Does it have to be “close to, but below two percent”?

I have previously referred to the dangers of a new “impossible trinity” for the euro zone: avoiding its disintegration; avoiding a significant move towards fiscal integration; and avoiding any relaxation of the current definition of price stability.  In Wednesday’s post, I held out hope that stronger mutual insurance mechanisms could follow credible mutual assurances of disciplined policies.   Here I want to revisit the possibility of relaxing current definitions of price stability.   I realise this is taboo – but one I believe has to challenged given the nature and extent of the challenge facing the euro zone. 

The move to formal inflation targeting in the euro zone, Canada and the UK (as well as informal inflation targeting in the US) followed the traumas of the stagflation of the 1970s, not least the expensive efforts in terms of lost growth and employment to bring inflation down in the 1980s and 1990s.  However, while it is understandable that governments would not want to squander such expensively bought gains, the danger is that policymakers end up fighting the last war. 

The particular constellation of problems in the weaker euro zone economies means that it will be very difficult – maybe impossible – to pull through the crisis under current arrangements.   The boom-bust cycle in capital inflows have left a number of countries with current account deficits that cannot be financed.   There is no alternative to adjustment.   Given nominal rigidities, internal devaluation is a slow and costly process, requiring deep recessions to curb the demand for imports and induce the necessary wage/non-traded price cuts.   Slow growth further undermines the creditworthiness of States and banking systems, creating damaging negative feedback loops.   The euro zone may not survive the trauma under current policies.   A higher inflation target could lower the costs of adjustment. 

The danger is that the protection of hard-won low inflation becomes a mantra, preventing a broader reconsideration of the appropriate macroeconomic regime for the euro zone that properly reflects the full range of challenges being faced.  Good macroeconomic management could become a victim of its own past success in institutionalising a low inflation-targeting regime.   The question is whether it is possible to maintain much of the achievement of inflation targeting, while putting in place a macroeconomic regime that is consistent with a path through the crisis that avoids a disintegration of the euro zone. 

It is important not to lose sight of the strong case for inflation targeting.   The benefits are not limited to low and stable inflation.  (See, for example, this account from the Bank of Canada.)  By anchoring inflation expectations, a credible inflation targeting regime allows central banks the freedom not to have to respond to temporary supply-driven jumps in prices – due, say, to oil price or other commodity price shocks.   If inflation expectations are not well anchored, central banks may have to tighten policy because of they fear second-round inflation change effects, which would result from the temporary inflation shock becoming embedded in inflation expectations.   A credible inflation targeting regime can therefore have important benefits in terms of output and employment stability.   (The financial crisis has made it clear that central banks put too much faith in the sufficiency of inflation targeting, taking a too relaxed attitude to the build up of financial vulnerabilities due to excessive credit growth.   But this is not an argument against inflation targeting per se.   Rather it points to the need to use other instruments – including macro prudential tools – to ensure stability. )

The key question is whether the benefits of an inflation targeting regime could be obtained with a higher inflation target.   While there are risks to increasing an inflation target, the institutional structures of an independent central bank with an unambiguous mandate to achieve the inflation target over the medium run should allow the important benefits of an inflation-targeting regime to be protected.  

With the euro zone facing an existential threat, it is not enough to repeat mantras about the benefits of price stability.   Recognising the full range of objectives – including the value of a credible inflation targeting regime – it is time to reconsider the appropriate inflation-targeting regime for a euro zone in crisis.

In which Paul Krugman and Ken Rogoff agree on many things, and Krugman displays the patience of a saint

Jeremy Paxman may have been disappointed by the extent to which Krugman and Rogoff agreed in tonight’s Newsnight programme, despite his having helpfully set up their conversation by asking Rogoff if the big problem was demand or debt. But the pro-austerity (or was that small government? and did they understand the difference?) pair at the end were straight out of central casting. Well worth watching, also for a reminder of just how utterly parochial and blinkered Irish debate on the eurozone crisis, and plausible solutions to that crisis, has been.

Boone, Johnson and Wolf on the euro zone’s future

Peter Boone and Simon Johnson raise an alarm here.  

Martin Wolf reviews Germany’s options here.   From Martin’s piece:

Now turn to the second issue: how does Germany want the euro zone to be organised? This is how I understand the views of the German government and monetary authorities: no euro zone bonds; no increase in funds available to the European Stability Mechanism (currently €500 billion); no common backing for the banking system; no deviation from fiscal austerity, including in Germany itself; no monetary financing of governments; no relaxation of euro zone monetary policy; and no powerful credit boom in Germany. The creditor country, in whose hands power in a crisis lies, is saying “Nein” at least seven times.

How, I wonder, do Germany’s policymakers imagine they will halt the euro zone’s doom loop? I have two hypotheses. The first is that they believe they will not. They expect life for some of the vulnerable economies will become so miserable that they will leave voluntarily, thereby reducing the euro zone to a like-minded core, and lowering risks to Germany’s own monetary and fiscal stability from any pressure to rescue the weak economies. The second hypothesis is that the Germans really think these policies could work. One possibility is the weaker countries would have so big an “internal devaluation” that they would move into large external surpluses with the rest of the world, thereby restoring economic activity. Another is that a combination of radical structural reforms with a fire sale of assets would draw a wave of inward direct investment. That could finance the current-account deficit in the short run, and generate new economic activity in the longer run. Maybe German policymakers believe it will be either harsh adjustment or swift departure. But “moral hazard” would at least be contained and Germany’s exposure capped, whatever the outcome.

