Simon Wren-Lewis on Self-Defeating Fiscal Adjustment

Simon Wren-Lewis widens the debate about self-defeating fiscal adjustment here, considering in particualr the cases of Spain and Greece.  I take a (very initial) stab at some of the analytics in this brief note.

40 replies on “Simon Wren-Lewis on Self-Defeating Fiscal Adjustment”

thanks for the analysis – as a student its great to see these things. I am sure others will make more meaty use of it but even those of us who will review it without comment will greatly appreciate it
go raibh maith agat

Today’s independent: ”THE Government has formally asked the European Commission for permission to extend Ireland’s infamous bank guarantee scheme until the end of the year.
The Department of Finance confirmed last night that it had asked to extend the €93bn scheme beyond the end of June on the same “general conditions” that are in place now.
The extension request comes as Greek banks report a massive outflow of deposits with €800m withdrawn last Tuesday alone, while deposits in Spain have reportedly also come under pressure.”

– Though given the pressure that was exerted on Spain to guarantee her banks – a threadbare mantilla though it would be – surely it’s highly likely that Kenny/Noonan received a ‘request’ to reques’ the extension ?

”… who exactly will do the deed of expelling Greece, if Syriza leads a government and interest stops being paid . Germany might be prepared to force a Greek exit, but following Hollande’s election I strongly suspect that they would not find a majority of countries supporting them…”

– yesterday the Greek president’s office saud that Merkel contacted the president asking for a parallel referendum on euro membership, and a German spokesman moved to deny the story. This could be seen as an effort to force exit in the absence of an established procedural means of expelling them.
But can we really be sure that they want them out ? Apart from those fearing ‘contagion’ consequences, there are others taking an intransigent position on the basis of their perception of the ‘project’ as an incontrovertible, never-to-be-undone, conquest.

They may not want them out but then their handling of this is extremely poor. Merkel phones and then denies, deGucht says plans being made for the exit, and the ecb ending direct funding to some Greek banks. All of these things have created a mood of possible exit.

If they want them to stay then they have as yet to follow a game plan that is convincing. As our lot in power might say (ad nauseam) – we need certainty.

@ All

It seems to me that this extract from the linked piece sums up the core elements of what is, when everything else is stripped out, a negotiation between creditor and debtor countries.

“Some commentary, like this FT piece [] by Lorenzo Bini Smaghi, suggests Greek voters are being irrational. Like Kevin O’Rourke, I disagree. I might even go further than Kevin. When debtors threaten to default, creditors always want to get their money back, but whether they can achieve this depends on how powerful the position of each side is. When the debtor is a government running a primary deficit, complete default does not look attractive because additional austerity will have to be implemented immediately, and creditors know this makes the default threat weak. However in this case the creditors’ position looks at least as weak. Politicians would have to explain to their already restive electorates why they have just lost a lot of money in their failed attempts to keep Greece in the Eurozone (or, indeed, why Greece was allowed in at all). More importantly, the analogy with Lehman’s looks appropriate. If Greece left the Eurozone there would be an immediate run on other ‘vulnerable’ Eurozone country banks, and here I agree with Lorenzo Bini Smaghi that the “contagion will be devastating”.

As in any negotiation, the balance of advantage see-saws from one side to the other until a compromise is found i.e. the one (or nearest) solution that does the least damage to both sides. Logic does not enter into it except to the extent that the negotiators show it in coming to the best deal that they can.

Logic in Ireland’s case would dictate that saying Yes to the TSCG is the best negotiating strategy if for no other reason than that it will confirm to the country’s creditors a continuing commitment to sorting out our budgetary deficit in a manner which would justify them lending the government money in the future.

That some doubt is beginning to creep in, not just because of the Greek situation but the increasingly surreal nature of the national debate, is evidenced by the rise in Irish bond spreads.

Does Syriza have their story straight on why, exactly, they want to stay in the Euro? An overvalued exchange rate is the classic preference of the non-traded sector elites in post colonial countries.

