The Self-Defeating Fiscal Adjustment Debate in a Depressed Economy

The paper “Fiscal Policy in a Depressed Economy” by Delong and Summers (from the BPEA conference linked to by Philip) is hugely relevant to the Irish fiscal policy debate.   While the paper ranges more widely, it provides a useful framework for thinking about the question of whether fiscal adjustment could actually be self defeating in terms of lowering “long-run debt financing burdens” in a depressed economy with interest rates constrained by a zero nominal lower bound.   Indeed, the analysis would seem to have even more general relevance for a small economy within a large monetary union, where the nominal policy interest rate is effectively a given.    A key message is that “hysteresis effects” – whereby today’s output level could have long-lasting effects on future output – could make higher deficit spending today pay for itself over the longer term.   In such a world, a slower pace of deficit reduction need not have an adverse impact on creditworthiness. 

There is a kicker on page 40, however, that is very relevant to the Irish debate. 

There remains the question, on which our analysis is mute, of whether temporary fiscal stimulus is inconsistent with a perception of long run fiscal consolidation. There is no necessary inconsistency. There is experience with temporary expansions, and also with phased-in long-run deficit reductions (e.g. The 1983 Social Security bipartisan agreement of the Greenspan Commission). But it is possible that short run fiscal expansion undercuts the credibility of long-run fiscal consolidation. It is also possible that, in a world with limited political energy and substantial procedural blockages, that effort towards one objective compromises the other.  On the other hand, as Cottarelli (2012) warns, if countries that have committed themselves to short-term deficit reduction as a down payment on a move to long-term sustainability find that “if growth slows more than expected… [they are] inclined to preserve their short-term plans through additional tightening, even if hurts growth more” then: “my bottom line:… unless you have to, you shouldn’t.” His fear is that fiscal austerity will be counterproductive because “interest rates could actually rise [even] as the deficit falls” if “growth falls enough as a result of a fiscal tightening.”

We do not see a good way to address this issue analytically or empirically. Clearly, the risks of short run fiscal stimulus having adverse effects on long-run credibility will be greater in settings where government debt already carries a significant risk premium. Clearly, it will be larger when there is evidence that deficit fears are impacting on stock market valuations and on investment decisions. But even in the absence of such evidence, there is always the risk that market psychology can change suddenly.

The Cottarelli VOX piece is available here.   See here for a related and much discussed blog post by Olivier Blanchard.  This post by Simon Wren-Lewis is also complementary. 

I would be interested in people’s views. 

71 replies on “The Self-Defeating Fiscal Adjustment Debate in a Depressed Economy”

Indeed, the analysis would seem to have even more general relevance for a small economy within a large monetary union, where the nominal policy interest rate is effectively a given.

Apologies for being a wet blanket, but I think the sort of situation Ireland is in can’t be modelled by simply taking interest rates as given. As I see it, the markets’ view of Ireland is really a view of how the ECB feels about Ireland. Think about what it was like to be a London or Bristol merchant in the early days of the Bank of England. You issued bills of exchange to pay for shipping slaves to Jamaica or whatever. As long as the Bank considered your bills to be good you had few financial problems. When the Bank showed any sign of doubt about you, you were screwed. They really had that kind of power and it really was that simple.

Is Ireland’s current situation really any different, fundamentally?


I agree with your basic point. While we may resent it, the attitude of the ECB to Ireland matters, and this has clearly affected key policy decisions.

I am saying something much more narrow when I say the “nominal policy interest rate is effectively a given”: I mean only that the course of this euro zone policy interest rate is independent of Irish fiscal policy decisions (though not necessarily the other way round). This is very different from UK say, where (lower nominal bound constraint aside) the Bank of England can neutralise the demand effects of fiscal policy decisions through monetary policy decisions.

Not sure if the American example is applicable to Ireland given the fact Congress creates the debt . the Fed now buys the stuff and sends most of the interest back to the Treasury making these a sort of not so secret Greenbacks.
However despite this extreme advantage American infrastructure spending has never been particularly smart with the Eisenhower highway programme perhaps as much as Vietnam the primary cause for America folding up the Bretton Woods agreement.
Now the Banks themselves don’t particularly care if the average hick can afford life support as the petro dollars flow back into the banks eventually – cutting off these poor saps from life , love and happiness.
Perhaps this is the true reason for the ineffective fiscal investments over the years – the Big Banks could not really care if these projects work or not as they will get this now globalised money back anyhow.

In the case of Ireland – obviously fiscal investments that would reduce our energy / balance of payments problems would of course be of great value , providing the peasants with more end use Euros for consumption.

But under the present European construct a French style Nuclear programme for example is impossible given these strange fiscal pact thingies.
The European banks seem to prefer us to reduce our standard of living to square our balance of payments – this now makes sense as they are all plugged into the petrodollar system and therefore we will get taxed anyhow one way or another – so why should our masters bother their pretty little heads about some dumb Micks falling off the ladder.
PS – The sort of privatised prototype fiscal proxy in the Eurozone – the EIB seems to have abandoned Ireland to the wolfs with little or no investment in infrastructure
Although there seems to be a token effort based around Irelands most crediable bank but……

However The isolation seems to be Stark when compared to French EIB investments.

Thats the high sexy speed stuff but there more………..

“In 2011, the EIB invested EUR 1.7 billion in French local authorities in key sectors such as transport, urban development and energy efficiency. These sectors accounted for 35% of EIB activity in France”

It appears Ireland has become a sort of European Limerick.

@ Kevin O’Donogue

I agree that Ireland’s agreement to pay it’s bondholders is only as good as the Market, influenced by the ECB, feels. I think the same system of international trading could police inflation if Ireland’s state was allowed to create it’s own money. Ultimately this recession will drag on until we get a state issued source of digital money to complement that created by banks through issuing loans.

Don’t suppose yee guys caught this little piece ?

The White House

Office of the Press Secretary

For Immediate Release March 16, 2012 Executive Order — National Defense Resources Preparedness


which includes …………
Sec. 102. Policy. The United States must have an industrial and technological base capable of meeting national defense requirements and capable of contributing to the technological superiority of its national defense equipment in peacetime and in times of national emergency. The domestic industrial and technological base is the foundation for national defense preparedness. The authorities provided in the Act shall be used to strengthen this base and to ensure it is capable of responding to the national defense needs of the United States.

