‘Panic Driven Austerity’ Post author By Brendan Walsh Post date March 1, 2013 Paul de Grauwe and Yuemei Ji have an interesting commentary on the causes and effects of austerity here. Categories In Economic growth, Economic Performance, EMU, European economy, Fiscal Policy, Political economy, Uncategorized 73 Comments on ‘Panic Driven Austerity’ ← More on Bogtec → Ireland v Pat Swords 73 replies on “‘Panic Driven Austerity’” Brilliant. 97% brilliant. The real source of ‘contagion’: fear/panic from flawed market signals infecting EZ politicos and their flawed policy decisions and too much of the ‘festina lente’ from the ECB. Who is Spartacus? EU Unemployment Thread [index of unnecessary misery] posted by Seamus Coffey below http://www.irisheconomy.ie/index.php/2013/03/01/eu-unemployment/#comment-385255 Macroeconomics ‘must’ incorporate the ‘behavioural’ to regain some relevance. The authors begin with an assumption that widening spreads equal a request from the markets to apply austerity. If an asset manager sells a bond thereby placing upward pressure on its spread he is doing so because he either thinks there is inflationary pressure sufficient to depreciate the currency it is denominated in (not relevant in the case of the Euro spreads considered here) or he has come to think there is a higher probability of default. Nowhere there, is there a request for the state to increase austerity. I might sell a bond because I have worked out economic fundamentals place higher default risk on the bond, and that likely policy responses (austerity is in vogue at the moment, but there could be others, see Japan for example) probably will not make much difference to that predicted path. This assumption that market participants and analysts are right wing cocaine addled Chicago worshipers as Paul Krugman once suggested, is not a sound foundation. Next: “The next question that arises is whether the judgement of the market (measured by the spreads) about how much austerity each country should apply was the correct one.” The interpretation that higher spreads should be responded to with proportionately more austerity was one made by democratically elected domestic politicians in the main, who chose which economic punditry to follow and which to ignore, not buyers and sellers of bonds. “There are essentially two theories that can be invoked to answer this question. According to the first theory, the surging spreads observed from 2010 to the middle of 2012 were the result of deteriorating fundamentals (e.g. domestic government debt, external debt, competitiveness, etc.). Thus, the market was just a messenger of bad news. Its judgement should then be respected.” So far, so sensible, but wait… “The implication of that theory is that the only way these spreads can go down is by improving the fundamentals, mainly by austerity programs aimed at reducing government budget deficits and debts.” Oh. I presume the authors will not be attempting to manage a bond portfolio anytime soon. If they did, they might discover their counterparts are not so naive – they will be aware that bond spreads can move an enormous amount on things like Central Bank Intervention, and will be constantly watching out for signs it might occur. “Another theory, while accepting that fundamentals matter, recognises that collective movements of fear and panic can have dramatic effects on spreads. These movements can drive the spreads away from underlying fundamentals, very much like in the stock markets prices can be gripped by a bubble pushing them far away from underlying fundamentals.” Is that really just a “theory”? Note “fear and panic cited here, no mention of exuberance – of the type that distorted EZ bond yields in spite of fundamentals for a decade under EMU. Why is it disallowed to consider that compression’s reversal to be anything other than “fear” or “panic”? This bit seems remarkable for the fact they find it anything other than obvious, they have noticed that when the ECB “intervened” or “rigged” via the OMT announcement, the spreads that it brought in the most were those that had previously blown out the most. If I’ve missed something please let me know what it is. “We find a surprising phenomenon. The initial spread (i.e. in 2012Q2) explains almost all the subsequent variation in the spreads. Thus the country with the largest initial spread (Greece) experienced the largest subsequent decline; the country with the second largest initial spread (Portugal) experienced the second largest subsequent decline, etc. In fact the points lie almost exactly on a straight line going through the origin. The regression equation indicates that 97% of the variation in the spreads is accounted for by the initial spread. Thus it appears that the only variable that matters to explain the size of the decline in the spreads since the ECB announced its determination to be the lender of last resort is the initial level of the spread. Countries whose spread had climbed the most prior to the ECB announcement experienced the strongest decline in their spreads – a remarkable feature. ” Further: “In previous research (De Grauwe and Ji 2012) we provided evidence that prior to the regime shift made possible by the ECB a large part of the surges in the spreads were the results of market sentiments of fear and panic that had driven the spreads away from their underlying fundamentals. Figure 2 tends to confirm this.” Why are widening spreads not viewed as equally possibly a reflection of actual fundamentals as the market corrects from its long and inappropriate compression of the spreads during the Great Moderation and EMU ‘convergence’? Then they move on to the fact that post OMT announcement, debt / GDP ratios have not reduced and try to argue that because spreads have compressed (because of a very significant ECB policy change) at a time when debt/GDP has worsened, this is evidence the market widening those spreads