I still believe there is a third “hypothesis”.   Germany is willing to move (if hesitantly) from some of these “no” positions, but requires certain assurances and demonstrations of intent.   Will these assurances be forthcoming?   Will it be enough?

John McCartney: “Short and Long-Run Rent Adjustment in the Dublin Office Market”

below is a summary of a new paper by John McCartney (CSO)

Research just published in the Journal of Property Research provides a
number of new insights into Ireland’s commercial property market.
The  paper “Short and Long-Run Rent Adjustment in the Dublin Office Market”
reveals  that  office demand in Dublin is quite elastic –  a 1% increase in
rents  brings about a 1.13% decline in the quantity of space demanded.   In
comparison,  a  similar  rental increase would only reduce office demand in
London  by  between  0.20-0.54%.   Author  John  McCartney  said  that this
difference  was unsurprising given the relative status of Dublin and London
as  global  business locations;  “London is a major world city and a global
financial  services  centre.   As  such  many  corporations  simply have to
maintain  a  physical  presence  in  London  –  irrespective  of rents.  In
contrast,  despite the advantages of our 12.5% corporation tax rate and our
young,  English-speaking  workforce,  Dublin  is a less compelling business
location.  Therefore,  if  rents rise too sharply occupiers will find other
suitable locations.”

Continue reading “John McCartney: “Short and Long-Run Rent Adjustment in the Dublin Office Market””

Exporting electricity

UPDATE2 Over on Twitter, Antoin argues that the plan as interpreted by me would violate EirGrid’s statutory monopoly.

Minister Rabbite yesterday announced plans to export wind power to Great Britain. This is a result of the energy summit organized shortly after the last elections. It now appears ready for public discourse.

The plan is simple. Build a load of wind turbines in the Midlands, where the relative lack of wind is made good by the relative lack of tourists and nature reserves, on land owned by Bord na Mona and Coillte. Build dedicated transmission lines to Great Britain. (The Spirits of Ireland hope that there will be pumped storage as well.)

The plan makes half sense from an English perspective. It is hard to get planning permission for onshore wind turbines in Great Britain. Onshore in Ireland plus transmission is cheaper than offshore in British waters. On the other hand, the plan is driven by the EU renewables target, which is pretty tough on the UK. With Germany abandoning its green energy plans (following earlier such decisions by Portugal and Spain) and with Theresa May wishing to ban Greeks from the UK, it is not immediately clear why the UK obeys the EU with regard to renewables.

It is not clear what is in it for Ireland: English-owned turbines generating power for England, transported over English-owned transmission lines. Dedicated transmission means that there are no benefits for Ireland in terms of supply security or price arbitrage. If the new transmission would be integrated into the Irish grid, Irish regulations would apply — and subsidies too, so that you Irish would sponsor my electricity bill. Ireland does not have royalties on wind power or transmission (and if it would, the same royalties should be levied on Irish turbines and power lines). That leaves some jobs in construction, fewer in maintenance, and 12.5% of whatever profits are left in Ireland for taxation.

It may well be that this plan is a quid pro quo for the UK contribution to the bailout of Ireland.

I am not convinced that the plan will go ahead. The English power market is in turmoil, and the companies may not be interested in an Irish adventure. Recall that the UK government also confidently announced that private companies would build new nuclear power. Well, they did not. The comparative advantage of Ireland in this case is the relatively lax planning regulations. Pat Swords may have put an end to that. But even the current planning regime can be used to block to an English adventure with no Irish spoils.

It is early days for this project still. It is worrying that the minister seems to think that more state intervention is required, and that the state still has money to waste. UPDATE: Paul Hunt points out that it is indeed the Government’s plan to intervene and subsidize: See the new energy strategy.

More academic thoughts on interconnection are here.

Guest Post by Timothy King: Keynesian Policies Under the Fiscal Treaty

The Stability and Growth Pact of 1997 permitted Eurozone countries to run a general government deficit of 3% of GDP.   The only economic innovation of the Fiscal Treaty is the replacement of this deficit measure by one that restricts the “structural budget deficit”—the deficit that that would be incurred if the economy was operating at full capacity—to 0.5% of GDP where the national debt is greater than 60% of GDP, and 1% otherwise.

The measurement of the structural budget deficit is to be cyclically adjusted, which will permit larger deficits in times of economic recession.  So far from outlawing Keynesian fiscal policies, as some of its opponents have alleged, this explicit acceptance that deficits may reflect cyclical factors will allow governments to cut taxes and/or increase expenditures as anti-cyclical policies require.  One-off or temporary payments such as those to the Anglo bondholders are also excluded from the deficit calculation.

Much depends, of course on how the adjustments are made.  The IMF, the OECD and the EU, all make estimates of the structural deficit, and the first two of these agencies both regularly publish these together with other data on government lending and borrowing.  I believe all three agencies use very similar methods of estimation.  (Knowing nothing about this topic I found Box 1 in the paper Tony McDonald, Yong Hong Yan, Blake Ford and David Stephan, Estimating the structural budget balance of the Australian Government in the Australian Treasury’s Economic Roundup 2010, Issue 3  ( very useful as an introduction.   This gives references to more technical papers describing the estimating processes of each of the agencies in detail.