Sec. 103. General Functions. Executive departments and agencies (agencies) responsible for plans and programs relating to national defense (as defined in section 801(j) of this order), or for resources and services needed to support such plans and programs, shall:

(a) identify requirements for the full spectrum of emergencies, including essential military and civilian demand;

(b) assess on an ongoing basis the capability of the domestic industrial and technological base to satisfy requirements in peacetime and times of national emergency, specifically evaluating the availability of the most critical resource and production sources, including subcontractors and suppliers, materials, skilled labor, and professional and technical personnel;

(c) be prepared, in the event of a potential threat to the security of the United States, to take actions necessary to ensure the availability of adequate resources and production capability, including services and critical technology, for national defense requirements;

(d) improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements; and


Sec. 201. Priorities and Allocations Authorities. (a) The authority of the President conferred by section 101 of the Act, 50 U.S.C. App. 2071, to require acceptance and priority performance of contracts or orders (other than contracts of employment) to promote the national defense over performance of any other contracts or orders, and to allocate materials, services, and facilities as deemed necessary or appropriate to promote the national defense, is delegated to the following agency heads:

(1) the Secretary of Agriculture with respect to food resources, food resource facilities, livestock resources, veterinary resources, plant health resources, and the domestic distribution of farm equipment and commercial fertilizer;

(2) the Secretary of Energy with respect to all forms of energy;

(3) the Secretary of Health and Human Services with respect to health resources;

(4) the Secretary of Transportation with respect to all forms of civil transportation;

(5) the Secretary of Defense with respect to water resources; and

(6) the Secretary of Commerce with respect to all other materials, services, and facilities, including construction materials.

Dork – Notice the list of priorities ?
1. Food 2. Energy 3. Health 4 . Transport 5 Water.
Meanwhile this goverment can’t even bring in simple rational tax policies to favour lets say importing cars with a 2CV design philosophy of basic minimalism.
As for their efforts with Food , energy, health………..

That other republic France is murmuring protectionist voices now…..

@John mch

” This is very different from UK say, where (lower nominal bound constraint aside) the Bank of England can neutralise the demand effects of fiscal policy decisions through monetary policy decisions”

It’s very late, but I don’t think they can necessarily do that can they?

Hang on a mo, doesn’t this throw away line “lower nominal bound contstrsint aside” bring us back to the academic research papers that postulate tighter fiscal policy leading to lower short term interest rates via the local central bank and all the Brownie points that go with that. Close to the lower bound surely that mechanism is fubared

@ Dork of Cork

Interesting Max Keiser report with Chris Cook on oil market risk and banks shifting risk to investors.

The Minister for European Affairs Lucinda Creighton is reported in today’s Financial Times as saying the referendum on the Fiscal Compact will likely be in late May or early June this year. This will give the Irish government the opportunity to deal with the issue of the notorious upward-only rent review commercial lease clause.

The Fine Gael manifesto 2011 stated
” We will pass legislation to give all tenants the right to have their commercial rents reviewed in 2011 irrespective of any upward-only or other review clause”
An Taoiseach Enda Kenny and Tanaiste Eamon Gilmore promised the Irish electorate this would happen as a matter of urgency and included it in their program for government. On the review of it’s government’s first year in office the Taoiseach said he was sorry they couldn’t do it because of constitutional reasons.
The Irish government can now add a further referendum on the same day to overcome this constitutional difficulty and allow all commercial tenants market rents. This is of the utmost urgency for the recovery of the Irish economy.

John Corcoran
M.Sc. Economics London School of Economics and Political Science.


The additional element is the risk/default premium of the interest rate. Based on the analysis of the paper, it is possible that less adjustment could actually lower the premium. But then you have the kicker in the quote. This boils done to how the credibility of future deficit reduction depends on today’s actions.

The Cottarelli paper, for the non-economist, sums up the situation rather neatly.

“For some advanced economies, limited access to financing leaves them no option but to stick to their deficit reduction plans this year. But fiscal tightening cannot be the only tool to restore market confidence. Structural reforms to boost competitiveness and growth are also critical, but even reforms started today will take time to yield results. So it will be critical to support countries that are adjusting at an appropriate pace by making adequate financing available to them – in the Eurozone, through the European Financial Stability Facility and the European Stability Mechanism – to provide a boost to confidence while market perceptions adjust. Markets eventually respond to improved economic fundamentals like stronger medium-term growth and lower future deficits, but on occasion this takes a while.

There are many other advanced economies, however, where fiscal policy has more freedom. If growth slows, these countries should avoid further fiscal tightening. They should allow the impact of an economic downturn on revenues and spending on things like unemployment benefits to raise the deficit temporarily”.

Very true! What cannot, however, be overlooked is the quid pro quo implicit in the approach by the creditor countries, and notably Germany, in the “support” referred to viz. assistance but subject to the conditionality of carrying out the necessary “structural reforms”. This is what many in Ireland still seem unwilling to face up to. Indeed, to any outside observer, the failure to tackle excessively high rates of pay in certain areas (a glaring example with regard to consultant level in the health service is detailed in the press today) and other issues such as that of upward only rent reviews (to which John Corcoran never fails to draw our attention), this self-inflicted myopia must seem remarkable.

Again, as a non-economist, I began reading the material thinking that it simply be a repeat of the usual i.e. economists scratching their heads as to why the real world was not behaving as their models suggested rather than questioning the limitations in their models. The statement “We do not see a good way to address this issue analytically or empirically” is, therefore, to be welcomed.

As far as Ireland is concerned, the proof of the pudding will be in the eating. In dealing with the quid pro quo the new team in charge is showing largely the same level of ineptitude as its predecessor. But facts on the ground are obstinate and cannot be circumvented in the unique historic situation of receivership in which the country finds itself.

Progress on reforms helps sentiment and Mario Monti’s efforts to push through labour market reforms will test that.

Once a fiscal consoldiation process is underway and making progress, it’s likely easier to have agreeement on easing the terms in a situation that warrants it.

The story in The Irish Times on hospital consultants in the public sector working 2.5 days weekly to enable them to also work in the private sector, illustrates how crazy the dual earnings system is. It serves neither the interests of the public patients nor the taxpayer.

@John McHale

No harm to you John but as a member of the Fiscal Advisory thingy were you not advising the Govt last Nov to step up the austerity measures before the Budget was introduced? Pot and kettle spring to mind.

It now seems that, as has pointed out above, that economists are slowly, very slowly , begining to realise that their models of economics are breaking down in a household/consumer debt suffocating environment.

It surely not beyond the wit of even the most amateur of economists to realise that trying to fix the Govts balance sheet at they same time that households are trying to fix theres doesn’t work. I don’t need a Phd to work that one out – blood stones et al do the trick. If memroy serves did Prof Philip Lane not also call for an acceleration of the VAT increases in Killybeggs last summer?

Why is it so difficult for those economists to figure out that the balance sheets of consumers/households deserve priority ahead of the Govt in a balance sheet recession such as we have now. Growth normally comes from the ground up not the other way around – we were told that fixing the banks would deliver us pots of Gold, nobody except the Govt and the morons in the CB believed it. Hey guess what that wasn’t true either.

Believe this – we need a massive debt write off for households and consumers ASAP. Until the powers in charge get that fundamental point no amount of fiscal tinkering will solve our domestic problems.

I’m not sure that 50 pages will improve my understanding of our current economic and finacncial predicament – since our predicament is the outcome of four decades of financial deregulation, incompetence, chicanery and criminal fraud. Fiscal rectitude, of whatever stripe, will do nothing except make a bad situation even worse.

In Development Studies, they set the lowest level of poverty at USD 2 per person per day. Below that you live on Coffin Corner.

Forget about money – its salient, but not the critical issue. Think about 2 liters of liquid hydrocarbon fuel [LHF] , per person, per day: 2 liters! Below the 2 l per person per day consumption level, your economy is underdeveloped. Between 2 l and 5 l your emerging. Above 5 l you are medium developed. Whilst above 7 l you have us.