in the first place was unrelated to economic fundamentals – it was all just ‘panic’. “First, while the spreads declined, the debt-to-GDP ratio continued to increase in all countries after the ECB announcement. Second, the change in the debt-to-GDP ratio is a poor predictor of the declines in the spreads. Thus the decline in the spreads observed since the ECB announcement appears to be unrelated to the changes of the debt-to-GDP ratios. If anything, the fundamentalist school of thinking would have predicted that as the debt-to-GDP ratios increased in all countries, spreads should have increased rather than decline.” Do the authors really think there is a significant sector of the market that thought the ECB policy change last year was trivial in respect of bond prices as compared to comparatively unsurprising worsening of debt/GDP ratios? Apparently so – because only three people predicted it could happen as one of the authors cites himself (not thousands of others, obviously: “From the previous discussion one can conclude that a large component of the movements of the spreads since 2010 was driven by market sentiments. These market sentiments of fear and panic first drove the spreads away from their fundamentals. Later as the market sentiments improved thanks to the announcement of the ECB, these spreads declined spectacularly. This was predicted in De Grauwe (2011), Wolf (2011) and Wyplosz (2011).” The conclusions. ~Two of the tree are noteworthy: “Three conclusions can be drawn from the previous analysis. •Since the start of the debt crisis financial markets have provided wrong signals; led by fear and panic, they pushed the spreads to artificially high levels and forced cash-strapped nations into intense austerity that produced great suffering. Actually, no. The financial markets have provided mixed accuracy of signals. They were right about Greece’s unsustainable debt position when politicians and officials were trotting out rubbish about the markets merely panicking and losing sight of fundamentals etc etc (anyone remember Lorenzo Bini Smaghi?), they were right that Ireland had lost all track of what liabilities it had signed itself up for, and how do these researchers know the market’s suspicions about Spain are wrong? ” •Financial markets did not signal northern countries to stimulate their economies, thus introducing a deflationary bias that lead to the double-dip recession.” This has me a bit puzzled. What market signal has the market failed to give, that it reasonably could and should have, in light of the pressures on it from QE, a liquidity trap and central bank action to suppress yields everywhere, deleveraging etc – which would have given a clear sign it wanted the Northern countries to stimulate their economies? A paper in which Mr De Grauwe explores selected aspects of the evolution of the Eurozone crisis while ignoring others, and finds that his data confirms the ealier predictions and prognostications of himself and other famous economists (Wolf 2011, De Grauwe 2011, Krugman 2011), ending with a prescription for future harmonious relations based on mutually agreed and voluntarily enforced northern stimulus and southern austerity, to which Greeks, Germans and Italians are likely to provide a unified response: “To hell with Mr De Grauwe”. In the third week of July 2007, the yield (interest rate) on the 10-year maturity Irish sovereign bond was lower than the yield on a comparable German sovereign bund. Over 90% of Irish bonds were held by non-residents and two weeks later, the credit crunch began. According to an IMF paper, foreign investors were net buyers of the sovereign debt of Greece, Ireland, and Portugal up until Q1 2010. Between mid – 2010 and end – 2011, foreign investors cumulatively reduced their exposure to high – spread euro area sovereign debt by about US$400bn. Panic is in the eye of the beholder but what was happening was that investors were responding to heightened risk factors despite rising yields, and small economies with most of their debt funded by non-residents are particularly vulnerable when selling new debt. Some of the ‘panic’ was triggered by fund rules requiring moves from credit downgraded debt. The IMF paper says data on cumulative sales and purchases of government debt by foreign investors during 2010 – 11 shows that “the reduction in exposure of foreign investors to high – spread euro area countries has been more than offset by their increased exposure to other euro area countries, in particular to Germany. This may partly explain why the euro has held up relatively well against major currencies despite the euro area debt turmoil.” So these panicky foreign investors were sanguine about a euro crash? De Grauwe and Ji suggest that the correlation in spreads with the severity of austerity medicine suggests the Europeans and the IMF were naively responding to bond spreads. However, wasn’t the Greek case the most dire – – in effect it was dealing with a kleptocracy? The desirable budgetary stance for the Eurozone as whole consists in the south pursuing austerity, albeit spread over a longer period of time, while the north engages in some fiscal stimulus so as to counter the deflationary forces originating from the south. Germany in particular could have a budget deficit of close to 3%, which would keep its debt-to-GDP ratio constant. Given the size of Germany, this would allow for a significant stimulus for the Eurozone as a whole. Maybe? But where is the data to support this claim? European Commission economists concluded last year that the main beneficiaries of greater German demand would be the central European economies closely integrated into Germany’s supply chains. The analysis suggests that a 1% rise in German domestic demand would improve the trade balance of Spain, Portugal and Greece by less than 0.05%. Spain and Ireland were property bubbles, or an error in property valuations,the others