@Frank Galton

George Soros mentioned in a recent u-tube video, the reason the Greeks want to exit is some of their elite ,including those who own the Greek newspapers,owe back taxes which when denominated in Drachmas will be significently reduced

So some economists are beginning to see that conventional economic policy based on conventional economic theory doesn’t work the way it should in reality…surprise, surprise. I don’t know what there is to be surprised about really. If spending is cut, then yes of course there is a domino effect of increasing enterprise and individual insolvency. And at some point that gets to tipping point where that trend becomes self-fulfilling. Then the next tipping pint is reached when there is enough damage done financially to cause social instability….What’s surprising in any of that.

Ireland’s domestic private sector has been decimated over the last few years – one only has to look at the enterprise liquidation stats. The financial damage to people is evident e.g. in the deteriorating mortgage debt stats and more. The fact that Ireland is reaching the social instability point is also becoming evident e.g. note the size of the N block plus undecideds in the FC ref context. Official Ireland is either ignoring this (via ‘best boy in class’ delusion and zealot belief in own propagranda) or, from its elite and protected vantage point (blinded by self interest), simply can’t see that this is what is happening.

It is still not too late for some change to prevent the inevitable that is now coming down the road for Ireland. However, it seems that Official Ireland will remain as intransigent as the Germans in approach and pursuit of the Almighty Austerity for austerity’s sake.

The Miller and Skidelsky article gives a steer on how that change in direction might look like:

“One of the lessons of history is that sovereign debts must be managed in ways that do not destroy either the economy or the political centre ground. Europe hosts some of the best – and best paid – financial experts in the world; let their talents help governments shake off their paper shackles and devise ways of reducing debt without austerity.

If this means project spending – financed off-balance sheet by jointly guaranteed liabilities or by higher taxes, so be it. If it means substantial restructuring of sovereign debts swapped into indexed debt or growth bonds, or with grace periods until countries resume growth, so be it. If it requires shifting some of the burden of debt finance on to older generations who own the debt, that political issue must also be faced.

Eurozone countries must be allowed to grow again.”

Spot on, excellent. Is Official Europe /Ireland listening? Is Official Europe /Ireland capable of constructive change? So far, no is the answer. So on we go to increasing economic self defeat and social instability. It is a question of when not if on this current path.


Your conclusions seem like official propaganda. Logic would not dictate that ratifying a Treaty that is bound to be changed ( as confirmed by the new French finance Minister yesterday) would achieve the result you foresee.
To my mind it demonstrates an irrational official sector that will not listen to any advice no matter how compelling.

“That some doubt is beginning to creep in, not just because of the Greek situation but the increasingly surreal nature of the national debate, is evidenced by the rise in Irish bond spreads.”

I doubt that any aspect of the Irish debate is a major contributing factor in the rise of Irish bond spreads.
Th biggest factor by far is a probable Greek exit with the likely scenario in that event that Greeks depositors will have their euros converted into drachmas.
Unless and until the EZ guarantees full value euros for current euro deposits throughout the EZ, the bank runs are inevitable particularly but not confined to peripheral countries like Ireland, Spain and Italy.

Throughout Europe, companies in peripheral countries will seek to hedge their euro deposits. Small depositors will rightly believe that they are as expendable as Greek depositors and take whatever money they have out of their countries and out of euros. [I have seen it posted here that Channel island banks are raking in deposits right now, probably sterling deposits.]

The second big issue is continuing recession weakening still further the already fragile possibility of Ireland managing to service its debts.

Ireland will vote yes in the referendum. That is what the polls say. The result will have no effect on bond spreads. That is down to Germany, Greece and growth.

@Paul W
“It is still not too late for some change to prevent the inevitable that is now coming down the road for Ireland. However, it seems that Official Ireland will remain as intransigent as the Germans in approach and pursuit of the Almighty Austerity for austerity’s sake.”

For the past two years Greeks have negotiated three bailout agreement with official Europe and the IMF. Each has been an unmitigated disaster. To my mind that demonstrates that the Greek officials (PASOK) and the Troika are incompetent.
It is beyond debate that the target of 160% debt to GDP by 2020 is unsustainable( in a monetary union) yet this is the relief designed for Greece by some of the supposed experts in such matters.
In our case the supposed target of 120% is highly debatable and according to Rogoff and Reinhardt is unsustainable.
So why should we have any confidence in the strategy being pursued by the government and the troika.