Next time you go to the convenience store take up a liter pack of milk. Put 2 side-by-side. That’s more than Chindia currently use. Now put 7 side-by-side. That’s us.

Now there are 3 bill of folk below that 2 l level who are real keen to have a better life. That’s a joke? Right? No, its reality. A very nasty one – for us. They get more: we get less. There is just not enough LHF to give everyone 5 l per person, per day. Actually we have only enough to give each of us billions – 2 l per day, and no prospect that that will improve.

Now please tell me how we will ‘grow’, if we (in Ireland) have a LHF consumption which is trending ‘backwards’. We will not ‘grow’: we will regress. So, I think some reality is in order here.

Oh, look, John Corcoran (M.Sc. Economics London School of Economics and Political Science) with a post about upward-only rent reviews…

Re “Clearly, the risks of short run fiscal stimulus having adverse effects on long-run credibility will be greater in settings where government debt already carries a significant risk premium.”

Don’t need an outpouring of Keynesian economic theory to accept the veracity of this. Don’t need a concept of fiscal tranfer adjustment managed equivalently by FOMC under the FED to study the evidence of need for this. Don’t need a future bell shaped curve looking at the apex of the euro before and after 2008 and looking at its decline into oblivion because of the absence of this and similar related adjustment mechanism.

“Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods” Austerity hits both consumption but also the money supply required for the trading of goods. If SME’s can’t get money due to credit contraction, the economy declines.

“Mises turned to the problem of socialism itself, writing a blockbuster essay in 1921, which he turned into the book Socialism over the next two years. Socialism permits no private property or exchange in capital goods, and thus no way for resources to find their most highly valued use. Socialism, Mises predicted, would result in utter chaos and the end of civilization.” Mises passed away in the early seventies, it would be interesting to have read his views on QE and LTRO credit expansion for the banks and socialism for the banks.

I’m guessing both Mises and the Austrian school against whom the charge of unbridled deregulated Greenspan economics post 1970 can be made and Keynesians who favour controlled credit expansion and stimulus in recession against its opposite counterpart during a boom, would both be abhorred at the current austerity driven and politically motivated Merkozy bandaid for Europeean austerity driven bailouts.

As the euro has met its waterloo, we should be thinking beyond the euro, all of whose vectors are going down and moving back to a form of capitalism that can work using devaluation, stimulus, living within our means avoiding at all costs, the ‘great pretend’ that has cost us so much already and now threatens the extinction of the Irish state not only economically, but politically as well.

From link above:

” The first general treatise on economics, Essay on the Nature of Commerce, was written in 1730 by Richard Cantillon, a man schooled in the scholastic tradition. Born in Ireland, he emigrated to France. He saw economics as an independent area of investigation, and explained the formation of prices using the “thought experiment.” He understood the market as an entrepreneurial process, and held to an Austrian theory of money creation: that it enters the economy in a step-by-step fashion, disrupting prices along the way. “

Lawrence Summers in today’s FT on similar.

“How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the time it may take to return to normality in a world where policy credibility is essential? The right approach is to use contingent commitments – policies that commit to action to normalise conditions, but only when certain thresholds are crossed. So, for example, it might be appropriate for the Federal Reserve to commit to maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a commitment that a financing mechanism such as a gasoline tax would be triggered when some level of employment or output growth has been achieved for a given interval. Tax reform legislation might propose that new rates be phased in at a pace that would depend on economic performance.”

‘Contingent commitments’ is a phrase I’ve been fumbling for. How about contingent commitments with the Troika next time round – as and when employment rises to, or as an when growth hits… and so on.

@ Eoin Bond

Thanks for that!
I have now read Johns post twice!
(Read this twice and we are even)

BWSnr puts it bluntly enough…. unless we can invent another few dozen million barrels of oil every day and remove the current resource constraints, the game moves on to how long highly indebted so called ‘rich’ countries continue to outbid solvent but so called ‘poor’ nations for resources.

@YoB I dont think anyone intelligent realizes that cutting public spending is going to help grow the economy. Maybe some economists believe this, after all a number of economists paid fortunes for houses during the boom….. so may some do, maybe they believed that Ireland had invented a new paradigm

I dont know what the answer is, I suspect there isnt one. I dont believe it is possible to write off the debts you speak of without also writing off most other debts, such as pay, pensions etc…

We have a very limited amount of money, resources, credibility left…. the real scandal is most has been used up by traitors in government buildings, in bailing out their cronies in the belief this is just another business cycle/recession and that energy/resource constraint are not that important..

Why would China buy Irish debt? Why not just buy Iranian oil/African land/Australian Uraniam and so on?

@michael h

“Progress on reforms helps sentiment” and sentiment will grow cold and wither before any reforms hit Ireland. There are more professors of history in Ireland than neurologists. The PN is a big news item, but the Croke Park Agreement is completely out of the news. Increments are still being paid. It’s an entitlement, you know.

Labour market reforms in Ireland went into reducing the minimum wage while doing the unthinkable and putting a cap on social welfare payments so that no one can earn more than an average industrial wage, irrespective of family size seems to have gone by the board. There is still the distortion that sees property prices on the floor but rent supplement still up in the moon.

The Central Bank Macroeconomic Review is relentlessly grim. Therefore it is essential for it to disappear from the news headlines quickly rather than upset the applecart. If there was any intelligent life in editorial departments it should a receiving a much greater airing.

Papers by X, Y and Z academics are interesting and stimulate debate no doubt, but once in awhile, not rarely, good stuff comes onto the public table courtesy of Irish minds. Apart from a few shavings, it is left untouched by the media (obviously not this blog).

@Brian Woods Snr

Re “Now please tell me how we will ‘grow’, if we (in Ireland) have a LHF consumption which is trending ‘backwards’.”

We’ll grow if we leave the euro. There’s no need for us to live on Coffin Corner which is the address the Troika is sending us to. They’ve hoovered out this economy and are intent on hoovering out the rest of it, financial services, CT, asset stripping.

LHF is not a good statistical tool to measure growth with. We are not the Sudan or Darfur, NI troubles are over. We’ve green fertile fields and a MNC footprint the envy of the world attracted here I believe by far more than low CT or euro foothold. These MNC’s export globally and even benefit from our cool climate. We can be a Hong Kong, Denmark or Sweden but we really lack investment in education. MA’s and PHD’s of all discipline should be required to work in ireland for at least 5 years after graduation unless circumstances provide evidence to the contrary in individual cases. Our political and public service systems need to be modernised; our banking system remains in an appalling mess. We’re low hanging fruit for EZ and global bottom feeders.

We’re a smart people but the smartest leave. Our contribution to the Arts show our potential. Corruption and an antiquated educational and political system fed by cronyism from both Church and State have led us to where we are.

Time to rise up out of the ashes of the euro and take our place in the modern world. Its not hard to do. We’ve smart people able to pick up and learn best practice from around the world. Worse that can happen, is that we fall into the euro septic tank. But, if we do, we can still emigrate and prosper in other lands.