PIIGS were excessive government spending. If David McWilliams warnings in 1998/9 were acted on then it’s likely the Irish and Spanish property crashes would have been avoided. Unfortunately the soft landing economists and the surveyors won the day and the rest is history. http://www.irishexaminer.com/opinion/letters/a-question-of-valuation-220487.html @ grumpy + 1 @ All Not one of de Grauwe’s best efforts! This one by Jean Pisani-Ferry is more to the point. http://www.project-syndicate.org/commentary/the-eurozone-s-persistent-regional-disparities-by-jean-pisani-ferry Notably; “The issue is not whether fiscal consolidation and external rebalancing are necessary – they are. It is how to make them politically and socially sustainable.” Only the countries affected really have the answer to this conundrum but they need assistance from the others in providing it. Finding the balance between the two is a continuing tug-of-war which shows no signs of abating. Notably little reporting of Regling’s suggestion that the ESM may not proceed to recap banks directly. What now for the Irish bank recap? http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_02/03/2013_485420 Some of the best social scientific research lies in comprehensively demonstrating the ‘obvious’. The EU/ECB response may be summed up as doing as little as possible as late as possible to buy a little more time. And that MerKozy continued to spiin a Fiscal Crisis when dogs in the street know is remains a Banking Crisis! Have we forgotten that Sinn, Issing and other little deutschelanders and not a few influential EZ politicos were suggesting that Greece leave the Euro hence increasing the risk of deafault across the weaker nations?_increasing spreads- while the ECB, which could have signalled its intent to ‘do what it takes’ in 2008_ sat idly and contentedly scratching its 2% behind. The IMF have noted the increased multipliers after the fact – so is it not plausible that the above authors are correct that unncecessary suffering has been loaded onto the serfs? The current issue of The Economist says: In fact the danger is less of break-up than of stagnation. This was the week, history may conclude, when Europeans made clear that they were not interested in reform. Nine months after the French ran away from change, the Italians sprinted past them. As many as two-thirds of Italians rejected not only German-imposed austerity but the entire reform agenda that was designed to improve their economy’s dismal record of near-zero growth. Follow that path, and it leads to the economic paralysis and political decline that Japan has endured for the past 20 years. It adds: “The euro zone has much left to do. But Italy’s underlying problems are home-grown. Above all, it needs growth-enhancing reforms in everything from its labour market to its sclerotic justice system.” Europe should ease its austerity demands; Germany could even cut taxes but Brussels or Frankfurt cannot provide magic solutions for growth. The FT reports that an Italian senator has told prosecutors he received €3m in bribes from Silvio Berlusconi between 2006 and 2008, to help bring down the last centre-left government, unleashing a fresh political storm in Rome as politicians struggle to break the deadlock resulting from this week’s inconclusive poll. Beyond the current battles on austerity, the spectre of stagnation hangs over Europe as Asia, Africa and Latin America grow while American industry will have a cheap energy resource for the next 30 years. Airbus was founded in 1970 by the governments of Germany, France and the UK and this week, EADS its parent, said that at the end of 2012, its order book had increased by 5% to €566.5bn. Airbus has not only been a stunning commercial success but also a European one. However, it is a rare success where there are few stars in new business sectors. In the United States, Yollies (young leading innovators formed after 1975) account for 35% of total R&D of leading innovators; in Europe, a mere 7%! Notably, Japan has almost no young firms among its leading innovators. Deutsche Bank Research said in a 2011 study that “companies in the US are distinguished by a strong startup culture. Over 50% of all US firms in the current (2009) Top 1,000 (global companies ranked by R&D spending) were founded after 1975, in Europe the figure is just 18% and in Japan a mere 2%.” @grumpy ‘This bit seems remarkable for the fact they find it anything other than obvious, they have noticed that when the ECB “intervened” or “rigged” via the OMT announcement, the spreads that it brought in the most were those that had previously blown out the most. If I’ve missed something please let me know what it is.’ Timing. ECB Timing. And perhaps, for a usually astute commenter, an underestimation of the patently obvious! @DOCM Anything of significance related to the social scientific content of the paper?_other than your ‘lazy’ “+1” to grumpy!_and the usual effort to sidetrack the discussion! @ Flj I think that the incapacity of the Irish media to follow a coherent narrative with regard to developments in relation to the euro crisis must be taken as a given. Regling spelt out in detail the sequencing with regard to possible recapitalisation by the ESM in his earlier detailed interview. http://www.ekathimerini.com/4dcgi/_w_articles_wsite3_1_17/02/2013_483485 The order of business now is clearly (i) put a cap on the Italian crisis (ii) soften the austerity requirements (even the Economist thinks this should happen) (iii) do something additional for Ireland and Portugal in respect of EFSM and EFSF loans and (iv) sort out Cyprus (before the end of March; as agreed in a joint statement of the French and German finance ministers). One could conjecture that Regling in his most recent remarks is simply underlining that there will be no immediate calls on the ESM as far as recapitalisation is concerned, if at all, it needing all the firepower it has to assist states (Italy?). @ MH I agree with your view in general. It all depends, however, on how the French react. Their economy is much more widely based than even the German and they have a functioning administrative and legal system together with, of course, a high-tech sector, as EADS demonstrates, the equal of any in the world (apart from excellent roads, the best trains, the largest tourist destination etc. etc.) @David O’Donnell [DOCM’s] ‘usual effort to sidetrack the discussion!’ +1 lol It appears the Greeks were offered a “velvet exit” from the euro. http://www.ekathimerini.com/4dcgi/_w_articles_wsite1_1_01/03/2013_485346 It would be interesting to find out if we were offered the same. fyi Ciarán Ó Lionáird, a modest Corkman, wins bronze in the 3000m EU indoors. Grillo is in fine form today….from the telegraph… “Right now we are being crushed, not by the euro, but by our debt. When the interest payments reach €100 billion a year, we’re dead. There’s no alternative,” he told Focus, a weekly news magazine. He said Italy was in such dire economic straits that “in six months, we will no longer be able to pay pensions and the wages of public employees.” He also suggests they will have to leave the euro. @David Od ‘Timing’ is not the point they raise. I’m trying to get an explanation of why they could be surprised to find out something that was obvious to the vast majority. It is basic stuff. One presumes these guys are teaching the next generation of risk managers and, investors, pundits and government advisers… @ All FYI (also carried in the IT) http://www.reuters.com/article/2013/02/27/us-eurozone-portugal-ireland-idUSBRE91Q0XB20130227 http://www.theportugalnews.com/news/algeria-throws-portuguese-construction-industry-a-four-billion-euro-lifeline/27806 The Portuguese minister for finance has stated that his country intends sticking to its programme and making the savings still required (€4 billion). Sound familiar? @grumpy Yes – it is basic stuff – but it is being ignored by the key policy makers. The landscape now would probably be somewhat different if the ECB in early 2008 had come out with a strong statement in line with the ‘Solidarity Principle’ that it would ‘do whatever it takes’ – hence taking sovereign default off the agenda [ to say nothing on preventing the Deauville Disaster by MerKozy]. Throughout this ‘Banking Crisis’, imho, TIME is a key variable. @Grumpy “Why are widening spreads not viewed as equally possibly a reflection of actual fundamentals as the market corrects from its long and inappropriate compression of the spreads during the Great Moderation and EMU ‘convergence’?” So, one possible view is that the ‘markets’ got bond pricing utterly wrong from euro inception until the ‘crisis’. If that is so, and it probably is, it merely strengthens the DeGrauwe arguments, ie that markets get it wrong all the time and that the fundamental error in policy was in governments taking their view and cue from the markets. The markets of course did not dictate government policy! Though I seem to recall George Soros effecting a substantial change in British government policy a long number of years ago. Perhaps his students have learned well from the master. @ Joseph Ryan Interesting how there’s clearly an revisionist imperative now to wipe out the slavish attention by Governments (egged on by media and certain economists) to bond markets of the past number of years. ‘Confidence’, bond vigilanties, etcetc. have all been made household terms… so we’re required to forget that this went on, so that the free market, rational choice ideologues can keep their nice little religion going. @ All FYI http://www.iew.uni-osnabrueck.de/WP_92.pdf Spain and Ireland were property bubbles, or an error in property valuations,the others PIIGS were excessive government spending. If David McWilliams and Paul de Grauwe’s warnings in 1998/9 were acted on then it’s likely the Irish and Spanish property bubbles would have been avoided. Unfortunately the soft landing economists, the surveyors and the Irish Times won the day and the rest is history. http://www.irishexaminer.com/opinion/letters/a-question-of-valuation-220487.html http://www.youtube.com/watch?v=vzNO4u8AU3Y http://www.econ.kuleuven.be/ew/academic/intecon/Degrauwe/PDG-papers/FT_articles/FT%201998%2002.htm @ All There is also the interesting question of whether or not ECB profits on holdings of bonds can be returned to countries in a programme as was agreed for Greece. I am taking the liberty of inserting this link to the recent blog post by Seamus Coffey on the subject. http://economic-incentives.blogspot.ie/2013/02/central-bank-holdings-of-irish.html See also the item in today’s SBP. Whether this element is considered as part of what makes the Greek situation “unique” and not to be repeated remains to be seen. At least one member of the ECB council appears to recognize that the eu elite are not loved! From the Observer “”People in Europe generally feel disconnected from EU decision-making and question whether their voice is being heard,” Coeure said. “People do not know who really represents them in Europe. Is it their prime minister? Is it their member of the European Parliament? Is it their local representative? They don’t know. Instead, they see a process controlled by elites with no truly democratic credentials.” That is a particular concern given that many of the steps urged to combat the debt crisis – including austerity spending cuts – have strained relationships among Europeans, both between nations and generations, Coeure said.” @DOCM,tks kinda has a whiff off monetary financing …. @DOCM Very informative post by Seamus Coffey. However I would be inclined to stress the capital gain portion in addition to the interest gain. The capital gain is clearly the ECB, and our European partners, gaining from a punt on Irish Sov bonds. [No pun or £punt intended] So monetary financing