Archive for November, 2011

Kevin O’Rourke on the eurozone crisis

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Wednesday, November 30th, 2011

Kevin O’Rourke delivered a hugely insightful talk on the crisis and the global situation at a conference in Dublin last week. His presentation is here.

Fixing Financial Crises – Lessons from the Asian and Global Financial Crises

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Wednesday, November 30th, 2011

Andrew Sheng will address this topic at the IIEA next Monday – details here.

Coordinated central bank action 
to address pressures in global money markets

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Wednesday, November 30th, 2011

The joint statement is here.

Twilight of the Technocrats: Ireland, Italy, and Austerity

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Wednesday, November 30th, 2011

Here’s a long-ish opinion piece I wrote for Foreign Affairs.

Let’s define austerity as a sharper than expected drop in government expenditure and a sharper than expected increase in taxes by a government experiencing a large budget deficit. To date there have been about 21 billion euros in austerity measures enacted in Ireland, with about the same amount to come in the future, and not a single riot.

The scale of austerity in Ireland must give Foreign Affairs readers pause. At the scale of the United States economy, this is the equivalent of shutting down the US Department of Defense. Italy is facing into a period of austerity as well. What can they expect?

(more…)

Environment news roundup

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Wednesday, November 30th, 2011

With all eyes on the euro, the budget, the Middle East, some remarkable, smaller stories emerged.

Irish roads are now among the safest in the OECD. I guess the main reason is that much traffic has shifted to the new roads.

The 2010 Drinking Water Quality Report is out. Water quality is getting better, but slowly. Biological contamination is down and trihalomethanes (which result from improper chemical treatment) are down too.

Construct Ireland reports on an unpublished SEAI study (the leak is easily identified) that shows that building standards were not enforced. This is not surprising in itself, but the scale is. Sean O’Rourke’s interview with Gerry Wardell is worth a listen, and SEAI’s response is intriguing.

The EU is putting pressure on Ireland to hurry up with water charges. Ireland is obliged to fully recover the costs of water services. This implies an average charge of 500 euro per household per year, 5 times what is expected to be announced in next week’s budget.

The carbon tax is likely to go up. Initially, the carbon tax was tied to the ETS permit price, which has gone down. The market is least distorted when permit price and carbon tax are equal. Coal and peat, the fuels that emit most carbon dioxide, are still exempt from the carbon tax and there is no sign of the commencement order.

Dublin is considering a fire call-out charge. This would be wrong. Fire is an emergency. One should never hesitate to call for help.

Solving the Fiscal Crisis Via Limiting Government Commitments

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Wednesday, November 30th, 2011

Ludger Schuknecht has a long track record in writing on public finance (in the mid-2000s, he was prominent in highlighting the windfall nature of revenues associated with real estate booms).  He is now with the German Ministry of Finance and this paper outlines one approach to solving the fiscal crisis.

Debt and Interest

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Wednesday, November 30th, 2011

There has been a lot of focus on the level of debt in Ireland.  The household sector is suffering from a debt overhang as a result of the excesses of the previous decade, the government sector has seen its debt level soar as it tried to cover the losses in the banking sector and continues to run huge deficits, while the level of debt in the non-financial corporate sector appears enormous but seems to require a closer examination.

Using the CSO’s Institutional Sector Accounts it is possible to come with charts like the following (starting from when the dataset begins).

The lines in the chart represent the non-consolidated sum of the liabilities of each sector under three headings.

  • AF2: Currency and Deposits
  • AF3: Securities other than Equity
  • AF4: Loans

The government is the only sector to have liabilities in all three categories as it had retail debt, government bonds and outstanding loans (mainly Promissory Notes) summing to €141 billion at the end of 2010.  The corporate sector has both loan and outstanding debt securities, though loans make up 97% of the €347 billion total.  The household sector has €185 billion of loans outstanding and is the only sector showing a declining level of debt.

The total of these is €673 billion which is equivalent to 430% of GDP or 526% of GNP.  There has been much speculation about where these aggregates are headed over the next few years and whether a default of debt in any or all the sectors is imminent.  A debt level in excess of 500% of GNP does suggest that only one conclusion can be drawn.

However, before declaring that the debt is “unsustainable” and can never be carried it is worthwhile to consider the actual burden that this level of debt is creating rather than simply focussing on the size of the debt.