@brian woods snr

Mr Kenny believes growth will come from China, even though it may be experiencing its own problems. I suspect once the IBECs, educational institutions, accountancy, management consultancy and legal firms are stripped out of his 100 strong entourage, the number of actual product exporting firms left is quite small. And good luck to all of them.

With energy costs climbing, I am skeptical that exporting food products such as dried milk powder from ireland to China will be of real significance. New Zealand is already well-placed. But we’ll see.


Grow up.

Mr Corcoran has a legitimate issue – businesses in the country cannot afford to pay rate charges based on crazy property prices and crazy property prices gave rise to equally crazy upward only rent movements, which businesses can’t afford either.

The Govt jails business people for non payment of rates but bails out investors into banks who financed properties which have fallen 80% to 90% since peak. It then promises then that UORR would be abolished but then claims it can’t do so because of some legal constraints – but refuses to publish the legal basis it claims that prevents it from implementing its own election promise. All the while smug and comfortable employees such as yourself tut tut at such issues but ultimately don’t give a damn, except insofar that it annoys you to read the actual truth of whats happened in the economy.

I’d safely suggest if you had taken a real economic risk in your professional life as Mr Corcoran has, rather than the pseudo one you believe you have, you may be singing a very different tune.

@ Colm B: God bless you optimism Colm. I think we shall just have to disagree – in the most agreeable possible way, of course. Thanks.

@ The Alchemist: China is one ‘bloodsucking’, Mercantilist state. As long as any Irish company is trading with China and they keep manufacturing here, then they will be OK – for a while anyway. But if they move to China, its bye-bye time. Two, possibly three years and the company will be stolen from them.

Deputy Kenny and a many others are listening to, and believing whatever they are being told. Its mindboggling. You’d think that they might have some glimmer of an informed opinion. Some folk are going to get a very unpleasant shock some day soon.

We have, at best, between 15 and 18 years to get our energy house in order (that’s not in 15 years, but by 15 years!). Think that is possible with the nature of our political leadership and their sychophantic advisors? Not a chance.

I am not a fan of nuclear, but small-scale Thorium reactors (several dozen are needed) will get us over the electricity hump. However, private transport (as we now know it) is doomed. Mechanized, large-scale farming and food production is also in for a hiding. As I said, a nasty shock is in store.

As I advised. Forget about the money. Follow the energy trail.

@ YoB

I’m simply pointing out that Mr Corcoran, who i have previously stated has very valid points, detracts from his argument by posting it in its entirety on multiple, only-vaguely related, threads, complete with the signature at the end. Grow up? How about you stop throwing toys out of the pram?

There are two immediate issues for us Irish arising from this.

1) FG’s policy of “dress to impress” and “super-pleasing the client” (as most succinctly expressed by John Bruton in the past) through exceeding the troika targets for fiscal consolidation and cuts if possible clearly have a serious risk economic risk associated with them.

2) Debates like his will be very different after the ficscal compact has been signed. After we have debated and formed a view on these difficult and uncertain economic policy issues we will then (if we have decided to run a sizable deficit) have to go to Europe and persuade a significant number of onational governments to support our views. Note that it is not the EU Commission or even the ECB that we willl have to persuade but a disparate group fo politicians with differing interests, subject to different domestic political pressures and with different psychological trope (including egomaniac narcissists).

As such, by voting for the fiscal compact, we are not only accepting that we are not competent to carrying on such debates, but we are also deciding to submit and decision to allow a dificit to a flawed political mechanism.

This flawed mechanism will only stop decisions which decide against increased austerity. Therefore, we cannot say that the decisions will even themselves out. There is an inbuilt bias towards austerity.

Granted, that there is an inbuilt bias against austerity amongst Irish politicians other than FG. However, surely the EU institutions and not certain member states are the people to temper this bias?

[I hope this is more readable]

There are two immediate issues for us Irish arising from this.

1) FG’s policy of “dress to impress” and “super-pleasing the client” (as most succinctly expressed by John Bruton) through exceeding the troika targets for fiscal consolidation and cuts clearly has a serious risk economic risk associated with it.

2) By voting for the Fiscal Compact, we are not only accepting that we are not competent to carrying on debates such as that posed by this thread, but we are also deciding to submit any decision to allow a deficit to a flawed political mechanism.

After we have debated and formed a view on these difficult and uncertain economic policy issues, we will then (if we have decided to run a deficit) have to go to Europe and persuade a significant number of European governments to support our views.

It is not the EU Commission or even the ECB that we will have to persuade. Rather it is a disparate group of European politicians; each with differing interests, subject to different domestic political pressures and suffering from different psychological tropes (probably including egomaniac narcissists).

This flawed mechanism will only stop decisions which decide against increased austerity. Therefore, we cannot say that the decisions will even themselves out. There is an inbuilt bias towards austerity.

Granted, that there is generally an inbuilt bias against austerity amongst Irish politicians and voters. However, surely the EU institutions and not certain member states are the people to temper this bias?



I have also requested (on more than one ocassion) that you please desist from making snide smart comments relating to other posters who raise very legitimate issues.

Mr. Corcoran believes the heart of the problem in the economy resides with the property valuation disaster that the bust has left us. Let me tell you little secret – he’s 100% correct.

Whilst many economists and posters on this site try to skirt around the elephant in the room I applaud Mr Corcoran for ensuring that we never lose sight of THE issue and that’s the property disaster and the trail of destruction that it has left us all in both polictically, economically and socially.

BTW children tend to throw toys out the pram when their frustrated and annoyed – believe me when I say I’m a very calm and serene individual.

@John McHale

While the paper ranges more widely, it provides a useful framework for thinking about the question of whether fiscal adjustment could actually be self defeating in terms of lowering “long-run debt financing burdens” in a depressed economy with interest rates constrained by a zero nominal lower bound.

This paper’s alternate title “The confidence fairy – might he be moody?”.

It is crazy talk though. I mean what are the chances that crippling austerity might cripple a state in the longer term? Austerity has worked well so far for Germany, though obviously it is other countries austerity….

It is good that John McHale acknowledges that something might be wrong with the centre right European economic consensus but that consensus remains remarkably resistant to evidence. Most prominent Irish economists still recommend we sign up to the Fiscal Compact when everyone outside Europe agrees it is faith based economics and, as @zhou_enlai points out in a very good post above, it makes Ireland’s position in Europe even more tenuous and subordinate to the self styled cores needs and political imperatives.

In a closely related post at the NYT Macroeconomic Policy Wagers Paul Krugman remarks on the nauseating spectacle of Jean Claude Trichet whining about the lack of good macroeconomic policy advice after having spent eight years trying to undermine it and three actively fighting against it.

Austerity is a faith based, right wing political position, not a coherent economic theory with a basis in fact. The Fiscal Compact will make it the law of the land.

How the hell did this happen?

In 7 Litre plus countries there will be little difficulty cutting fuel consumption by 30 to 40%. The link is to the US sales figures for individual models in 2011. The top selling vehicle is a Ford F150 pickup that weighs 4680 Lbs. (2122 Kg.) there are three similar vehicles in the top ten best sellers. In the developed world we will shed weight as the underdeveloped world copes with declining car sales. In the long run sales will decline in the developed world and we will be no better off than India or Indonesia. In the meantime let us enjoy our fortunate position as long as we can.