of sovereigns by the ECB is a big no-no. But the ECB engaging on a little profiteering, on the side, is just fine, even if done under the guise of ‘we’re here to help you’, and this is the medicine you are obliged to take, so that in ‘our’ opinion we can make a profit! Would Ireland have been ‘allowed’ to buy its own bonds, with its cash reserves, at a time when those bonds were yielding up to 14%, as was suggested by some people at that time? @joseph…cash reserves..did I miss something 🙂 @JG “kinda has a whiff off monetary financing ….” On reflection, you are 100% correct. That is what it is. Still, we will have to wait for Mr Weidmann’s opinion. He is the expert on this kind of thing. @JG Our posts crossed. That is unusual for me. I usually start and end up talking to myself! But yes, there were fairly significant cash reserves throughout the crisis, not as high as at present, but not small either. I don’t have the detail. @Joseph Ryan,hi Joseph optically a bit tricky when you relying on the kindness of strangers to pay your day to day living expenses…..philosophically in complete agreement but….. @Joseph,comfortably ensconced thousands of miles away the proposals and commentary by some leading economists is often bewildering. It was my understanding that a portion 50% I think,from the sale of state assets was to be allocated to creating employment.Given that its one the biggest challenges facing the country,why no commentary on the ludicrous decision to utilize the proceeds from dumping Irish Life,the CoCo bonds etc. to retire cheap debt. Interest rates are at riducolus low levels…..supposedly the debt level is ahem sustainable….so why not create jobs…..I find me too pleadings desperate and whinny….desperate is so unattractive to creditors.Bit more shoe banging and job creation from sale proceeds perhaps. Apols off topic,read the article,Grumpy nailed it. Joseph, the authors have not claimed that markets are generally imperfect at pricing (thousands of other people got there first, long ago) so my pointing out spreads were probably too low for years does not “strengthen their argument” They appear to be claiming that: 1. When periphery bond yields started to rise, and some pundit at SocGen said austerity would be a good idea, and some other pundit at Goldman said it wouldn’t, any investor not holding these bonds who failed to step in and buy them – so putting downward pressure on the yields – was ‘demanding more and more austerity’. That is baloney. 2. Government advisors, The European Commission, politicians, The ECB and the IMF did not choose to listen almost exclusively to pro-austerity pundits and ignore other arguments, in response to the increasing signal from the markets that the EZ might have to break up or that some state’s debts were possibly unsustainable. They are all innocent. The guy who didn’t step in and buy the bonds is the guilty party. 3. Nobody could have expected that the bonds whose spreads had blown out the most, would benefit the most from the ECB’s new “anything it takes” and OMT policies – and that this proves markets are useless. @John G. I have no idea why the Irish government, even at this late stage, cannot see it way to a strong employment creation program using funds saved elsewhere. There have been a multitude of job creation announcements, monies abrogated from private pensions supposedly for job creation, money promised as you point out from sales of assets, but basically all hot air. In fact, there has been a jobs destruction program, the clearest example being the shedding of jobs in the PS and, as part of the latest agreement, the insistence of more hours for those at work, rather than a more comprehensive jobs sharing program both in private and PS to get those not at work back to work. The clue to the governments approach may be in the economic philosophy/dogma of the current ‘Minister for Enterprise’, whose view is that ‘governments do not create jobs’, the simply create the conditions where the private sector embarks on …well, who knows what. @Joseph…from above trying stay on topic ! “As it becomes obvious that the austerity programs produce unnecessary sufferings especially for the millions of people who have been thrown into unemployment and poverty, resistance against these programs is likely to increase. A resistance that may lead millions of people to wish to be liberated from what they perceive to be shackles imposed by the euro. ” The link from DOCM,to the SC piece proposes potentionally a “stimulus” or sorry monetary financing off… “This potential €500 million is there and could be recycled back to the Central Bank of Ireland which would give it back to the Exchequer. It would be a welcome boost to the public finances.” But half the proceeds from asset stripping the country via dumping Irish Life and the CoCo’ exceeds that,never mind the multiplier effect of creating jobs….. It’s my understanding that to date ALL sale proceeds from jettisoning state assets have retired long term cheap debt….it’s in your creditors interest to have a strong vibrant economy…how else you gonna pay them back. My own “pet” project is the proposed new DIT campus at Grangegorman…shovel ready and likely to attract private capital,specifically the student housing component…. @Grumpy I congratulate on your rebuttal of the arguments made in the DeGrauwe article. I am finding it difficult to pick holes in your rebuttal. It is certainly true that governments and various institutions must take full responsibility for their policies leading into the crisis and their responses to it. Blaming the markets is a rather weak argument. “Nobody could have expected that the bonds whose spreads had blown out the most, would benefit the most from the ECB’s new “anything it takes” and OMT policies – and that this proves markets are useless.” Fair point. Of course the alternative to OMT was countries not being able to borrow, except at