Again we can turn to the CSO and this time to the Non-Financial Accounts and the interest expense in the Primary Allocation of Interest Account (item D41). 

Two of the lines here appear to make sense.  Household interest expenditure rises with interest rates and debt accumulation and peaks in 2008 at €8.1 billion and then falls as interest rates fell and debt was repaid and was €4.2 billion in 2010.  The interest expenditure of the government begins to rise from 2008 due to well-known reasons and was €4.9 billion in 2010.

The pattern on interest expenditure by non-financial corporations does not present itself to such a straightforward analysis.  This peaked in 2008 at €7 billion but in 2010 had fallen to just €712 million.

At 2.3% of the liabilities from the first chart, the interest for households appears low but the figure for non-financial corporations is startling given that we have just seen that they had €347 billion of potential liabilities requiring interest payments.  Surely firms paid more than €712 million of interest in 2010?

One thing to note is that these accounts are non-consolidated so there could be intra-company loans in the total.  Secondly, firms did make substantial payments in 2010 as distributed income of corporations (€18.0 billion) and as reinvested earnings on direct foreign investment (€14.6 billion).

The interest expense of government is set to increase over the coming years but lower interest rates and continued repayment will reduce the figure for households.  The total for businesses remains an anomaly.

In total in 2010, the three sectors allocated €9.8 billion to interest.  This is equal to 6.3% of GDP or 7.7% of GNP.  Under neither measure does this look like an impossibly large burden but perhaps the discussion will unearth a deeper understanding of these figures.

Saving the euro zone

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Tuesday, November 29th, 2011

I don’t think it is an exaggeration to say the next few weeks will be make or break for the euro zone.   Four elements should be kept in mind:

1.  Lacking a reliable lender of last resort to (large) states, the creditworthiness of countries with large debts and uncertain growth prospects is extremely fragile.   Where any doubts exist about solvency, it is easy to shift to bad equilibrium, even where it is very likely that the state would not default if interest rates stay low.   Ryan Avent at the Economist provides a good analysis here. 

2.  Introducing a credible lender of last resort creates big transfer-risk externalities.   All euro zone countries should be wary of such a lender without some central controls on fiscal policies. 

3.  Even absent the need for central controls, euro zone countries would benefit from stronger national fiscal frameworks given the propensity to (structural) deficit bias.   And some degree of external surveillance and enforcement can help to make those frameworks more credible.   The cost of central controls should not be exaggerated. 

4.  It will be much harder to pull out of the crisis without the use of growth oriented macroeconomic policies where they are feasible.   This applies to fiscal policy in countries where some degree of fiscal space exists, monetary policy and macro prudential policy.

Variable-rate Mortgages, Liquidity Funding, and the Euro

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Tuesday, November 29th, 2011

The Financial Regulator, Matthew Elderfield, received a clamour of popular support recently when he publicly objected to the Irish domestic banks planned decision not to decrease variable mortgage rates in response to the ECB cut in interest rates. The political establishment was warmly enthusiastic for Elderfield’s intervention. The government used its shareholding and political muscle to ensure that the banks’ decisions were reversed. The government also offered to provide the financial regulator with legislative power to determine banks’ mortgage rates. Wiser heads within the Central Bank prevailed, and the government was told by the Central Bank “thanks, but no thanks” for the offer of new legal power to set retail mortgage rates. (more…)

WSJ: Ireland Enduring a Long Age of Austerity

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Tuesday, November 29th, 2011

The WSJ analyses the Irish austerity experience here.

Olli Rehn: There is Light At the End of the Tunnel

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Monday, November 28th, 2011

Olli Rehn marks the one-year anniversary by writing in the Irish Examiner today  – his article is here.

Reform of household energy policy

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Monday, November 28th, 2011

Minister Rabbitte for Energy sketches several reforms of household energy policy in today’s Irish Times. These are plans for the longer term.

There are a range of fuel allowances. Some are means-tested, some are not. None are needs-tested. Houses may be insulated at the exchequer’s expense, but the occupiers are still entitled to fuel allowances. Minister Rabbitte suggests that, in the future, fuel allowances will be directed towards colder homes. That is a welcome improvement.

There are grants for home energy efficiency improvement and micro-renewables. These grants are optimized for administrative convenience rather than emission or fuel poverty reduction. These grants also imperfectly address the core issue: The lack of access to capital to invest in home improvement. Minister Rabbitte suggests that, in the future, grants will be replaced with cheap loans. That is a welcome improvement.