Potential output is derived using two-factor constant-returns-to-scale Cobb Douglas production functions with some assumed rate of growth of total factor productivity.  If you are an international agency needing to make regular internationally comparable estimates of the potential output of scores of countries, this may be the best you can do, but this method of calculating potential output seems particularly inappropriate for Ireland, where the sudden arrival and departure of foreign firms and fluctuating rates of international migration can change the productive potential of the economy very quickly.   The agencies can presumably also use only very approximate rules of thumb when trying to calculate how tax revenues would increase to the achievement of this potential output.  The only expenditure that is held to be cyclically determined is unemployment compensation.

The inevitable imprecision of these calculations makes it unsurprising that agencies can differ quite markedly in the proportion of a given government deficit they attribute to non-structural causes.  For example, averaging estimates for Ireland for 2000-2009, the IMF had an average structural balance of -4.4% of GDP; the OECD had -2.2%.  In 2010, the OECD had a structural balance of 25.5% where the IMF had 9.9% (presumably reflecting different treatments of payment obligations under the banking bailout scheme.)   Unfortunately I do not know of a readily available internet source of EU Commission estimates.

Since Ireland is clearly in the “excessive deficit” zone, these differences are not currently of critical importance.  But eventually this position will change, and one can envisage very considerable argument about the proportion of any given deficit which is to be considered non-structural.  It would be advisable for the Irish government to develop its own methods of estimating structural deficits, and to be prepared to defend them under sceptical questioning if they show lower structural deficits than Commission or IMF figures.  Indeed it would be worth seeking the help of one or two economics of unimpeachable international reputation, and who have not previously taken public positions in rejecting EU stabilisation policies, to guide the process of making the estimates and certifying their credibility.

There is no reason why built-in stabilisers need be confined to payments to the unemployed.  A perfectly feasible Keynesian measure would be legislation that inversely relates VAT rates to the level of unemployment.  Discretionary stabilisers, such as a list of non-essential infrastructure maintenance projects that could be speedily put into operation would be another possibility, though more likely to be challenged by the EU monitors.

Although the Treaty regards national budget surpluses with favour, they have a potential deflationary impact on the Eurozone as a whole.  If Keynes had been involved in designing this treaty, he would probably have attempted to have supplemented the “excessive deficit procedure” with an “excessive surplus procedure”, to have forced countries with large budget surpluses to reduce these, even at the expense of greater domestic inflation.  He would of course have had as little success with the Germans as he did with the Americans when he made comparable proposals about persistent creditor countries at the Bretton Woods conference in 1944 that set up the postwar international monetary system.

The concept of a structural budget deficit has been in use for decades by the IMF, but it is not one that is in general discourse, even among economists.  It does not refer to the structure of an economy, which is normally taken to be a set of productive activities, many of which are locationally fixed, and includes both capital equipment, infrastructure and human capital which can change only slowly.  The EU funds designed to help areas of high unemployment to improve their productive capacity are accordingly known as structural funds.  This structural deficit is quite different—it involves a snapshot (if a one-year flow measure can be called a snapshot) of how the existing system of taxes and public expenditures implies for an economy operating at full capacity.

It is easy to get confused about this difference.  Finance Minister Michael Noonan interviewed on RTE’s This Week on May 20th appeared to be implying that needed structural reforms—he alluded to the retraining of unemployed construction workers—were part of the programme to reduce the structural deficit.  Of course, such reforms will lead to increases in both GDP and government revenues rises (and presumably reduce the structural as well as the general deficit)  but this is to use the word “structural” in its more usual meaning, rather than in the sense used in the treaty.

When the Maastricht Treaty was first agreed in 1993, there was much criticism that it required purely monetary convergence, and paid no attention to labor market convergence, either cyclical or structural.  At that time unemployment rates in different Eurozone countries diverged sharply.  Spain had an unemployment rate of over 20%, and Finland and Ireland rates of over 15%.  In contrast, it was only 4% in Austria.  There were concerns that whole countries might find themselves saddled with uncompetitive economies unable to devalue, and become permanently depressed regions within a larger federation, rather like the Italian Mezzogiorno or the US Rust Belt.

This fear appears to have been premature.  The pre-crisis convergence of unemployment rates has been striking.  The standard deviation of national unemployment rates was 5.1% when the treaty came into force, 3.6% in 1999, the first year of the euro and only 2.1% in 2007.  Even in Spain, which appears to be the country in which unemployment has been most persistent, unemployment rates fell until in 2007 they were, at 8.3%, lower than in Germany (8.7%).  The effect of the crisis has, however, been sharp divergence among national rates. The standard deviation in 2011 was 5.4%;   Spanish unemployment was 21.7%.

None of this means, of course, that when stabilization has been achieved and a respectable rate of economic growth reestablished throughout the Eurozone, there will be no further need for reform.  The fear of permanently depressed countries has not gone away—(see, for example a recent article by Martin Wolf (Irish Times, May 21st).  This reinforces what this crisis has made sharply evident—the need for some central fiscal authority, (and also a properly empowered Central Bank).  But the 1993-2007 convergence in unemployment rates suggests that such central authorities ought to be able to adopt Keynesian policies as required.

What We Talk About When We Talk About the Fiscal Treaty

Ireland votes on the Fiscal Stability Treaty on Thursday. The local debate over the last month has been highly revealing in terms of the evolving attitude to Europe and the euro.