rates that would sink them pretty quickly and sink the EZ as well. @ Joseph Ryan et al What we have is a very messy situation which Coeure of the ECB sums up rather well. He is right that citizens in Europe do not know how the EU functions when it should be clear to all – and not just the the elites – that it has the aspects of most democratic systems i.e. a division of powers subject to the rule of law and review by a (European) Court of Justice. Ministers are in the Council to represent the interests of the sovereign states that make up the EU while the democratically directly elected members of the European Parliament are there to provide a counter-balance, with the added security that legislation can only be decided on the basis of a proposal from the Commission, the “Administration” of the EU. (If countries want to overrule it they have to get every country to agree and in a manner which does not denature its original proposal). The mechanism is either too complicated in practice, while simple in basic construction, or those participating have failed to explain it. I think the latter is the case and largely because of the apparent ungovernable capacity of national politicians to attribute all successes to their sole efforts and all difficulties to “Brussels”. Nevertheless, the resilience of the system, which had its origins in the trial and error period of the initial Coal and Steel (the “sinews of war”) Community, has been demonstrated time and time again, most recently in the not so trivial matter of banker bonuses. As I have pointed on another thread, the curious situation is that all the tactical twists and turns by Merkel, coupled with the decisions of the German constitutional court, have combined to remove from the German federal government its capacity for executive action without the permission of its parliament in matters relating to the euro. If the same situation pertained in all EA countries, the euro would collapse. The paradox is that the most recent action by the opposition of the Greens and the SPD in the Bundesrat to adoption of the fiscal pact – Merkel’s baby – seems to have moved the core debate on austerity to a wider trans-national-frontier basis; whether intentionally or not. On the issue of bond spreads, I find the paper linked to above much more persuasive in terms of the narrative – leaving aside the “mathematics” – than the paper that originated this thread. P.S. For the life of me, I do not understand the souls-searching in certain quarters in Ireland with regard to whether actions by the ECB constitute monetary financing or not. Is this not for others to worry about? @JG I am fully with you on job creation. In relation to the proposal by SC, my view is that while the original purchase of the bonds, could be considered ‘monetary financing’, the ‘recycling’ of the subsequent profits to the country off whose back those profits were made, rather than the retention of the profits in order to benefit countries not in difficulty at all or to benefit countries who vehemently opposed the ‘monetary financing’ intervention in the first place, seems very hypocritical and duplicitous. @ Joseph Ryan “The clue to the governments approach may be in the economic philosophy/dogma of the current ‘Minister for Enterprise’, whose view is that ‘governments do not create jobs’, the simply create the conditions where the private sector embarks on …well, who knows what.” Can you give me an example of a “government” job that is not funded by the taxpayer? As to the point made that creditors are demanding that the country pay down debt before embarking on another splurge, the only real question is whether this approach enhances or diminishes their chances of ultimately being repaid in full. There appears to be a growing realisation that their calculations in this respect may be wrong. @Joseph,I find irish policy makers and politicians relationship to “debt” remarkably immature almost as if they are somewhat “ashamed” of the current situation…..10 Billion according to M of F…..nada,zilch,zero proceeds directly invested in education,job retraining,capital projects.WTF is with early retirement of cheap long term debt,unless unless there is some concern regarding its sustainability. Who actually makes these decisions,your creditors ? “All told €10 billion has been invested or committed in the past six months, mainly by international investors, in transactions managed by the State or entities controlled/owned by the State” http://www.finance.gov.ie/viewdoc.asp? DocID=7564&CatID=78&StartDate=1+January+2013 @DOCM just having a laugh regarding monetary financing…bring it on the more the merrier. @ DOCM Can you give me an example of a private sector job that doesn’t exist (even when only externalities are factored in) without government investment and policy? @ EWI Where would you like me to start? In retail; restaurants; music business; professions etc. etc.? The government’s only involvement, in most instances, is to raise taxes on the back of their activities apart, that is, from whatever level of regulation is necessary in the public interest. But neither involvement creates the business in the first place. If you know of other “externalities” that can be factored in, you might care to list what they are. @JG re: Ashamed Irish policy makers. “as if they are somewhat “ashamed”” There is no ‘as if’ they were ashamed. It is as nothing compared with the ‘The Great Shame’ of the famine, (author Thomas Keneally), but it is shame nonetheless. The pink slip over here is called a P45, and when the country has filled out ‘pink slips’ for 15% of all those employed, there is a lot of shame to go around. For those in policy making and decision making positions, there must or at least there should be a very deep shame that they have visited such destruction on the citizens of the country. “Who actually makes these decisions,your creditors ” That is exactly