Lack of information is another issue with household energy use. Minister Rabbitte suggest that, in the future, Building Energy Ratings will be mandatory. They are already, but this is not enforced and many prospective buyers/renters seem to be unaware of their legal right to a BER. Reinforcement of this regulation is a welcome improvement.

I had a close look at BERs in England. An English BER is about half the price of an Irish BER, and it contains much more information on heating costs and potential improvements.

Minister Rabbitte also suggests that houses with a poor BER will be taken off the market. I’m not sure that that is wise. It is rather tough on the current owners of such houses. It will also drive up rent particularly in the lower price segments.

UPDATE: 30.9% of houses have a BER of E, F or G.

Three good ideas, so, and one bad one. There is plenty of time to reconsider and refine.

COP17 in Durban

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Monday, November 28th, 2011

Today, the 17th Conference of the Parties (COP17) of the United Nations Framework Convention on Climate Change (UNFCCC) starts in Durban, South Africa. Unlike the summit of 2009 in Copenhagen, expectations are low. The political attention is firmly fixed on the economy. The negotiators will thus make the same demands that were rejected by their counterparts at previous conferences.

Climategate 2.0 broke last week, too late to influence official positions. Besides, the new batch of emails show more of the same. The main new element is the role of the BBC.

Some 20,000 people are expected to travel to Durban. These events are expensive, definitely when compared to the expected result. Some Irish civil servants are rumored to travel in style. This is not at the expense of the Irish taxpayer. Travel to climate negotiations is covered by the development aid budget. As the aid budget is fixed, Irish travel to Durban comes at the expense of people in Ethiopia, Lesotho, Malawi, Mozambique, Tanzania, Timor-Leste, Uganda, Vietnam, and Zambia.

The low expectations for Durban are a blessing in disguise. I have argued that the current international climate regime is complete. The UNFCCC has standardized monitoring of emissions. The Kyoto Protocol / Marrakesh Accords has created international trading mechanisms for emission reduction credits. (Kyoto’s targets end in 2012 but the Protocol itself has no sunset clause.) The COPs have increasingly morphed into fora for pledge and review of domestic policies and targets. That is all that is needed, and all that is feasible (bar a transfer of sovereignty to the UN).

The negotiators in Durban should therefore focus on refining the existing mechanisms. That is quite boring stuff, so that hopefully the majority of the 20,000 in Durban will decide not to return to COP18 in Qatar or South Korea. UPDATE: It will be Qatar.

UPDATE: After pretending to be greener than Labour for a while, the Tories now argue that jobs are important too. This would put London on a collision course with Brussels. The UK will want to rid itself of the Large Combustion Plant Directive too.

UPDATE: Less than 72 hours after I predicted nothing much would happen in Durban, the EU changed its tune. Poland is not particularly keen on EU climate policy. They have the presidency. Talking tough, they at once please the greens and reduce the chance of success.

Euro Zone Weighs Plan to Speed Fiscal Integration

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Sunday, November 27th, 2011

This seems significant.   Gavyn Davies does some scenario analysis here.

Update: Wolfgang Munchau provides his analysis here

Shares of Public Expenditure

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Sunday, November 27th, 2011

The lead editorial in today’s Sunday Times (not on the web) states

Many in Fine Gael believe it is almost impossible to judiciously — and fairly — cut €2.2 billion from spending if 70% of the total, in the shape of public-sector pay, is protected from further reduction.

Now I know that the Irish government is pretty hopeless at presenting its fiscal accounts but it’s really not too hard to find out the true figures on the shares of expenditure taken up by pay and other elements.

Go to page 49 of this document which we have to send to Brussels on a regular basis and which uses the perfectly sensible approach of reporting all of the government’s spending and revenue, rather than specific sub-components picked out according to some unintelligible criteria. The shares of public expenditure for major categories this year are as follows:

Pay and pensions = 25.5%
Social payments = 37.8%
Intermediate consumption = 11.4%
Interest payments = 8.4%
Capital formation = 6.4%
Other (including subsidies) = 10.5%

So not 70%. Closer to one-third of that figure. And, as I’ve dicussed before, when income taxes paid by public sector workers are factored in, the net cost is significantly less.

I have stated repeatedly that I think further cuts in public sector pay rates are required. However, it is hard to see how any reasonable debate on this issue can be had when so many of our media outlets hopelessly misrepresent the basic facts at hand.