This analysis is fine but it fails to account for market manipulation. As long as we have run-away financial markets nothing is sustainable. Everything becomes a kind of game.

I might come back to this later on but for the moment re @ docm, might some one at some point be able to get through to Lozza BS and persuade him to just shut up and stop digging.

@ Ceterisparibus

The Socialists still have the legislative elections to win (10 and 17 June) and the new French finance minister was hardly going to strike his colours before the battle has even really begun with Merkel. I am not a betting man but I would lay odds that not a dot or a comma of the TSCG will be changed. There will, undoubtedly, be a side letter, the content and legal nature of which has yet to be agreed, but in a format that does not require general re-ratification of the TSCG.

My reasoning arguing for the advantage of a Yes has nothing to do with what the French, or any other EA government for that matter, decides to do but with the reality of the bond markets. Either we restore our creditworthiness or we do not. The “faux austerity” practiced hitherto by the previous and the current government is only feasible because of the support we are getting from “official sources” and at the cost of contributing further to real austerity for those in the private sector impacted directly by the economic downturn.

The current managed extended period of faux austerity will continue whatever the outcome of the referendum. It is what wil come at the end of it that will be changed, assuming that there is not some miracle recovery in the economy.

In fact, there are, in my view, strong arguments for the possible benefits of a “sudden sharp shock” cf. the discussion on Austerity Games contributed by Ronan Lyons. This is what makes me rather indifferent to the outcome of the referendum. If the answer is No, there will be no apocalypse. The road ahead will be simply steeper.

Just read the article by Alan Aherne in the IT. It is a good analysis of the situation and the inclusion of an outsiders view adds weight to his reasoning.

“We got a timely reminder this week of how valuable an outsider’s perspective can sometimes be when Canadian finance minister Jim Flaherty urged European leaders to do the right thing and “use some of their taxpayers’ money to bail out some of the weaker members of the euro zone – or start moving away from the euro zone and just say this was an experiment that has not worked”. For the euro, we have arrived at the moment of truth.”

I fail to see how an ever increasing debt GDP ratio will restore our creditworthiness.
It’s supposed to peak at 120% on the assumption that growth rates will increase. But we all know that this is not about to happen.

That’s why you can earn 7.5% on Irish government bonds. Alternatively you can earn 8 to 9% on government guaranteed senior bank bonds.

You are making the assumption that it was a series of mistakes.

The Greek & Irish officials maybe incompetent but nobody talks about the advisors or “the people” that replaced Merrill Lynch and their role in this.

David Frost interviewed George Papandreou this week and it was clear at least from his perspective that political reps are the junior partners in all this although he could be washing his hands of it now.

Once politicians give up their money power they have no power……they become a Bunch of Teletubbies.
We sit down to our televisions and watch this spectacle of G-8 unity.

When the reality might be somewhat different.

Goverments are supposed to observe Gold standard like rules but there is no Gold standard or banking standard now….. they make up the rules as they go along and expect treasuries to observe strict fiscal rules.

I suspect they can’t believe how stupid the electorate truely is.

I luv your graphs, John. Line C is of course not straight throughout its domain, it is important that the size of the fiscal adjustment is chosen to get the maximum positive impact on actual ps. As Enda observed, an immediate closing of the fiscal deficit would be economic suicide and almost certainly self defeating i.e. line C most likely dips violently downwards at some stage.

The vertical line is the one which needs the most skilful management and this is where contagion of all sorts threaten. It does seem that Greece’s vertical line is currently left of the critical point, but any move to accomodate that gap would drive the verticle line in the other PIIGS violently to the left. If Greece was truly firewalled, there would be scope for its EZ partners to pander to its looney left, but as things stand the message this would convey would be most destabilising. What is currently happening is that the dire consequences of Grexit are being dangled in an attempt to force Greece’s vertical line to the right.

The smart money would say that this won’t succeed. That would lead to Grexit, chaos in that country followed by a violent right shift of the vertical line in the other PIIGS followed by a surge in the euro.