One strand of the debate has been narrow in scope, focusing on the technical details of the Fiscal Treaty (measurement of structural balance, implications for speed of austerity). My own take is that, if the Treaty is implemented in an intelligent, cyclically-sensitive manner (consistent with the flexible, holistic interpretation laid out in the “six pack” regulations), the new fiscal framework will be a positive force, helping Ireland and other European countries to gradually exit from high debt levels and avoid destabilising pro-cyclical fiscal policies in the future. Calibrating the optimal speed of fiscal adjustment at national and European levels is no easy task, especially in periods of shifting macroeconomic conditions, and we may expect many future debates about the balance between austerity and growth in delivering the fiscal targets laid out in the Treaty. Indeed, the recent resurgence in European discussion of growth initiatives is a good example of the type of policy rebalancing that will periodically occur in plotting the fiscal trajectory that balances short-term growth concerns with medium-term fiscal sustainability. (The Treaty does not mandate any particular mix of fiscal actions and growth actions to attain the target outcomes.)

In any event, even before the EU/IMF bailout, Ireland was already planning to introduce some type of fiscal framework along these lines and the Treaty is really a marginal addition relative to existing European commitments. Importantly, having fiscal rules built into domestic legislation should improve local accountability relative to purely European regulations.

Moreover, the Fiscal Treaty is a pre-requisite for other important reforms of the euro system. Shared responsibility for the resolution of banking crises, eurobonds and joint fiscal initiatives (such as the European Stability Mechanism, expanded EU or EIB investment programmes, EU-level unemployment insurance) all build on a common platform of sustainable national fiscal policies, as does ECB support for national banking systems and sovereign debt markets. While there is clearly a strong desire for a “big bang” approach by which all of these reforms are simultaneously introduced, that is not currently on offer and does not reflect the incrementalism that characterises the EU approach to institutional reform. Rather, it is more realistic for the Irish government to engage in the hard slog of ensuring that the Fiscal Treaty is quickly followed by progress on these other fronts. To take one example, the euro-nomics group (of which I am a member) advocates the rapid introduction of ‘European Safe Bonds’ which are a type of eurobond that do not require time-consuming Treaty revisions.

Over the last month, the referendum debate has been much broader than the narrow terms of the Fiscal Treaty. As always, a Referendum provides an opportunity for a segment of the electorate to vent disappointment and anger at the current government and widespread economic distress. However, to quote Colm McCarthy, “anger is not a policy.”

Still, two interesting alternative policy visions have emerged from the No campaign. Attracting support from elements on both Left and Right, one theme has been that a No vote would strengthen the Irish government’s bargaining position in reducing the burden of bank-related debt. This argument has two limitations.

First, it fails to accept that the European governance system relies on applying common principles to all member states – bilateral “interest-based’’ bargaining between Ireland and European institutions / fellow member states is at variance with core principles of European integration. Rather, Ireland has a better chance of success through sustained lobbying for a change in European policy (most obviously, the sharing of the fiscal costs of resolving systemic banking crises). Although progress on this agenda has been frustratingly slow, the increasing urgency of addressing similar banking problems in Spain provides extra impetus behind the broad coalition (including the IMF) seeking this change.

Second, as a practical matter, a No vote would not deliver a radical change in Ireland’s negotiating stance, since the current government is in place for the next four years and there is no sign that it would overturn its current strategy. How, exactly, does a No vote force a change in the government’s strategy?

Rather, the most coherent version of this alternative policy narrative accepts that there is a substantial risk that Ireland’s bluff would be called and Ireland enters an antagonistic relationship with our European partners. Such an isolationist strategy is especially risky for a high-income country with an economic structure that is deeply embedded into global financial and trade networks. A badly-played hand could map in significant output and financial losses over time that would be far greater than any reduction in the debt servicing burden obtained through a disorderly default.

In the end, then, the narrow Fiscal Treaty debate can be framed in terms of a broader debate about Ireland’s future relationship with Europe. Although there is much to be done at a European level to build a more stable eurosystem, it seems to me that there are more downside risks to pursuing an isolationist alternative path.

Treaty and future of eurozone

I wrote the following background piece in response to a request last week.  It’s similar to John’s Compact Logic.  My respondent wrote back:  “So a Yes will facilitate EU growth policies, the exact opposite of the No position?”. I was also asked about the consequences of a Greek exit:

Adopting the euro as our currency was supposed to give us much greater stability than the fixed exchange rate regimes that preceded it.  But if Greece leaves the euro, financial markets will no longer accept at face value a statement by a struggling country such as Ireland that it intends to remain within the single currency.  We are likely to see a repeat of the Irish currency crisis of the early 1990s when markets lost their faith in the fixed exchange rate arrangement of the time and Irish short-term interest rates quadrupled over the space of a few months.

Ironically, the currency turmoil of that time was triggered by the outcome of a European treaty referendum but, for once, not one of ours.  Everything had been proceeding smoothly towards the eventual introduction of the euro.  Financial markets believed that Central Banks would intervene to any extent necessary to defend existing exchange rates and a speculative attack on a currency could not possibly be successful.  All changed when Denmark voted no to the euro in June 1992.  It was possible that France would do likewise in September. Suddenly the single currency was no longer inevitable.  Sterling succumbed to  speculative attack and devalued, and attention shifted to Ireland.  Over a billion pounds flowed out of Irish financial markets over the course of a few days and short term interest rates soared to almost 60 percent.