David Drumm Interview

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Sunday, November 27th, 2011

With extracts carried in today’s Sunday Business Post, IrishCentral.com carries a very extensive interview by Niall O’Dowd with David Drumm here.

The Dynamics of the Net External Position: Slides and Paper

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Saturday, November 26th, 2011

The slides are here.   The draft paper is here.

See also Paul Krugman on Hedge Fund Ireland.

WSJ on Irish and Portuguese situations

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Saturday, November 26th, 2011

Charles Forelle writing in the WSJ points out some of the risks peripheral nations like Ireland and Portugal still pose for the Euro area, including the chances of our export-led growth strategy collapsing if the international economy begins to sputter, and the possibility of debt forgiveness and/or restructuring. From the piece:

Beside the government debt, Irish households are also heavily indebted—household debt hit €185 billion last year, or 119% of GDP. That’s down from the €203 billion peak in 2008, but it’s still more than twice household income.

“We are going to have to make a choice: What do we want to restructure”—government debt or household debt? asks Constantin Gurdgiev, an adjunct lecturer in finance at Trinity College Dublin and head of research for St. Columbanus AG, an asset manager.

Much of the debt is mortgage-related, and the government has faced intense pressure to craft a mortgage-relief program for homeowners, something it has resisted. Data show rising mortgage arrears and rising levels of negative equity among borrowers.

It’s a risky move. If too many borrowers with negative equity “strategically default,” the cost becomes huge for Irish banks, which would then have to turn to the government for more help—in effect, household debt would be transferred to the government.

“At a macro level, a debt-forgiveness scheme makes sense because people will be consuming rather than paying their debt,” says Philip Lane, professor of international macroeconomics at Trinity College Dublin. “But the scheme has to be surgically targeted so only the people most in need use it.”

Pension Funds and Infrastructure Investment

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Saturday, November 26th, 2011

The FT reports on UK developments here.

Revealed preferences for climate

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Saturday, November 26th, 2011

Eight academic economists have left Dublin in recent months or will leave shortly. That may seem like a small number, but there are only 200 or so academic economists in the country. They all have moved / will move to warmer places: Stirling (2.0K warmer on average than Dublin), Brighton (2.2K), Oxford (2.2K), Canberra (3.4K), Melbourne (5.3K) and Lisbon (7.0K). Dublin economists thus disregard the opinion of the European Union that a climate change of 2.0K is dangerous.

Between 1998 and 2009, intra-union migration has been towards warmer places. The average migrant in the EU experienced a warming of 0.6K. The average masks a wide spread. About 10% of migrants stayed in roughly the same climate, 17% experienced a cooling of 2K or less, and 16% a cooling of more than 2K. 24% experienced a warming of less than 2K, and 33% a warming of more than 2K. 450,000 people opted to live in a climate that is more that 5K warmer than what they were used to.

Obviously, one cannot compare the individual impact of moving to a warmer climate with the impact of global warming, but at the same time it is clear that both Dublin economists specifically and intra-European migrants generally do not object to a warmer environment.

City climate data from World Guides. Country climate data from the Climate Research Unit. Migration data from EuroStat, for Czech Republic, Denmark, Germany, Estonia, Ireland, Greece, Spain, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Austria, Poland, Romania, Slovenia, Slovakia, Finland, Sweden, United Kingdom.

New ECB Executive Board Member: Benoit Coeure

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Friday, November 25th, 2011

Lorenzo Bini Smaghi is set to be replaced by the very-smart Benoit Coeure of the French Treasury – his website is here.

Germany is the real winner in a transfer union

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Friday, November 25th, 2011

So Sebastian Mallaby writes in this FT article.

School of Economics Research Bulletin

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Thursday, November 24th, 2011

UCD School of Economics has launched an Economics Research Bulletin, edited by Kevin Denny, to be published three times a year.  The first edition is here (pdf).