who makes these decisions at present, and ‘our’ deep felt shame, seems to prevent us from disputing even the most egregious of these decisions. Some of the afflicted even take the side of the creditors, so that we can be seen to have accepted our subservience in full. I would say it is a psychological problem, though I have little understanding of psychology. @DOCM “Can you give me an example of a “government” job that is not funded by the taxpayer?” That is a neatly phrased question. But lets ask it this way, ” How many sustainable jobs have been created with an initial tax funded investment”. One then can list a variety of Semi-State employments, eg Bord Gais, ESB, Coillte etc. The same question that you ask could have posed to FDR in November 1932. I recall my own father, who lived through the 1930s talking about the hungry 1930s. Yet the State found the resources to start Coillte during those times. Current policy is now to sell off the harvests that were planted in those hungry 30s and later. It is strange and selfish thinking from the cosseted generation that destroyed the country. I do not buy into the philosophy that all State investment spending is somehow nonsensical and that private sector investment, if to be found in a deep recession, is somehow superior. To be the father of school age or younger children and to be unemployed in Ireland is akin to having committed a mortal sin of a magnitude that commits one to a living hell. The only redemption is to find another job quickly, hence emigration. The Irish internalize their problems as opposed to the French who hit the streets and terrify their politicians into doing something constructive. We are still stuck in the smallholder, small busines, small retailer, independent craftsman era where people controlled their own destinies. Unfortunately most people are now beholden to MNCs and have little control. Collateral damage, nothing personal. Some day we will twig on. Really for most of you it is not “your own fault”. @ Joseph Ryan Neither do I! If we were facing a deflationary spiral and had the funds to do something about it, I would be all in favour of increasing deficit spending. This is the situation confronting the Dutch government, by way of example. Unfortunately, not us. cf. Colm McCarthy on the need to avoid further needles infrastructure spending (although I would argue for a motorway between Waterford and Limerick which would start the orbital motorway which an inventive student suggested some years ago instead of the daft structure now almost complete of all roads – except those from Donegal – leading to Dublin). http://www.independent.ie/opinion/analysis/colm-mccarthy-now-is-not-the-time-to-splash-out-on-building-29105460.html @JG Re my post above 4.10. I made a complete mess of that long sentence and managed to say the exact opposite of what I was trying to say. Profits or capital gains made by the ECB on the purchase of Irish bonds should be ‘refunded’ to the State involved. The ECB or ESCB keeping any gain made on the backs of distressed countries is very objectionable. [Lesson 1: Avoid long sentences] and [Lesson 2:Avoid Too many posts] @Joseph…not at all i have read one or two of yours,to know what you intended saying. @DOCM here is the impact of early debt repayment…sweet feck all,just because something did not wok out exactly as planned,public private partnerships is not reason enough to abondon it altogether. @Grumpy I recall reading a speech by one central bank chaps,bemoaning the widened spread over comparable German paper,any sign of this tightening given the best boy in class status? “A €1.3 billion cash injection would, combined with the Bank of Ireland Contingent Capital deal, and all other things being equal, reduce GGD to GDP from 121.3% at end 2013 (per Budget 2013) to 119.9%. As the acquisition did not constitute a capital transfer it will not have an impact on the GGB but the €1.3 billion will positively impact the Exchequer deficit.” http://www.finance.gov.ie/viewdoc.asp?DocID=7564&CatID=78&StartDate=1+January+2013 @ DOCM Re Colm McCarthy: ‘Building things that are not needed on tick is what got the country into the current mess. The economy will not recover until the exporting sectors become competitive again.’ Hard to disagree with the first sentence. The second sentence might be true of Spain, but most of our exports are not ours in any meaningful economic or political sense. A more accurate statement mingt be ‘ No one yet knows how, or when the economy will recover…’ @ DOCM Where would you like me to start? In retail; restaurants; music business; professions etc. etc.? Oh, c’mon. You list off restaurants, the music business and professions, none of which could exist without Government involvement…? @ DOCM Someone recently accused non-free-market believers of being “KnowNothings”. I presnt to you Colm McCarthy, a much more worthy recipient of that title: There are certain droning noises in the soundtrack of Ireland’s economic policy debate that just never seem to go away. One of the most persistent is the assertion that Ireland labours under a serious deficit in public infrastructure, the solution to which is more spending on civil engineering projects. More capital spending would stimulate the economy too, it is asserted. I find it astounding that this man finds employment as an economist. It’s not as if more than a century of public record doesn’t flatly contradict him, after all. returning to the focus of the thread on ‘Panic Driven Austerity’ Martin Wolf Misses the Real Reason the Eurozone’s Unhappy Marriage Has Not Broken Up Yet – 02/20/2013 – Yves Smith Wolf … proceeds to tell us that the Eurozone continues to be a resolute practitioner of austerity policies. Readers may recall that there was a huge kerfluffle in the economics-related media when the IMF admitted it was all wrong, that the fiscal multipliers in the Eurozone had turned out to