The Irish government tried to hold off the speculators.  Currency control were reintroduced.  The Central Bank raised its lending to the money markets more than twenty-fold to prevent mortgage and commercial interest rates rising by more than 4 to 5 percent.  But this could not be sustained over the longer term as all the country’s foreign exchange reserves would be lost.  Ireland succumbed to devaluation in January 1993.

The same turmoil, with a run on the banks and a massive risk premium on foreign lending to Ireland, would undoubtedly follow a Greek departure from the euro.  The difference in the present case is that where then we had only our own Central Bank, we now have the European Central Bank with its vastly greater firepower.

The fact that numerous other countries would be calling on the firepower of the ECB at the same time, and possibly indefinitely into the future, is why the eurozone powers seem lately to have drawn back from the precipice of countenancing a Greek exit.

The ECB has recently shown itself ready to provide enough liquidity to stave off catastrophe.   At the behest of the Americans, the IMF and now the French, the German government now seems to agree that austerity alone on the fiscal side will fail, just as it did in the Great Depression of the 1930s. But can the Germans be expected to run deficits to stimulate the European economy, or countenance eurobonds – which would put their own credit rating at risk –  before the rest of the eurozone has promised to limit its borrowing?  As a German politician said this week, “you don’t lend your credit card to someone who doesn’t know how to control their spending”.

Compact Logic

After wavering for some time, Deputy Shane Ross has now publicly taken a No position on the Treaty. (See Sunday Independent article here.)   His position is that he is withholding judgement until he sees later growth-focused elements, and takes it that there would be another opportunity to vote on the complete package later. 

While this is a coherent position, I think it is worthwhile to stand back and recall the genesis of the fiscal compact.   The euro zone crisis was spinning out of control late last year, with runs on the sovereign bonds of Italy and Spain.  (The crisis has flared up again recently with the renewed uncertainties in Greece.)   It became ever clearer that the euro zone might not survive unless stronger mutual insurance mechanisms were developed.   Understandably enough, the euro zone countries most at risk of having to make positive net transfers under such mechanisms wanted some degree of assurance that all euro zone countries would follow reasonably disciplined policies, both to limit the expected value of the contingent liability and to minimise inevitable moral hazard.   Politicians in stronger countries also needed a degree of political cover in order to convince their electorates to take on large risks.  

For the most part, it was evident that stronger commitments to mutual discipline would have to lead that strengthening of the mutual insurance mechanisms, but the logic was clear.   In the event, the actual fiscal compact did not go much beyond what countries had already signed up to under the revised Stability and Growth Pact, but it did attempt to strengthen domestic ownership by introducing domestic enforcement mechanisms for the already existing structural balance rule.   Recent events in Spain have brought the possibility of more centralised bank resolution, deposit insurance and supervision onto the agenda as part of this process. 

An often heard complaint in the debate that the commitment to develop these mutual insurance (and related growth) measures are too vague – hence Deputy Ross’s position.    But it is interesting that where the linkage is made explicit – i.e. access to a scaled up ESM – it is considered a “blackmail” clause.  

Not surprisingly, the Treaty debate has ranged widely – the impacts of austerity measures, the implications for post-2015 fiscal adjustment of the existing SGP rules, the nature of additional commitments made under the Treaty, access to alternative sources funding if the Treaty is rejected, etc.   An unintended positive spinoff is that voters are now much better informed on fiscal issues – even if sick to the teeth from hearing about them.   But in the few days remaining before the vote, and with the euro zone again in turmoil, it is important to bring focus back to the core purpose of the compact. 

DeLong and Summers and Self-Financing Fiscal Expansion (very wonkish)

Advance warning: This post will only be of interest to those who have read the DeLong and Summers paper.

As has been referenced on this blog a number of times, the recent paper by Brad DeLong and Larry Summers has had a significant impact on the debate over optimal fiscal adjustment in a depressed economy.    Although the authors themselves note that the balance of arguments may be quite different in a non-creditworthy economy, the paper is still important to our debate (see also here and here).   

The key innovation in the paper is to incorporate the fiscal implications of potential “hysteresis effects.”  Put simply, these effects refer to long-lasting effects on future output – and thus on the future fiscal position – of fiscal adjustment measures today that reduce today’s output.   For example, the loss of a job due to weaker growth this year could have long-lasting fiscal implications if it makes it harder for the person losing their job to gain employment in the future. 

A striking conclusion in the paper is that, under what appear to be a relatively undemanding set of conditions, an expansion of government spending (or alternatively not engaging in some planned expenditure cut) could be self-financing from a long-term fiscal perspective.    Put another way, fiscal expansion could bring about improvement rather than disimprovement in a country’s underlying creditworthiness.  Thus, fiscal adjustment could be self-defeating from a creditworthiness perspective.   Given the influence of their argument, it is important to look closely at the assumptions that underlie this result.  Continue reading “DeLong and Summers and Self-Financing Fiscal Expansion (very wonkish)”

What is not in the Fiscal Compact?

At 1,395 words, Title III of the Treaty on Stability, Coordination and Governance is a very short document by official standards.  The Fiscal Compact contains just six articles and 11 paragraphs.  Understanding what is in the Fiscal Compact should not be difficult but there continues to be significant misrepresentations of the what the provisions actually mean.