‘The current managed extended period of faux austerity will continue whatever the outcome of the referendum’
+ 1. You have them sussed.

‘Either we restore our creditworthiness or we do not’

My money says we do not, because of the above factor, as much as any other. We don’t really do reform.

Secondly, even if the bank bailout aspect of the sovereign debt is less than the fiscal balance problem, the guarantee has wedded domestic banks and sovereign til default do them part. That will be a messy divorce, believe me.

SWL again:

‘However, when lower output generates falls in asset prices and adds to personal or company liquidations, this could make a big difference to the solvency of highly leveraged banks’

Our banks’ deep-rooted problems will, like Spain, drag the sovereign yields back into the red zone, and the prospect of market access will fade. Wake up time.
SWL again:
‘Demonstrations of austerity designed to show that the government will not default become pointless if those demonstrations mean the government falls to others who would default.’
Mortgage problems, unemployment and emigration will see off any democratic government. Who knows what regime which will preside over the 1916 anniversary, or what will be the tenor of European politics by then.

@ hogan
Thanks for the link. The photo says it all really. Obama and Cameron looking one direction while the Euroheads look the other. Interesting how Obama is pointing in a direction that only Cameron follows.

Europe looks confused. The Anglo-Americans look prepared (but maybe deceptively so..). Greece will leave the Euro. And we will eventually have to do the same.

First step – the Greek Euro will not be accepted outside of Greece – in effect – the Greek Euro will be their drachma. And it’s such a short hop from there to us


The difference between Hollande and Sarkozy programs was largely artificial .Sarkozy was perceived (wrongly) as having followed an austerity policy so Hollande had to attack him on that score but ,at the same time his program promised to balance the budget only one year later than Sarkozy (with very optimistic growth projections ).Sarkozy was supposed to cut expenses more and Hollande raise taxes more, but in fact taxes have already been raised substantially in the last year of Sarkozy’s mandate and Hollande will be obliged to make savage cuts if he wants to increase he education budget and roll back a small part of the retirement reform of Sarkozy as he promised.
Merkel can rest peacefully ,the French know very well that they will be obliged to conduct an austerity policy ,we are broke and there is no way we can engage in a keynesian contracyclical policy with the level of debts that we have.
If the Irish think that their referendum will have any influence on the policy of the rest of Europe ,they are mistaken .Right now the Greek ,the Portuguese and the Spanish keep us too busy to notice what happen in Dublin..

I think, though, that it is important to see that Mr. Obama is trying to garner support for his proposed domestic policy by having it first enacted in Europe. He is as incapable of getting a decent level of deficit spending out of Congress as Spain is out of the bond markets (for example).

Also note that Mr. Cameron favours the twin track – a reduction in current spending offset by an increase in capital spending, matched by private sector money (project bonds). Note that these might have the side-effect of providing high-quality investment opportunities at a time when bank offerrings are in doubt (pension funds need a consistent level of quality assets to be available).

It is unfortunate that the current government has continued the errors of the last government in concentrating cuts on the capital side. The same mistake of the ‘eighties is being repeated. The opportunity that the state has in a recession is to put a floor under I. Instead, our state is trying to maintain C, a C that involves mostly imported goods…

@ Overseas commentator

I would not disagree. The real question is not who will lead but will the French population follow?

No previous German Chancellor would have allowed the balance between Germany and France become so disturbed (although Schroeder, unwittingly I think, contributed to it). While the relationship remained bilateral, problems could be resolved. The difficulty with the introduction of the euro lies in the fact that there are many countries in the room, some of which should never have been allowed entry (including, possibly, Ireland).

On your final point,

I would agree entirely. The posturing about exercising the “veto”, for example, is so totally divorced from the real world as to beggar belief. It raises real questions about the quality of political leadership in Ireland and the electoral system that gives rise to it.

“we are broke and there is no way we can engage in a keynesian contracyclical policy with the level of debts that we have.”

I agree a Keynesian policey of “growth” which means growth in the debts to Banks is a non runner.

Debt is a hypothecial construct , Austerity is a policey of destroying the stock of wealth to peserve the stock of debt.
It follows these efforts of trying to block the flow will destroy more wealth.

