Year: 2012

As the note by Holland and Portes linked to earlier by Stephen is likely to be influential in the fiscal policy debate, it is worth taking a closer look at the findings with the Irish case in mind.   The note is based on a more detailed (and very useful) analysis by Dawn Holland (available here). 

Although the main message on the impact of (coordinated) fiscal adjustment is quite negative, the fact that Ireland is the only country for which the adjustment leads to a (small) fall in the debt to GDP ratio might appear to give some comfort.   But I don’t think we can take comfort on the score.   Not surprisingly, the reason Ireland stands out as an outlier in this analysis is because of relatively small (normal-case) multipliers.   (The multipliers are assumed to be higher in the context of the current crisis, but the precise “crisis multipliers” used for Ireland are not given in the paper.)  The assumed normal-case multiplier is -0.36 for a decrease in government consumption and -0.08 for an increase in income taxes.   I would guess that the relatively low assumed normal-case multipliers for Ireland reflect Ireland’s high imports as a fraction of GDP.   But as discussed here, a large fraction of imports in Ireland are used as inputs into the production of exports.   As a result, the high import share can give a misleading view of the marginal propensity to import out of domestic demand.   Controlling for exports, a simple regression shows that a one euro increase in domestic demand is estimated to raise imports by 0.23 euro, indicating substantially less leakage from expansions in domestic demand than the crude import share would suggest. 

While I don’t think we can get any comfort from Ireland being an outlier in the analysis, I do have concerns about the broad conclusion of the paper.   This conclusion is that fiscal adjustment has actually raised debt to GDP ratios.   To the extent that the debt to GDP ratio is critical for creditworthiness, this suggests that efforts have been self-defeating on this central measure. 

check it out here.

From PER’s announcement:

Dawn Holland and Jonathan Portes present the results of their macro-econometric model of the EU in this Vox column. Specifically they argue that because of the times we live in, large scale and largely uncoordinated fiscal consolidations across the EU will lead to a collective fall in GDP and an increase in debt to GDP ratios. The increase in debt is obviously the opposite of what was intended.

The figure below shows their scenarios.

Scenario 1 is a fiscal consolidation with a working financial system, scenario 2 models a constrained financial system and so is a bit closer to reality.

Meanwhile, this paper just published in the Economic Journal (unpaygated .pdf here) tells essentially the same story using a New Keynesian model with all the bells and whistles.

On the Private Debt Relief thread, commenters Brog and John Gallagher (same person?) usefully draw our attention to the debate on participation of the GSEs (Fannie Mae and Freddie Mac) in the HAMP-PRA programme (Home Affordable Modification Program – Principal Reduction Assistance).   

The federally sponsored GSEs hold a substantial fraction of US mortgages, and so their position is somewhat analogous to Ireland’s state-owned banks.   The GSEs are administered by the independent Federal Housing Finance Agency (FHFA).    John draws our attention to correspondence from the US Treasury to the agency, urging its participation in the HAMP-PRA programme.    (See here; speech by head of FHFA at the Brookings Institution here.) This program, one of a number in operation to improve the functioning of the US housing market, provides subsidies to mortgage holders for principal reductions.   The gist of the correspondence is that such reductions could, depending on the case, have a positive net present value for the owner of the mortgage.   Indeed, it is argued that the gains in NPV would more than cover the cost of the subsidy, resulting in a net gain to taxpayers.   The correspondence also discusses strategic default concerns. 

Of course, given the differences in the housing markets – e.g. the relative importance of non-recourse loans in the US – the estimations are at best suggestive for the Irish case.   But the broad approach to thinking about the issue is useful.  

One issue that is not explicitly taken into account is the possible macroeconomic benefit of facilitating household balance sheet repair.   Here again the Irish situation is different given the state creditworthiness challenge and the importance of avoiding further losses at the banks.   A programme that ends up with a net cost to the state (from combination of any subsidy and the need to inject further capital into the banks) would further erode the financial position and creditworthiness of the state.   To the extent that weaker creditworthiness (and the associated “fear of default”) feeds back to higher interest rates and lower growth this would be a macroeconomic cost.   Nevertheless, it is worth looking at how these issues are being addressed elsewhere. 

Here are some details of an upcoming SSISI seminar.

Justin Doran, Declan Jordan and Eoin O’Leary of the UCC School of Economics are to present a paper to the Statistical and Social Inquiry Society of Ireland at the Royal Irish Academy on Dawson Street on Thursday November 1^st at 6pm. The paper is called Effects of R&D spending on Innovation by Irish and Foreign-owned Businesses. Details and a draft of the paper are here.

The paper finds that Irish owned businesses are significantly more likely than foreign-owned to introduce new products as a result of creative R&D work undertaken. Foreign-owned businesses, which spend nearly six times more per worker on R&D than Irish-owned, enjoy very high returns mostly from the purchase or licence of patents. According to the authors this points to a dichotomous Irish innovation system.