As a response to the causes and consequences of the current crisis the Fiscal Compact is wholly inadequate.   From an Irish perspective it is true that “had the the Fiscal Compact been in place since 1999 it could not and would not have prevented the crisis in Ireland”.  It is possible that, in the run-up to the crisis, a greater adherence to the rules across Europe would have created some additional fiscal space to deal with the downturn but this leniency did not cause the crisis.

As regards the ongoing policy response to the crisis, the Fiscal Compact will make little difference.  At present 23 out of the EU27 (and 13 of the EZ17) are in the Excessive Deficit Procedure so even if the Fiscal Compact is torn up it would not lead to a significant change in policy.

However, when assessing whether the crisis could have been prevented it is important to realise that the Fiscal Compact only covers some aspects of the EU framework on economic policy. For example, the Compact does not mention the 3% of GDP overall deficit limit that was introduced in the Protocol on the EDP in the Maastricht Treaty.

The Compact also excludes some elements of the ‘Six Pack’ introduced last year.  From an Irish perspective, two additions worth considering are:

Continue reading “What is not in the Fiscal Compact?”

Mortgage Arrears Crisis deepens

To the surprise of exactly no-one the residential mortgage arrears problem has continued to worsen. The Central Bank’s Q1:2012 figures show that 116,288 accounts were either in arrears of over 90 days or had been restructured in some shape or fashion.

10.2% of private residential mortgage accounts were in arrears.

There are others, but right now two important (and updated) questions arise:

  1. at what point will this growth in arrears begin to slow appreciably? As Jagdip and Carson in the comments point out, the rate has fallen off but clearly arrears levels are increasing at an alarming rate.
  2. what projected effect will the proposed personal insolvency legislation have on these arrears going (ahem) forward?

Patrick Kinsella on the Treaty

Patrick Kinsella (no relation) writes on the Treaty in today’s Irish Times as the Taoiseach assures us the Treaty text won’t change. From Kinsella’s piece:

The Government is rigorously following the policies required by the troika of intergovernment lenders who support our current spending deficit and our bank rescue, and voting No will not change that. But the political situation in Europe is changing radically, and it is absurd to think that our partners will leave us high and dry for future loans because we reject a legal straitjacket on future policy demanded in the dying days of the Merkel regime. And don’t think the ideological rebalancing demanded by the fiscal treaty is limited to the euro zone members: the final article says “steps will be taken” to incorporate the substance of it “into the legal framework of the European Union”.

The political context for the social market economy in the 1950s and 1960s was the spectre of communism that haunted Europe. The context now includes the indignados of Spain, riots in Greece, and right-wing parties. Those of us with no great wealth other than our education worry for our children: where will they work, how will they live?

On this issue, the Labour Party in Government has abandoned its traditional constituency, signing up to support the banks at the expense of equality, jobs and fair working conditions. It has abandoned the social pillar of the European Union in the interests of an illusory “stability”. I sense that its traditional constituency will abandon Labour at the next election.

In the meantime, those of us who think that on balance the European Union has been good for Ireland, and do not want to see that balance overturned, have compelling reasons to vote No to this treaty.

Gavin Barrett Responds to Vincent Browne

A Guest Post By Gavin Barrett

While I am second to none in my admiration of Vincent Browne for his willingness to engage with the legal issues raised by the Fiscal Treaty, I would have difficulties with some of the assertions made by him in his article in the Irish Times today.

1)      I am unable to see how the Pringle case (or any other case) can be the source of a legal threat to the Fiscal Treaty’s validity (as opposed to the ESM Treaty’s). The Fiscal Treaty is a normal intergovernmental treaty which the member states are perfectly entitled to agree with each other in international law.

2)      To my mind, the European Stability Mechanism Treaty clearly does not violate Article 3 TFEU. Nor does the Fiscal Treaty.  (Article 3 TFEU, as Vincent Browne correctly points out, confers exclusive competence on member states whose currency is the euro). The ESM Treaty has nothing to do with monetary policy. It sets up a permanent bailout fund to lend to member states in distress. The Fiscal Treaty also has nothing to do with monetary policy. As its name suggests, it has to do with fiscal (i.e., taxation and expenditure) policy.

3)      It is very far from clear that the Article 136 TFEU amendment process gives an opportunity to member states to veto the setting up of the ESM. It may be argued that it does, but it is not something I would bet the house on, much less the future of the Irish economy, which is what the ‘no’ side appear to want to do. The Referendum Commission does not support the view that there is a veto. Nor do the member states themselves, which will establish the ESM in July 2012 without Article 136 being in force. 

All going well, Article 136 TFEU should however be amended shortly afterwards by 1 January 2013. (Ireland, incidentally, has very little interest in vetoing this amendment, since it will put the legal basis of the ESM Treaty beyond any possible doubt. That is a good thing, since it looks increasingly likely Ireland will need to turn to the ESM for a second bailout in 2014.)

4)      I am unaware of any reason for questioning the use of the so-called Article 48(6) simplified revision procedure to effect the amendment to Article 136 TFEU.

5)       I am not aware of fundamental changes being planned for the EU’s structure which bypass procedures suitable for such change. The only one question mark that might be posed is in going ahead with the ESM Treaty without the Article 136 TFEU amendment. However, even if one took the view that the ESM Treaty should be supported by the Article 136 TFEU amendment, the latter amendment should follow its establishment within six months, then removing whatever doubt may be felt to exist in this regard.