I caught it earlier in the week – I am expecting a collapse of price also but I subscribe more to Steve of Virgina views although he is at the same time too Maltusian for a taste.
Even so Chris Cook stated the banks have no capital in this game and this echoes what Steve is on about.
“The system as designed: cheap inputs + cheap credit = marginal system returns.
This leaves out the returns to ‘entrepreneurs’ that are independent of marginal system returns to a large degree.
Now: expensive inputs + expensive credit = negative system returns.

Negative real returns here weigh down the entire interconnected system. Increasing the amount of credit within the system increases both input- and credit costs. Credit does not exist (or is allowed to exist) outside the system: the expansion of debt cannot outrun increased input costs — which are a feedback outcome of debt expansion. There are obvious limits to credit forcing beyond these limits system returns are unaffected.

Debt itself has become the obsession du jour: the problem is not the sufficiency of debt or even its costs but the defective structure within which debt subsidizes profitless waste. We love our waste, it makes us feel human: right now the world’s economies are at the point where debt can just barely stretch to fill the waste gap. We can just barely afford the costs of the debt, provided we put to use every sort of extraordinary tactic to manage them. We add more debt, we borrow our way out of it, we shuffle it around: running faster and faster to remain in one place.

Debts can be managed this way only because the state can always run faster: as long as there is a marginal return somewhere within the debt-y universe the system will continue to lend to itself ever-larger nominal amounts. Unfortunately, the real capital that the debt is supposed to represent diminishes while the claims made against capital increase. The efforts to manage debt by ‘renewing’ it become counterproductive. Adding debt becomes another form of waste with costs that cannot be met.

A decline in nominal price of petroleum is no cure: temporary declines allow price-thwarted demand to rush back into the markets and push up the price. This decline-push dynamic remains in force until the ability of customers to meet the high price price is exhausted, when the credit runs out. The producers must then lower the price to meet a diminishing cash market. What supports a price also supports the ability to meet it, the waste gap persists and continues to expand. Marginal costs swell to become the entire costs. Before that point is reached the system stops working as inputs cannot be had at prices users are able to afford.

Demand shifts from the purchase of goods to the purchase of fuel to support legacy ‘investments’. Demand destruction takes place first within the goods-producing sectors rather than in energy sectors, it takes place even as fuel prices decline.”
Dork :Notice the dominance of rail in the EIB loans with it even providing money for the partial reconstruction of the Waverley line in Scotland despite it been cut to pieces in a least 2 places by post 1960s road developments which will make it a very expensive line to bring back on line.
Also its not the most populous of places with a few Satellite towns of Edinburgh and a few ~10,000 market towns…/borders-railway-gets-european-financial-boo...
This is the terminus now

The line is not too unlike the Midleton line yet the Youghal section would be far cheaper to bring on line and would possibly turn it into a 4 carriage DMU setup(at least in the summer) rather then a 2 carriage line making it more effiecent.
Our remaining fixed capital formation should be directed at these areas as car transport is likely to become much more expensive in my view.

The goverments goal should be about maximising the internal resourses of the state via fiscal means.
Unfortunetly we live withen a non optimon monetory area which could make these investments work below capacity such as it happening in Spain now – meanwhile the UK rail passenger numbers continue to soar….


On The Merkozian Fiscal Corset …. merely an example of ‘Methododological Merkozian Franco_Deutsche Localism’ of a certain time and place: it has ‘absolute zero’ universal validity.

Several particularly central ideas emerge from large threads of thought provided here. First is a point about social ontology. Social research should be based on a realistic understanding of the fact that social phenomena are constituted by socially embedded individuals in interaction with each other. Higher-level social entities—states, organizations, institutions—are real enough, but they must be understood as being composed of individuals in interaction. So social science must avoid the error of reification—the assumption that social entities have some kind of abiding permanence independent of the individuals who constitute them. This is the approach I describe as “methodological localism.”

@Bond Eoin Bond

The Wall Street multibillion scandal no one is talking about

[…] there is another scandal that has come out of the financial crisis that at least to me makes the mortgage underwriting scandal look like small peanuts, and it has been heating up lately. Two weeks ago, the government disclosed that it is looking into bringing criminal cases against traders and banks that manipulated a key bank lending rate, called LIBOR. A source close to the case says the government’s “may” will be dropped soon. Both Barclays and Deutsche Bank have disclosed that they have been the focus of investigations. Banks have suspended dozens of traders. Today, Credit Suisse announced that it was cooperating with regulators on the case. Traders at UBS reportedly are already working with the government on its investigation. Looking for instances in which Wall Streeters go to jail, unlike mortgages, this may be the one.

And yet because it is over an technical sounding bank lending rate, and has been developing for years, the scandal has mostly passed over the public without a real knowledge on what it’s about. But to understand the real rot on Wall Street, and how widespread it is, you should.

Consider what went on here. Banks took a rate that they artificially set themselves, and then went out and convinced municipalities and pension funds and others to bet against them on the rate. LIBOR rates were supposed to be set by bank treasurers reflecting what it cost them to borrow from other banks. But reportedly a number of bank treasurers consulted traders when deciding what rate to report to the organization in London that collected and posted the rates. (LIBOR stands for the London InterBank Offered Rate) What’s more, traders at a number of banks were given access to the systems that bank officials used to enter the rate so they could overwrite the rates with ones that would better suit them. When the rate went the way Wall Street traders programed it to do, the banks cashed in millions.

h/t on both: Naked Capitalism

@Bond.Eoin Bond

It’s much more nuanced than upward-only rent reviews. If I were a tenant in France or the Benelux counties I would have a three year rolling commercial lease with rents reviewed annually to the CPI. I could exit the lease every three years. In Ireland lease lengths are 25/35 years with five yearly upward-only rent reviews. Most tenants believed the arbitration system was systemically corrupt. The arbirator had the delegated power of a High Court judge and his decision was final and could not be appealed. He did not have to give a reasoned decision. The ruinous lease law incentivised the corruption of the rent review process and there were lots of malpractices eg secret agreements,confidential agreements etc etc. It was an organised cartel.

This feudal lease law was a twin headed monster which incentivised the over-renting of tenants and was the rocket fuel for the commercial property valuation model which created the monster commercial property bubble. When this bubble burst it bankrupted the banks. The banks lent tens of billions against these leases not against the properties. In all other eurozone countres you value property on the quality of your property,in Ireland you valued commercial property on the quality of your tenant.

No other eurozone country tolerates this feudal lease law. Many commercial tenants are massively over-rented for between five and ten years and are been bled dry by the members of this cartel. No other commercial tenants in the world have to endure what Irish commercial tenants are enduring.

So social science must avoid the error of reification—the assumption that social entities have some kind of abiding permanence independent of the individuals who constitute them.

Really? So when Sapper O’Donnell falls ill and is unable to march with his regiment it becomes a new regiment?

