very difficult to empirically disentangle the causes and effects of defaults, there is at least some evidence supporting the idea that defaults may magnify the output drops observed during debt crises.   Once output costs in line with this evidence are assumed in parameterized models of sovereign borrowing, the level of sovereign debt that can be sustained in equilibrium rise to more reasonable levels compared to models in capital market penalties are the only punishment. 

One interesting possibility is that in a world with uncertainty about government/country type, revealing yourself as “non-honest” can have implications for broader dealings both domestically and internationally. 

Even if we take a strict cost-benefit perspective, we should approach “default” cautiously – whether it is debt restructuring or the revocation of guarantees.

Your Country, Your Money

Five finalists have been announced for the Your Country, Your Call competition which, you may recall from the large advertising campaign earlier this year had the modest ambition of finding “two major proposals that, when implemented, will transform our economy – or significant elements of it – by creating jobs and opportunity.”

Competing ideas include installing solar panels on wind farm sites, creating “an Irish Content Industry Association which would then drive the development of a cultural and creative quarter. A media park would be established to attract global content industries” and, my favourite, “Building a world-beating entrepreneurial and innovation ecosystem around digital services aimed at positioning Ireland at the forefront of its associated spin-off industries.”

Two winners will be selected. They will be awarded €100,000 and then be given a development fund of, em, up to €500,000 each to implement the ideas. (Isn’t it great how these transformative ideas are so cheap?)

Obviously, it’s easy to poke fun at this competition. However, there is a serious question. The Times reports

The Department of Enterprise, Trade and Innovation said yesterday it had not provided money to fund the competition but a spokeswoman said formal arrangements were being put in place to allow a payment to be made. Earlier this year, Your Country, Your Call asked the department for €300,000 in funding for the initiative.

The question is whether public money should be used to support this idea. Just to be clear, my answer would be no.

A Comment on Comments

I think this blog has been a useful initiative and the comment feature has been an important part of this success. The large number of comments that the site receives is proof of its popularity and impact. However, unlike some popular economics blogs from other parts of the world (Calculated Risk, Baseline Scenario) the debate in the comments is often (not always) well informed and useful. Also, unlike many other blogs, the contributors here have often shown a willingness to engage with the commenters.

As everyone knows, the underlying economic news has generally been pretty bad over the past couple of years. And, even with signs of economic recovery around, there are lots of serious problems and things to worry about. For this reason, many of the posts focus on facts and figures that are negative.

Over time, certain patterns have emerged in the debate in the comments. Some of the commenters on this site have decided that there is somehow a conspiracy of bias among the contributors to deliberately focus on negative things or to (sigh) “talk down the economy” or that contributors are motivated by some sort of political agenda. For people who are contributing in an unpaid manner in their spare time and motivated by the desire to inform the public, this stuff is quite disheartening.

Debate in the comments is practically never censored – personal abuse and Don’t Get Philip Sued are, as far as I can tell, the only things that trigger contributors to lose precious time deleting comments.

However, policy on policing of comments is generally up to the individual contributor. Other contributors can make their own rules but, after what has been a particularly fractious week in the comments, I’ve decided to make the following request of people commenting on my posts:

1. No personal abuse of the economists who contribute to the site or other commenters.

2. No insinuations about grand conspiracies on the part of the evil blog henchmen or commenters.

3. No insinuations about contributors being motivated by their support for some political party.

Those who fail to honour the request should not be too surprised if at some point in between doing all the other things I actually get paid to do, I decide to delete their comments. Personal abuse of named individuals by those who decide to use a nom de blog will be particularly frowned upon. Also, comments whinging about having your comments deleted will also be deleted.

In return, those who keep to the guidelines can disagree with me all they want.

No Really, We Did Have A Huge House Price Boom

There are lots of aspects of the performance of the Irish economy that people disagree about. However, I had been under the impression until this week that everyone agreed that Ireland experienced an exceptional increase in real housing prices in the during the period before the recession.

It turns out, however, that I was wrong. Not everyone agrees with this. Earlier this week, there was a discussion on this website of a paper by Carmen and Vince Reinhart, which reported some figures for real house price appreciation between 1997 and 2007.

Among the figures reported by the Reinharts on Table 4 of their paper were the following:

U. Kingdom +150.1pc
Spain +118.5pc
Sweden +114.9pc
Ireland +114.8pc
France +111.6

These figures have been debated elsewhere on this site but not in a way that would clarify the key fact. That Ireland really did have a larger increase in real house prices than these other countries is not that hard to check.

Here are the facts. The Department of the Environment reports that the average second hand house in the Republic of Ireland cost €102,711 in 1997 and cost €377,850 in 2007, an increase of 268%. The average value of the CPI increased by 42.4 percent between 1997 and 2007. So, from the DoE figures, we can calculate the real house price increase from 368 / 1.424 = 258. In other words, real Irish house prices rose by 158% from 1997 to 2007.  And, for what it’s worth, the real increase from 1995 to 2007 was 246%.

So, yes we really did have a huge house price boom. Certainly a boom that was bigger than occurred in Spain, Sweden or France. Morgan Kelly didn’t just make it up.

Cue comments from house price boom deniers, flat earthers and folks who believe Elvis is alive and living with Michael Jackson …