But a increase in money production need not increase the amount of debt.
Great Britain, AD 1914

A subsititute for scarce gold coins

The First World War (1914-18) placed great demands on Britain’s gold supply: the Government needed gold to meet the costs of the war, and the public tended to hoard gold as private security in this time of uncertainty. This depleted the circulation of gold sovereigns and half sovereigns (coins worth one pound and ten shillings, respectively). To supplement the scarce coinage, the British Treasury began to issue paper notes for these amounts.

The first pound notes were issued on 7 August 1914, only three days after war was declared. Because they were produced in a such a hurry, the printing and design were very simple, and a more elegant note was issued in October 1914. The note shown here is from this second series, decorated with a bust of King George V, with St George and the Dragon shown on the right. Like the first series, the notes were signed by Sir John Bradbury, Permanent Secretary to the Treasury, and they were soon nicknamed ‘Bradburys’. Later issues carried more elaborate designs, printed in colour with larger, patriotic images of St George and the Dragon and Britannia.

Treasury notes continued to be produced until 1928, when the Bank of England took over responsibility for issuing the one pound and ten shilling notes.”

Now the modern Brits are not really printing enough to replace the private debt being paid back but the interest on the sov debt is being recycled at least.

re’Faux austerity’

1. The bank redundancy deal will cost the banks ie the State approx €500m.
2. A salary of €52,000 and 35 years service with get you €147,600 redundancy. All State funds in State owned banks.
3. A salary of €62,400 and 35 years service with get you €168,000 redundancy. All State funds in State owned banks.
4. A salary of €83,200 and 35 years service with get you €224,000 redundancy. All State funds in State owned banks.

Above €62500 to ~€98000 you get a special option on the deal to get you a little extra from the normal 3 weeks plus statutory. It gives an additional 9% at a salary ~€98000. An essential item of State expenditure no doubt.

Like the old indispensables in the PS, some selected ones will no doubt get their jobs backs in some shape or other.
In the private sector you get statutory redundancy in most cases. In many of these cases you will have to wait to 12 months to get the money.

The Statutory redundancy payment in all the above cases is €46,000.
The generosity of the State to certain insiders knows no bounds. It is not even bounded by the State own bankruptcy.

@ Joseph Ryan

I do not mean to dismiss the real problems of those facing redundancy from bank employment, and individual circumstances vary greatly. Your figures are, however, a nice illustration of the incestuous relations which pertain between private and public institutions in Ireland.

I don’t know enough of the relevant history, but it seems we never really developed an independent currency or monetary policy. There were only a few years between the sterling peg and the euro.

In any case, a job in the bank was traditionally regarded as equivalent to a state job. This deal reflects the expectations, and the accommodations which flow from that social perception and arrangement. The IBOA is not a mere trade union, but is, like the Church, a pillar of our society.

Given all the guff about ‘market solutions’ in recent years, it’s ironic that the manifold costs of bank failure end up being gouged out of Joe and Jane Public.

@Joseph Ryan There is a difference between private sector redundancy where companies cease trading and ongoing businesses who seek voluntary redundancy.
Recent Aviva voluntary redundancy was 6 weeks/annum, more than the above.
Also Bank of Ireland is not owned by the State, although it has been the recipient of much State largesse.

@ Peter

The only reason business is ongoing in our banks is the grip that they have had on the state. They were always TBTF, absent a state default, hitherto, but no longer, inconceivable.


The difference is between €224,000 above and €46,000 paid out of State funds to two different individuals who are to be made redundant.
That the State chooses to treat those two individuals as different classes of citizen is the real difference.
The people making and approving and supporting the decisions invariably fall into the category of superior class of citizen.

@ Joseph Ryan
Precisely. It’s a state backed redundancy package. That is to say, it is a socially sanctioned, authoritatively issued judgement of social worth, which the majority of citizens have been conditioned to accept as reflecting a proper, natural state of affairs.

This is the social magic which Pierre Bourdieu so eloquently describes, and which serves to conceal otherwise indefensible discrimination.

It might also be remarked that the package serves to confirm the essential, untarnished respectability of banking and bankers.