After making an embarassingly intemperate response to Richard Fedigan some time back, I had planned to practice the virtue of silence for the forseeable future, but I think this post requires comment.

There is clearly, in general terms, a trade-off between the damage caused by increased outstanding debt and that caused by hysteresis effects. Hysteresis effects are undoubtedly real, and to my mind are in general dominated by three components:
1) Damage to human capital arising from long term unemployment and from employing people below their potential.
2) Damage to the accumulation of business knowledge and productive capacity arising from reduced productive activity and reduced investment in capacity.
3) Damage to the base of productive infrastructure through insufficient public investment.

To my mind, while we are clearly suffering hysteretic damage through unemployment, Ireland’s SOE status and history of infrastructure investment are doing much to limit the wider damage. Large parts of our economy are dependent on overseas demand, and are unaffected by weak demand in the domestic economy. Those parts that serve the domestic economy are mainly innovation takers, and there must be considerable doubt about whether their capabilities will suffer significant long term damage from the current dip in demand.

This contrasts with the position in larger economies which are very much more dependent on activity in their domestic markets as a source of learning and innovation.

On infrastructural investment, I think there is great doubt over whether higher current levels of investment would improve the economy’s long term prospects. The big multi-decade project of building a national road network is more or less complete, and most of the big infrastructural projects still on the drawing board are of very dubious value from an economic performance perspective (although some such as the National Childrens’ Hospital look good from a social perspective).

So, at least to my mind, the damage from hysteresis, while real, is likely to be much less than for a larger less open economy.

Avoiding damage from hysteretic effects does not come free. Higher public borrowing also has long-term damaging effects, and it is ideally desirable to find the optimal trade-off between the two. In the case of Ireland, because the hysteretic effects should much weaker than for a larger more closed economy, the optimum trade-off between the two should be significantly more favourable to cutting public borrowing than for a larger more closed economy.

While hysteresis is, I think, relatively less important for Ireland than for other countries, it still deserves policy attention. However, I suggest that what most demands attention is the design of fiscal adjustments so as to minimise their hysteritic effects, more than the scale of the adjustments. To my mind, this means reshaping the adjustment so as to limit its negative impact on employment. Contrary to Croke Park, cuts in public spending should come through lower pay and more rigorous procurement practices, more than through employing fewer people.

@Ernie Ball

Precisely. Not only so, but four critical realists fall out to carry his stretcher!

@ DoD

no one trusts Libor anymore. Its a meaningless reference rate. Eh, except for the fact that there’s a few trillion in nominal contracts tied to it…


Ta. Simply continuing me financial system education as a responsible director of The Blind Biddy Hedge Fund.

Couple of trillion eh!

@ DoD

actually probably more like a couple of dozen trillion now that i think about it.

… and chance you might tweak a few bits and bytes and pick up a half a trillion or so and we’d be sorted 😆

You are ignoring one tiny little point about our infrastructure investments – They were the wrong investments……….
The input costs are now simply enormous and unsustainable at present oil prices.
Oil imports(5.168Billion) in 2011 was higher then our food imports(4.995B) , a similar phenomena happened in 2008 and then the collapse in road freight haulage and oil price reversed this for a period…… now its back again.
Also Oil imports were 3 times higher then our road vehicle imports(1.706B)

These figures are simply unprecedented.
Private Road vehicle fuel consumption must go back to at least 1990 levels which will entail more then a halving of the present oil consumption pattern.

Y1990 :
Road Private car :926KTOE
Road Freight :334KTOE
Residential oil
(heating) :389KTOE

Road Private car :1,986 KTOE
Road Freight : 733 KTOE
Residential oil :1,288 KTOE

Off-thread – but recent in Die Nederlands is worriesome for EU Integration

Something’s gone wrong in Tulip Land
26 March 2012 NRC Handelsblad Rotterdam

Dutch Prime Minister, Mark Rutte, has yet to distance himself from the anti-immigrant web site recently launched by the far-right Party for Freedom (PVV) headed by Geert Wilders. This silence reveals the country’s political divisions and a lack of vision on immigration issues, argues philosopher Paul Scheffer.

@Ernie Bell on reification

Really? So when Sapper O’Donnell falls ill and is unable to march with his regiment it becomes a new regiment?

Do you not think that a contribution to Ireland’s current weakness is that we did think that Merkel’s Germany was Kohl’s Germany and that a European Commission stacked with nominees from the unfortunate recent plague of right wing governments was effectively the same as one of Delors’?

Colonel Hunt’s regiment will most definitely choose a different set of battles to fight as Colonel O’Donnell’s one.

@John mch

“The additional element is the risk/default premium of the interest rate. Based on the analysis of the paper, it is possible that less adjustment could actually lower the premium. But then you have the kicker in the quote. This boils done to how the credibility of future deficit reduction depends on today’s actions.”

I was getting at the Alesina point about tighter fiscal policy leading to lower interest rates and lower bond yields – the market’s way of getting there is via lower inflation expectations. Near zirp context means that mechanism is not available. It is often used , or at least the historical results without mention of the mechanism are, to sell the pro- austerity line.

The bit I pasted above really is to a large extent bog standard uncertainty over policy choices and how to react to them for investors. In a way the remarkable thing about it is that it is so obvious yet it is a revelation in a Summers paper. Are there people who didn’t understand this point until just now?

@JohnMcH “I agree with your [KD’s] basic point. While we may resent it, the attitude of the ECB to Ireland matters, and this has clearly affected key policy decisions.”

KD’s basic point would true in a solvent debtor situation. Hardly equivalent to Ireland’s current situation. Whether we like it or not, the current attitude to Ireland is a N European banker one: Ireland is the insolvent debtor from whom the max must be recovered, in as short a timeframe as is possible, with minimum input required from the Debtor (other than to keep the Debtor compliant with Debt Service), for the benefit of the Creditor. The provision of additional liquidity under the FC is only being provided to keep debt service going….It is certainly not being extended for improving Ireland’s solvency.

It is the basic non-acknowledgement /denial of Ireland’s insolvency that appears to be driving policy decisions, even in face of increasing negative economic performance indicators. That strategy depends on a significant uptick in the global economy to resusicitate the situation….but that’s not happening, is it. Therefore, the orthodox economic expectation that recovery is around the corner is a misguided one at present….Maybe (but it’s a big maybe) you’ll get lucky with the timing of global recovery….and then you can tell us that you were right…..Everyone hopes you will be right but, again, what happens if you are wrong? Will you then put up your hand asbeing one of those who advised on the leading of Ireland into the abyss?

Where is the PN restructuring process at this point? Still stuck on “technicalities”? The EU /ECB are interested in making themselves whole and will extract many more pounds of flesh from the Irish who they consider overpaid and wealthy enough to pay all of the money back (certainly deserving of far less a standard of living currently being enjoyed by the Debtor)….Plenty more to be extracted from the Irish before they are in danger of “termination”….and extracted it will be.

If the Irish people agree to the noose (the FC), then they can’t then complain if they are subsequently hanged. But they certainly will be entitled to hold their expert advisers to account for (unluckily perhaps) leading them to that point.

