BIS Annual Conference: Fiscal policy and its implications for monetary and financial stability

The recent BIS annual conference focused on fiscal policy: the impressive set of papers and discussions are available here.

The paper by Roberto Perotti on “The ‘Austerity Myth’: Gain without pain?” is especially interesting for an Irish audience – he revisits previous adjustment episodes (including Ireland in the late 1980s) and provides new evidence on why fiscal austerity is intrinsically contractionary in the short term.  The written discussion by Carlo Cottarelli of the IMF is also worth reading.

9 replies on “BIS Annual Conference: Fiscal policy and its implications for monetary and financial stability”

Interesting to see Carlo Cottarelli, of the IMF’s Fiscal Affairs Department, conlcuding with this call “It is therefore critical that, while gradual adjustment takes place, credibility is not shaken. Hence the need for clarity in the definition of medium-term fiscal adjustment plans”.
Hardly anybody would disagree.
But clarity – and feasibility – might be in the eye of the beholder, especially if the programme does not allow for taking the pain (the inevitable pain) on the chin, and now.
A play for time, by spinning out the pain, might instead dilute the political capacity to instigate and manage the sharp adjustments that are still needed… still needed now as we enter the fifth year of crisis since subprime blew up.

Fiscal austerity is only contractionary in the short term when there is easy energy to burn – typically what happens is that goverment programmes are cut and private credit fills the new energy vacuum.
It then usually proceeds to build net energy negative structures and endeavours using private credit.
Not much about the 1980s – 90s hyperinflation of credit in the UK as North sea oil was reaching its peak – this must have benefited Ireland to a large extent with both exports of goods and people.
In a energy starved world the 80s are not a good anology – in the early eighties the dollar hyper inflated but high interest income from Arabian oil kept its value.
Japan was the first large economy to hit a credit /easy energy wall after it hyper inflated credit during the 1980s.
Large goverment money ratios low interest environments prevent malinvestment through lack of leverage as any credit multiplied malinvestment is very costly in a energy starved world.
Japan is the best we can hope for now – the party is over.
Large goverment defecits are needed so that private citizens can pay down or default on private credit debt.

PS increasing goverment defecits is only a reduction of leverage in the system – banks do not like this as a reduction of leverage reduces their profitability.
This system desperatly tries to heal after every lending crisis but no sooner has the scab formed on the wound the banks rip it off again.
Its getting harder and harder to recover after each crisis as the worlds resourses become more degraded over time.

Mr. Perottis document is very unclear in what it actually suggests. It seems to be saying that the evidence is clear that fiscal contraction is not expansionary in the medium term, and that especially in the current case, even short term benefits are doubtful.
On the other hand it concludes by saying that fiscal consolidation is nessecary for output expansion.
So I don’t know what he’s trying to say. In any case Ireland obviuosly needs to get the banking exposure of its back.

The Perotti paper is indeed excellent if only to read of a few amazing lapses — the OECD missing 25 years of revised Irish data? The IMF missing key documents in the late 1980s budget process?

It also suggests a reinterpretation of the apparent miracle recovery of 1987-89, which was very much FF’s claim to fame in the 1990s (a narrative that sowed the seeds of our current disaster): It was Nigel Lawson wot done it. Overvalued sterling helped us a lot.

Beyond a shadow of a doubt austerity is contractionary in the short term. Avoiding imposing austerity is disastrous in the medium to long term. Our Gov’t has continued to conduct business in the manner to which we have become well accustomed. Essentially that is first and foremost to avoid inconveniencing any group that has a vote. The result is policy paralysis that is enabled by the ECB and the IMF as the debt hole is dug deeper. Only when the ECB/IMF shuts off funding will our Gov’t be forced to cut spending and increase revenue. The longer the procrastination, and the attendant extend and pretend stance continues the longer we will remain mired on the brink of insolvency.
The first duty of any Gov’t is to remain solvent. In our case we are willingly and eagerly playing with fire as we blindly support uncompetitive wages in the private sector, over staffing in the public and quasi public sectors, propping up property values that are still non competitive.

We have to ask ourselves where the growth in export of goods and services is going to come from in a country where the cost structures are out of balance. Do we think that the Gov’t will find another scam similar to the taking in of each others washing that was characteristic of the building boom. What might it be?

Comments are closed.