Two New EU Pillars, Where One Old International One Will Do Better

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Thursday, November 24th, 2011

The Eurocrats are anxious not to waste the current debt crisis. In today’s Financial Times, Manfred Schepers of the European Bank for Reconstruction and Development proposes not one, but two new EU institutions, to be staffed by transfers from the senior civil services of member states, and promotions within the Brussels/Frankfurt bureaucracies. There will be a new European Monetary Fund, taking on the roles of the International Monetary Fund managing troubled sovereigns, but working on a permanent rather than temporary basis within the Eurozone. Then there will be a new European Debt Agency, managing debt issuance and deficit control for all member states. At a minimum, Schepers’ proposal will aid the Brussels and/or Frankfurt commercial real estate markets, since these bodies will need a lot of office space.
Schepers is keen to retain the ECB’s restricted mandate as a central bank without the ability to engage in quantitative easing, restricting its work to commercial bank liquidity provision and inflation control. He holds this view despite the growing evidence that this central bank design does not work, and the alternative, more flexible mandate of e.g., the Bank of England and US Federal Reserve, does work.
Much more sensible are the views (via a skype video) of Jeff Sachs suggesting that the IMF, together with a reformed ECB acting as a lender of last resort, be brought in to restore stability and confidence to the Eurozone, in the interests both of Europe and the world economy. We also get a glimpse of Professor Sachs’ chi-chi Manhattan kitchen in the background of the video.

Sovereign debt, government myopia, and the financial sector

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Thursday, November 24th, 2011

Viral Acharya and Raghu Rajan provide an explanation as to why sovereign defaults are rare events in this VOXEU article.

Sovereign Risk and Banking Crises

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Wednesday, November 23rd, 2011

Ashoka Mody and Damiano Sandri summarise their recent paper for the Economic Policy panel in this VOXEU article.

IFAC: Oireachtas Committee Hearing

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Wednesday, November 23rd, 2011

The members of the Irish Fiscal Advisory Council were in front of the Oireachtas Joint Committee on Finance, Public Expenditure and Reform last week – the transcript is here.

SSISI Talk: The Dynamics of Ireland’s Net External Position

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Tuesday, November 22nd, 2011

I will talk on this topic on Thursday at 6pm at the Royal Irish Academy.

Update:  I will post the paper and slides early next week.

Abstract

Ireland’s net external liability position expanded in dramatic fashion during 2008- 2010, despite relatively small net financial flow during this period. Understanding the the source and persistence of this negative shock is critically important in as- sessing the future path for the Irish economy but data analysis is made difficult by the confounding impact of Ireland’s major role as an international financial centre, such that the “core” international balance sheet remains obscure. However, there is considerable indirect evidence to believe that a substantial component of this decline is genuine and relates to the internationally-leveraged structure of the financial port- folios of domestic Irish residents.

Academic Perspectives on Sovereign Default, Austerity and VAT Hikes as a Substitute for Currency Devaluation

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Tuesday, November 22nd, 2011

Harvard’s Gita Gopinath is interviewed on these topics in the Review of Economic Dynamics Newsletter here.

A Euro Proposal: ECB-Funded, IMF Bailout Bonds

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Tuesday, November 22nd, 2011

Colm McCarthy and many other commentators want the ECB to print euros to whatever extent is necessary in order to keep essentially-solvent Euro states from being unable to finance their deficits. Colm argues that this ECB-provided unlimited funding back-up can prevent an inefficient coordination-game outcome in which investors flee Euro bond markets … because other investors are doing likewise. Once the unshakeable resolve and money-printing firepower of the ECB is demonstrated clearly, the Euro crisis will diminish, in Colm’s view. Many other commentators, e.g, Gavyn Davies, Mervyn King, numerous Germans, argue that this money-printing solution will just generate an indirect subsidy of wasteful Euro governments by prudent ones, with Euro-wide inflation or eventual ECB capital losses serving as the income-transfer mechanism.
There is some talk in today’s papers of a Eurobond system linked to closer EU control over national finances. The EU’s record for governance of this type of national fiscal oversight is not good, and the core nations are rightly sceptical.
Why not a combination policy? The IMF agrees to run sovereign bailout programmes for any Euro countries as needed, with funding provided via IMF-issued, ECB-purchased bonds. The ECB gets a decent, non-exorbitant yield on all new Euros issued, and the IMF has access to an unlimited supply of Euro funding as needed. The guarantee from the IMF-ECB that Italy, Spain and France could be brought within this bailout process as needed, with no funding limits, would probably eliminate the need to bail them out at all (via the same “good equilibrium” mechanism that Colm suggests). To make it credible this programme would need to be ready to activate as needed without exception. Recalcitrant Euro governments who failed IMF programme criteria would be booted from their bailout programmes in the normal way.