John O’Hagan on the Treaty

Guest post from my colleague John O’Hagan

Many things in life are complex and are not, understandably, properly understood by most people, unless they devote enormous amounts of their time to do so. That is why we leave so many important decisions to our democratically-elected representatives and not to plebiscites/referendums.
The Fiscal Stability Treaty (FST) though has to be decided by referendum and because of its necessarily complex economic/legal language the electorate must rely partly on expert witnesses, as in any major court case by jury. A key thing for any jury is the credibility and reliability of these witnesses. And so it is with the referendum on the FST.

Continue reading “John O’Hagan on the Treaty”

New issue/re-launch of journal Administration available

A new issue of the journal Administration is out today.

To mark the journal’s ‘re-launch’, this issue is available in full for free online here.

As many readers will know, Administration is published by the Institute of Public Administration, and has been a key locus for research-led debate on economic development, and of course on wider developments in the public sector and society, since 1953.

The current issue includes prefatory articles from the incoming editor Muiris MacCarthaigh, who `sets out his stall’, and from Tony McNamara, who has edited Administration since 1989. These will be of interest no doubt to a wide readership and to various contributor bases, (e.g., from academic, practitioner and civil society perspectives).

As the contents indicate, the focus of this issue is on public sector reform, with an opening piece by Brendan Howlin TD, Minister for Public Expenditure and Reform. I guess that Ministers historically have been uneven in how or whether they contribute to debate at this level; perhaps this is a good cue to them, and to politicians more generally, to get their quills out.

Notes from the Editors:

  • “Renewing public administration research and practice” by Muiris MacCarthaigh
  • “A final word” by Tony McNamara


  • “Reform of the public service” by Brendan Howlin, TD
  • “Progress and pitfalls in public service reform and performance management in Ireland” by Mary Lee Rhodes & Richard Boyle
  • “Regulating everything: From mega- to meta-regulation” by Colin Scott
  • “Trust and public administration” by Geert Bouckaert
  • “The reform of public administration in Northern Ireland: a squandered opportunity?” by Colin Knox


  • Third report of the Organisational Review Programme
  • The challenge of change: Putting patients before providers

Martin Wolf and the new “impossible trinity”

Martin Wolf provides a cogent if sobering analysis of the euro zone crisis (FT article here; Irish Times article here).    I previously discussed the “impossible trinity” facing euro zone in posts here and here.   The euro is facing an existential threat; there are political limits to the possibility of a transfer union (including limits on potential net transfers under strengthened euro zone mutual insurance mechanisms); and the ECB does not consider a higher inflation/nominal GDP growth target as consistent with its price stability mandate. 

Martin Wolf describes the dilemma thus:

If dismantling the euro is out of the question, true federal finance is unavailable and mutual solidarity will remain limited, what is left? The answer is faster adjustment, to bring economies back to health. Indeed, that would be essential even if stronger solidarity were available. The euro zone must not turn the weaker economies of today into depressed regions, permanently supported by transfers, a policy that has blighted the south of Italy.

So how is faster adjustment to be achieved? The answer is through a buoyant euro zone economy and higher wage growth and inflation in core economies than in the enfeebled periphery. Moreover, the required growth strategy is definitely not just a matter of policies for supply.

According to forecasts from the International Monetary Fund, euro zone nominal gross domestic product will rise by a mere 20 per cent between 2008 and 2017. In the latter year, it will be 16 per cent lower than if it had continued to grow at the rate of 4 per cent achieved between 1999 and 2008 (consistent with 2 per cent real growth and 2 per cent inflation).

For the economies under stress, such feeble growth is a disaster: it means that the euro zone as a whole tends to reinforce, rather than offset, their credit contractions and fiscal stringency. They can blame the universal adoption of fiscal stringency and the policies of the European Central Bank, which let the money supply stagnate.

Something may give, and it is potentially disastrous if it is the euro.   The possibility of higher nominal growth targets needs to be part of the debate. 

On strengthening the mutual insurance mechanisms, the discussion in our Treaty referendum debate of the legal mechanisms to stop the ESM going forward borders on the surreal.   The purpose of the fiscal compact is to provide an added degree of assurance that euro zone members will pursue reasonably disciplined policies.   The idea is to give other members sufficient confidence (and a degree of political cover) to allow the mutual insurance mechanisms – probably eventually including some form of euro bonds – to develop. 

Varieties of Eurobonds

Eurobonds have returned to the forefront of the euro debate.  There are many varieties of eurobonds.  Some have been designed to mitigate the moral hazard risks that concern German officials (and many others).  The euro-nomics group (of which I am a member) have been advocating the concept of “European Safe Bonds” (ESBies) that does not involve joint and several liability, while other proposals have also been made.

Shahin Vallee recently made a presentation to the European Parliament comparing the main alternatives – the presentation file is here.

The External Value of the Euro

Jeremy Siegel points out in this FT article that a weakening in the external value of the euro can be important the recovery of the euro area;  Paul Krugman raises the objection that “… Europe as a whole, like America, remains a relatively closed economy. Its salvation must be mainly internal.”

Of course, trade with the rest of the world is a limited channel for the collective euro area.  However, it is important to appreciate that trade with the “rest of the world” is especially important for the peripheral countries, so that a substantial euro depreciation can be a contributory factor to the recovery process.  There is an interesting IMF paper that quantifies the role of external trade for the periphery countries – I will post a link once that paper goes online.