Olivier Blanchard’s conclusion sums up Official Ireland’s approach:

“Is all hope lost? No, but putting the recovery back on track will be harder than it was a year ago. It will take credible but realistic fiscal consolidation plans. It will take liquidity provision to avoid multiple equilibria. It will take plans that are not only announced, but implemented. And it will take much more effective collaboration among all involved.

I am hopeful it will happen. The alternative is just too unattractive.”

I would agrue that tipping Ireland into a bad downward spiral (from its current position) is the unattractive route to be avoided.

It would be useful to know if the various commentators are arguing against austerity in Europe in general or against austerity in Ireland in particular.
Pr Krugman who is very much in favor of relaxing fiscal constraints in the US, would probably not advise to do the same in the state of California, which is nearly bankrupt.
Likewise, one can be in favor of relaxing the fiscal policy in countries that are near the equilibrium in terms of public finances and running a surplus in their balance of payment (mainly Germany) and against doing the same thing in Ireland ,which is running a huge deficit that could not be financed without the Troika. Unless you believe in the Laffer curve ,lowering taxes or increasing expenses ,right now would be suicidal.

Gavin Kostick et al.

Agree completely with the idea of contingent commitments. Here’s what I wrote a few weeks ago

So it is quite possible that at some point in the next ten years, that this automatic correction mechanism kicks in, acts in a pro-cyclical manner and further deepens a contractionary cycle. The economic thinking behind the treaty is that there is a linear relationship between budget adjustments and deficits. However in the real world this is not the case. Instead there is a certain pace of budget adjustment that needs to be followed, and too much austerity too soon is self-defeating (e.g. this is the view of the IMF). Adjustments need to be capped, and made a function of growth. This treaty allows for the possibility that Ireland will be forced, against its better judgement, to be locked into automatic excessive austerity measures that are based on flawed economics.

The size and pace of fiscal adjustment needs to take as input metrics such as levels, rates and acceleration of growth, unemployment, inflation etc. There needs to be thresholds when measures kick in and when they stop.

An analogy might be driving a car up a steep hill. Selecting top gear and pushing hard on the accelerator isn’t the way to get to the top in the quickest way. As the hill gets steeper you need to select a lower gear. Current EU policy is all about pushing on the accelerator as hard as possible. The Fiscal Compact seeks to enshrine this permanently. There needs to be a concept of economic “torque” rather than simply “speed”, and a recognition than not all roads are flat well-paved autobahns.

@Overseas Commenter

Pr Krugman who is very much in favor of relaxing fiscal constraints in the US, would probably not advise to do the same in the state of California, which is nearly bankrupt.

I can not find any Paul Krugman column that compares the state budget of California to Irish economic policy, possibly because California is eight times the population of Ireland and part of a federal state rather than a sovereign republic and possibly because California and Ireland have quite different problems (Ireland: property bubble, socialized banking debt, borrowing in a foreign currency, Angela Merkel; California: Too many Republicans, not enough taxation.).

However this recent blog entry in the New York Times would be fairly typical of his output on the case for austerity.

Austerity and Growth

Watching Europe sink into recession – and Greece plunge into the abyss – I found myself wondering what it would take to convince the chattering classes that austerity in the face of an already depressed economy is a terrible idea.

So what would it take to change your mind on austerity OC?

@ overseas

‘Pr Krugman who is very much in favor of relaxing fiscal constraints in the US, would probably not advise to do the same in the state of California, which is nearly bankrupt.’

Perhaps not, but he would argue for fiscal transfers from the Federal budget surely. Regional economies go up and down and factors of production move, so there has to be rebalancing.

@ Bryan G
The problem of course is to get agreement on and evolution of the contingency triggers. On one end of the spectrum (those who are owed money), the desire will be to set agreements in stone; in legally enforceable and relatively rigid terms. One the other end, greater flexibility and input is required. There are inherent conflicts for both ends.

That is no different in reality to the existing situation, bar the former group is firmly in control while the latter is not afforded any latitude. That reality reflects the inherent dominance of creditors over distressed debtors.

@ Overseas: ultimately, there will need to be debt resolution. However, it appears that this will not be before the crs are ready. Fair enough on one level. However, in the meantime, the drs are in real danger of falling over….so delay will cause greater pain and greater losses all round in the end. Anyone professionally involved in debt resolution knows this. One can analyse and analyse….but in the end, it is a very simple concept which N Europeans in particular well understand.

The issue for Ireland of course is whether, in the meantime, it continues to be the compliant debtor, to its increasing, unsustainable cost (note Ireland’s rapidly deteriorating economic indicators), or whether it pushes for earlier resolution….and I say push, as leniency will not be forthcoming….How many exampples of this do we need?

And yes, there will have to be simiilar resolution for others also in Europe. It’s coming anyway….

Heard on Joe Duffy today:

‘ I know the Greeks are in worse trouble than us, Joe, but it’s not today or yesterday that started. Sure we are hearing about them for thousands of years’

An interesting paper but so not relevant for our current situation.

As I understand the main message it is that because of hysterical effects during a depression a 1% fiscal deficit can be long term self financing. But it does not imply that an 8% fiscal deficit would enjoy these benefits 800% fold.

Also it talks of a government being able to live off a long term confidence in its credit worthiness. Without official support, Ireland would be a basket case in terms of its long term creditworthiness.

@Paul W
“debt resolution” is a nice euphemism for “sovereign default”.
If you sincerely believe that the best course of action is to default ,ask the troika to leave and then leave the Euro,I agree it does not make much sense to continue austerity (still there will be the little difficulty of financing the deficit).

@Paul W

Of course there would be a lot of debate about the details of the contingent commitments, but that would be a huge step forward from where we are today, which is basically a linear path from a state of sin to salvation via deep fiscal cuts, based on an inappropriate extrapolation of the “prudent housewife managing the family finances” model to the state/EU level.

This is perhaps exemplified by the IFAC’s last report, which took Noonan’s baseline and then said that faster fiscal adjustment is better, in the range of 10%-20%. Someone could then say – the IFAC target should be a baseline, and that faster fiscal adjustment is better, in the range of 10%-20%, and so on in a reductio ad absurdum. There is no recognition that thresholds, caps, feedback etc could or should be used to modulate the pace of adjustment in response to actual developments in the Irish or EU economy. The counter arguments were considered in that report, but dismissed:

If these impacts were strong enough it is possible that austerity could be self defeating but the conditions for this seem unlikely.

One of the advantages of making the size of the fiscal adjustments or other targets a function of national and EU growth, for example, is to better align incentives for all parties concerned in the wider interest. For example if the ELA repayment schedule was tied to growth rates, then the ECB would have a direct financial incentive to pursue policies that stimulated growth in the EU overall, with the result that they would be more likely to demand measures that need to be taken in surplus countries, rather than solely focusing on measures that need to be taken in deficit countries, for example.