@Paul Quigley

I must read Bourdieu, though I am not a great reader.
One gets a feeling that the pressure in the Irish cooker is rising all the time lately. One wonders when and how it will blow.

@ Joseph Ryan
You are an excellent analyst, If I may say so, and that’s what matters. I read this board consistently, although I don’t always have the time, energy, or the technical knowledge, to contribute.

Internal conflict will intensify as growth prospects recede, but our society is so atomised, and our institutions so compromised, that it’s difficult to frame a meaningful collective response.

I suppose it will be a question of how much additional misery (eg bankruptcy, unemployment, crime, addiction, emigration, suicide etc) has to be endured before we are willing to face up to our deep-rooted prejudices and assumptions. If the recent experience in Ulster is any guide, that will be quite a bit.

As the Russians say, however, the situation is hopless but not serious 🙂


“That some doubt is beginning to creep in, not just because of the Greek situation but the increasingly surreal nature of the national debate, is evidenced by the rise in Irish bond spreads.”

Your posts in favour of a Y built on stabilising the euro, on the management of Greek default now extending to the management of Spanish need for a bailout, are becoming increasingly surreal.

You are I presume referring to the acknowledgement that the amount of mortgage default combined with the failure to achieve promised growth levels and acknowledgement we will need further bailout, this is something you refer to as, ‘some doubt beginning to creep in’.

That doubt is not from me, its coming from you and the Y campaign and their fairy tale balloons that reality is beginning to burst.

Greece will need another bailout, the first attempt has failed, once again its banks are collapsing. The money for another bailout of Greece will go into an escrow fund that will be used to pay off Greek lenders in the northern countries. Its economy will not revive, its debt/gdp ratio even by 2020 is expected only to be somewhere around 135% on some estimates.

Now Spain’s banks are beginning to collapse as they did in Ireland. There is not enough ammunition to save both Greece and Spain. There is certainly no mechanism to revive their economies. Slowly in Ireland the penny is beginning to drop that our own bailout has failed; the last thing we need is a bailout to bailout the last bailout, we need debt writedown.

Given that the design of the euro was to facilitate the

“More than a third of Germany’s GDP derives from exports (the most of any country in the world), with 60% of those exports going to its European neighbors. Germany’s mercantilist economy relies on these countries’ purchases of German goods.”

where the formula of cheap lending to peripherals facilitated this, given the peripherals are bankrupt and cannot pay back the bailouts required to bail them out, the notion that bailouts can be negotiated to fund both growth required to pay back bailouts and to continue the export led German surplus/peripheral deficits, is becoming more and more absurd.

Simply Der Euro Ist Fertig, its finished as a currency union. We are witnessing its failure and its collapse. Its sad to see the only thing to come out of the G8 summit was a vague exhortation for Greece to remain in the euro. In 1935, when the Great Depression had to be dealt with from 1929 – 1935, leadership was there from Senators Glass and Steagall, the IMF was established, FDIC Federal Deposit Insurance Corporation was set up, new regulations on financial paper including the separation of investment banking from commercial banking were introduced.

Today, when the dangers of currency collapse are far greater, every move is designed by the banks, for the banks and of the banks, to shore up the failed problems that caused the problems in the first place. Politicians are standing by looking at a property on fire and the best they can do is throw further petrol on it!

The surreal is becoming the new normal. Now the IMF is accepted as part of the Irish political landscape and we’re about to install the Trojan Horse of the FC and the ESM into our constitution. You couldn’t make it up!

@ Joseph Ryan

One wonders why we’ve had to wait so long for the banks design its package to implement the 3000 redundancies. In fact, off the top of my head, the above packages are likely to cost ¢250m +. When will these workers lose their jobs? What effect on the economy? I’m coming around to the view there is lots more bad news in the pipeline that is being withheld until after the FC.

@Frank Galton

“Does Syriza have their story straight on why, exactly, they want to stay in the Euro?”

I can only answer from the PR perspective: they think by saying that it will win them votes.

@Colm Brazel

“I’m coming around to the view there is lots more bad news in the pipeline that is being withheld until after the FC”


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