(The heterogeneous exposure of the periphery versus the core in relation to the external value of the euro was also much studied in relation to the very large euro depreciation against the dollar during 1999-2001. For instance, see this paper that I wrote with Patrick Honohan.)

An illustrative budgetary scenario for 2016-2020

It can be hard to get an intuitive sense of potential evolution of Ireland’s budgetary situation post-2015.   With this in mind, readers might be interested in seeing a hypothetical scenario for the period 2016-2020.   I hasten to add that this is neither a forecast nor a recommendation.  

The scenario begins with the Government’s projections out to 2015 as recently published in the Stability Programme Update.    To limit the number of assumptions, I focus on the actual budget balance rather than the structural budget balance.   The post-2015 scenario assumes: (1) an annual nominal GDP growth rate of 3.5 percent (which, for reference, compares to a forecast in the SPU of 4.5 percent nominal growth in 2015); (2) an average interest rate on outstanding debt of 4.9 percent for 2015-2020 (equal the projected interest rate for 2015 in the SPU); (3) total General Government  Revenue grows at the same rate as nominal GDP;  and (4) non-interest (or primary) General Government Expenditure grows at half the rate of nominal GDP.   Of course, a faster rate of primary expenditure growth would be possible for the same evolution of the budget balance with the tax system not fully indexed to nominal GDP. 

The evolution of the key aggregates (measured in millions of euro) are shown here; these aggregates as a share of GDP are shown here.   The debt to GDP ratio is shown here. 

Under this scenario, the actual deficit as a share of GDP would fall from the projected 2.8 percent of GDP in 2015 to -0.4 percent of GDP in 2020, a change of 3.2 percent points of GDP.   (The improvement in the underlying structural deficit should be broadly similar, starting from a projected 3.5 percent of GDP in 2015.   The rate of improvement is above the minimum required rate of improvement in the structural deficit of 0.5 percentage points of GDP per year along the adjustment path to structural balance.)   The debt to GDP ratio would be falling at a rate of 3.5 percentage points of GDP in 2019 and 4 percentage points in 2020, within the requirements of the one-twentieth rule, which comes into force after 2018.   

What the weaker euro zone countries could do for Greece

In Saturday’s Irish Times, Alan Ahearne does a good job laying out the dangers of unfolding events in Greece (see here).    Political support for the adjustment programme has been lost, with the Greek population understandably perhaps blaming much of their disastrous economic performance on the conditions of the programme.   While the austerity measures have certainly played a role in the growth performance, they are just one component, with the confidence-sapping effect of the fear of a melt-down situation itself playing a major role.   The correlation between austerity and weak growth is now deeply established in the minds of many Greek voters – whatever the actual contribution of the austerity measures.   A rejection of the programme in the elections is a real possibility.   So too is a tough response from official creditors to an unwillingness to meet the programme conditions.

A Greek exit from the euro zone could be containable with sufficient will.   However, there is a likelihood that moral hazard concerns could lead the response might be too halting, leading the crisis to easily spin out of control.    As Alan argues, even with a successful containment, the precedent of a country leaving the euro would fundamentally change the stability of the monetary union, making it more prone to the runs that plague fixed-exchange rate regimes.  (See also Martin Wolf here.)

Is there room to give Greece more time, providing at least some political counterweight to the massive anger at the programme?   The stronger euro zone countries are understandably concerned about the moral hazard problems of any backtracking on the conditionality being applied to Greece.  

This is where the weaker countries could play an important role.   They could do so by making it clear that they see no interest in seeking relief through default or in a relaxation of formal/informal commitments, regardless of any additional accommodations for Greece.  This need not include measures currently under discussion for strengthening the overall crisis management, including the lengthening of the maturity of the promissory notes, direct injections from the ESM into undercapitalised banking systems, or relaxing the aggregate stance of the Excessive Deficit procedure (especially for countries with fiscal space).    I think this goes with the grain with the approach of governments in Ireland, Italy, Portugal and Spain.   (Indeed, in the case of Spain, their unwillingness to accept a one-year extension for reaching the 3 percent target under their Excessive Deficit Procedure (EDP) may show excessive unwillingness to accept the easing of conditions, given that it can be viewed as part of broader easing of the aggregate stance of the EDP on the basis of the aggregate euro zone considerations.) 

I don’t want to exaggerate the impact of leadership of the weaker countries on this issue, but it could help tilt the steering wheel from what looks now like a very dangerous course.   Greece has got itself into a mess, much of it of its own making.   Greece has no choice but to make tough adjustments, but giving more time may be the only way to prevent political rejection.   Solidarity – but most of all self interest – should lead all euro zone countries to work hard at finding a workable way out. 

New Mortgages = Zero + Noise, Forecast and Outcome

Six months ago on this blog I made a quasi-prediction that the number of new residential mortgages in Ireland might shrink to zero-plus-noise. Arguably this has now happened. I claim no great insight and concede that it might have been dumb luck. My quasi-prediction was based on some informal liquidity-risk analysis of the Irish banks. The banks are in a corner solution with respect to long-term illiquid assets. There is little good reason for an Irish-domiciled bank to issue a new residential mortgage, rather, they might be keen to sell any of their existing long-term illiquid assets at a loss. This has only second-order policy importance relative to Greece, etc., but is worth documenting.