@ Overseas
Sorry, debt resolution does not necessarily mean sovereign default. But even accepting it as that, as I have said here before an orderly (agreed) default on that element of Ireland’s debt attributable to the bank guarantee (apporx 1/3) would be equitable and mutually beneficial in the long term for dr and crs, but not painless (for anyone). In the absence of that debt element, Ireland’s sovereign debt is sustainable……at present. In that context, orderly default is a viable alternative to the existing austerity path. The point is that if the resolution is sooner, it will be smaller. If later, not only will it be bigger but Ireland will (increasingly) be in very bad shape to service the sovereign debt element i.e. if there isn’t resolution sooner, Ireland will ultimately be reduced to the (near) abyss, not unlike Greece…..and the consequences will be worse for the crs.

There is no question of asking the Troika to leave. They are Ireland’s (massive) crs. Without agreement, they have much at stake also….

Ditto for Portugal, Spain, etc. For instance, at present Spanish “accounting” is hiding massive capital shortfalls in the hugely underprovisioned CRE and other property sectors, etc. These items will not go away but will get much worse over time until resolution of the problems become inevitable.

We have debated the issue of leaving the euro. There is no obligation to do so. Just as was the case for Greece, it is in the interests of the crs that Ireland would remain in the euro or otherwise they will have to be paid in punts….with the consequential write-off of sovereign debt.

One solution does not fit all in a European context….but the underlying principle of debt resolution remains, albeit timing is an important variable.

@ Brian G: Yes, it would be better than present to have a more responsive action /review /adjust-based-on-feedback system. If implementation could be positioned with an independent “Receiver” and with growth being an emphasis then, yes, there is merit in that. Growth is afterall one of the key elements of recovery.

What would you propose for say an Ireland in recession….fiscal easing? Ref. Overseas’ question on this.

I just don’t see that anytime soon, however (and we need practical solutions now). The current work-out is distorted as it is narrowly debtor /creditor relationship oriented. It is by that definition based on a prescriptive, legalistic “python” method of debt management (strangulation) with little input allowed to the debtor. In that narrow sense, it by definition is blind to the wider negative implications and ignores the welfare of the debtor…..It is therefore an outdated, backward debt management system. It has become a book keeping exercise for bureaucrats.

@Paul W

I did not think until now that Greece was an exemple to follow.
A while back the exemple was Iceland and before that Argentina.

@Overseas: I have said here before that Greece is a viable example to follow, given that it is the “live”, recent precedent in the EU /Euro. The problem with the Greek resolution was not the resolution as such. The real problem was that the debt right off was not large enough and has not left Greece in a stable, sustainable debt position. However, from a cr point of view, I agree that it can also be argued that Greece’s economy is simply not robust in the first instance….Which is why there will be further bailouts there.

Ireland is different to Greece in that its underlying sovereign debt level (approx. 85% I believe) is high but sustainable……”at present”. As set out very well by Colm McCarthy last week, removal of the bank debt element (now sovereign debt) would leave Ireland in a sustainable place. The austerity path currently being pursued is derailing Ireland….and that is not in the crs’ interests. Ignoring the welfare of Ireland will in the end undermine the crs’ interests as Ireland goes down.

There are merits to the Iceland and Argentina precedents. However, I don’t think it is in dr or cr interests for Ireland to exit the euro as I have said above.

@ Myself, Brian G, Overseas: Fiscal easing cannot be a solution for Ireland at present, unless part of a pan-EU re-alignment (unlikely).

So far, it seems that it is (A) stay the present course or (B) partial debt resolution.

Apologies for the typos today…as some have said before, it would be good to have an editing function available.

@ John McHale, Karl Whelan, All

Not on the correct thread, but here are my simple “bubble up” thoughts re the PN restructuring…..My understanding is as follows:-

The Irish Central Bank (CB) wrote a loan (created a funded asset), representing CB printed funding euros on the liability side of its balance sheet, to the IBRC (Anglo and Irish Nationwide) on a back-to-back basis with the Govt PNs given to the IBRC (essentially unfunded IBRC loans to the Govt). The PNs were legally pledged by the IBRC as collateral for the CB loan to it. The Govt must now service principal and interest repayments on the PNs by paying Euro 3.1bn odd pa to the IBRC which in turn pays the CB.

Under EU rules, the CB cannot make loans without sufficient collateral, and there is a Q-mark over the PNs in this regard. So, the making of the loan by the CB to the IBRC is a bit of a problem in the first instance.

Question – Instead of receiving PN repayments from the Govt. via the IBRC (which causes liquidity strains and demands on the taxpayer), is there any reason why the CB couldn’t make a “capital contribution” of its loan asset (PV of principal and interest…circa Euro 31bn I believe) to the IBRC ? i.e. convert its loan asset into a capital holding in the IBRC? Such a “capital contribution” mechanism is not uncommon (debt-to-equity is quite topical nowadays!). The CB loan to the IBRC then becomes capital not debt for its accounting purposes….so the CB debt PN collateral issue falls away.

It then begs the question as to how the CB services its liability. At present, the annual Euro 3.1bn is apparently “burnt” i.e. there is simply a write-off versus that (notional) accounting liability (again, principal and interest). It seems to me that it should be possible to net the PN collateral against the CB liability, via a netting arrangement (it is afterall on the one consolidated balance sheet) e.g. in return for the capital contribution, the CB liability is assumed by the IBRC and extinguished against its Govt PN asset.

So, classic debt-into-equity restructuring (for a banker). Any thoughts? Do you know whether the Govt has thought about alternatives other than the present attempt at debt-to-debt restructuring (with all its interest-matching, risk transfer, etc. limitations)?

If this or some similar version is workable, all steps are within Irish control. Importantly, the cash issued to the IBRC remains in place (no external refinancing of that aspect required).

What am I missing?

@ Paul W

the equity the CB has is worth how much, exactly? Zero? Any chance this exercise would make the CBI insolvent?

@ Paul W

You have been watching too many Karl Whelan movies. That 3.1bn would not be “burnt”. It would be used to pay down Target2 liabilities to the ECB. These are real liabilities of the CBI not entries in an internal ledger to be written down or bits of paper to be burnt.

@BEB Credit enhancement for the IBRC can always be considered e.g. unfunded Govt guarantee. The idea is that not much changes except the E 3.1bn annual cashflow, and the fact that the CB loan is now capital.

@ BW II: The set off /netting of the PNs against the CB liability would do the same.

Any more questions? If not, then why not?

@ Paul W

to get the fair value of the equity stake, given that it has no dividend´, and no prospect of re-sale, you’d have to NPV it against the expected redemption date, which it appears you have left as “blank”. Ergo is has an NPV of close to zero.

The situation in Hungary is relevant, I think. Attempts to spur short-term growth have largely had negative impacts on the external view of the country and so have resulted in reduced financing/increased interest rates.

@Paul W

“What would you propose for say an Ireland in recession….fiscal easing?”

In a word – yes. Easing or tightening is relative to the reference point, which has been a very large sustained consolidation over 4 years. The overall economy is now back in recession, and the domestic economy has been in recession most of that time. After 9 consecutive quarters of GNP declines, GNP began to grow in Q3 & Q4 2010. This was then followed by the €6bn adjustment in the Dec 2010 budget, and since then GNP growth stalled and then went negative. Coincidence? Perhaps not. A 4% of GDP adjustment is too high in one go – I’d prefer to see a cap, say 2% GDP in any one year.

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