be larger than one. In econ-speak that means you can’t starve your way back to health. Cutting fiscal deficits results in an even greater economic contraction, resulting in even worse debt to GDP ratios. But the rest of the European officialdom seems to be in shoot-the-messenger mode. DO Read more at http://www.nakedcapitalism.com/2013/02/martin-wolf-misses-the-real-reason-the-eurozones-unhappy-marriage-has-not-broken-up.html#LpZ0PPl6Ev7wHbVT.99 Worth reading @ EWI I have to confess that I have not seen any government minister serving at table or twanging a guitar recently. But I have been on half-empty trains, little-trafficked motorways (for parts of which the taxpayer has to pay the developers as expected traffic volumes have not been met) and walked through echoing over-dimensioned airport terminals, having paid the hefty charges which are funding them, while watching another entire generation emigrate because we have not adopted the policies that would give them a lifetime of productive employment. A century of public record does not contradict Colm McCarthy but it does condemn wasteful unproductive government expenditure the debt associated with which we are finding almost impossible to service. Comment #1 reloaded Brilliant. 97% brilliant. The real source of ‘contagion’: fear/panic from flawed market signals infecting EZ politicos and their flawed policy decisions and too much of the ‘festina lente’ from the ECB. Who is Spartacus? @grumpy we agree to differ, yet of over 50 comments you are the only other to attempt to address the focus of the thread. @Paul de Grauwe and Yuemei Ji Devastating presentation of the patently obvious. Keep up the work. @DOCM ‘… wasteful unproductive government expenditure the debt associated with which we are finding almost impossible to service.’ Minor point really …. a pittance really … hope this not upset you …. … you neglected to mention the .. er… SIXTY FIVE OR SO BILLION IN ODIOUS FINANCIAL SYSTEM DEBT btw, well done – neat job on sidetracking another thread – Hi to Lorenzo! @DOD,I find obsessive linking specifically to other blogs tiresome. Here ya go…heads up I read it…what’s z point of above article,all yours ….the markets are inefficient ,,,yawn. @DOD…newsflash…some people make a few bob from market inefficiencies..top of their game lads. The article rambles on and on and on…any chance say specifically on Sundays you and DOCM,can give it a rest. @John Gallagher for the 3rd time: The real source of ‘contagion’: fear/panic from flawed market signals infecting EZ politicos and their flawed policy decisions and too much of the ‘festina lente’ from the ECB. Do you agree/disagree with this interpretation? Care to expand? BTW the focus of the paper is ‘Austerity’. @DOD truly David,you lost me..who’s panicking z paddys…oh they paying it back then .. give it a rest. “Eurozone policy seems driven by market sentiment. This column argues that fear and panic led to excessive, and possibly self-defeating, austerity in the south while failing to induce offsetting stimulus in the north. The resulting deflation bias produced the double-dip recession and perhaps more dire consequences. As it becomes obvious that austerity produces unnecessary suffering, millions may seek liberation from ‘euro shackles’.” @DOD… Per crisis Irish gilts/bond yields mirrored Germany…r creditors panicked. Know is the time to extract job creation initiatives… the article is barking at the moon nonsense. @JG Your comment that sustainability may be driving repayment prioritisation is probably right. John McHale’s recent posting arguing that there is no alternative ultimately but debt reduction alludes to this issue. He didn’t get many postings in response to that…..but the underlying issue is there. We know that, without growth, Debt /GDP % will look terrible going into 2014…The Troika’s own figures pre-Christmas clearly demonstrated the issue and predicted Debt /GDP in excess 130% by 2016 if I remember correctly. I suspect that there is concern (and panic) under the surface. First quarter figures for the country will be interesting…..retail spending down significantly in January, car sales dramatically off, etc….Hopefully industrial unrest doesn’t muddy the waters and leave them off the hook. @ paul quigley “re: Colm McCarthy: ‘Building things that are not needed on tick is what got the country into the current mess. The economy will not recover until the exporting sectors become competitive again.’” Actually I don’t agree with that as an argument against government action: except as a circular statement that building things that are not needed is a mistake (and even then). In a different monetary environment I would think building useful public works – eg Commissioning Diego Rivera to paint some murals, or the modern equivalent (John Kindess perhaps?), or an underground for Dublin – is exactly the way to go. I’ve no problem with trying to find inventive ways to provide a stimulus. Ambrose Evans Pritchard has a go at the Irish situation here: ‘Brave Ireland is the poster-child of EMU cruelty and folly’ “Club Med can take no comfort from Ireland’s success, but is even Ireland itself out of the woods? The budget deficit is still 8pc of GDP five years into the ordeal, and public debt is already nearing the limits of viability at 121pc of GDP this year. “Dublin has pencilled in a 3pc deficit by 2015, but dissidents say 6pc is more likely. The IMF warns that a “stagnation” scenario of 0.5pc growth a year into the middle of the decade would cause the debt ratio to spiral up to 146pc by 2021.” http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9906230/Brave-Ireland-is-the-poster-child-of-EMU-cruelty-and-folly.html @ Gavin Kostick We could bring in the Japanese to handle a few projects as they’ve lots of experience of building bridges to nowhere! The first problem would be the lead time to handle all the shakedown demands of say an underground: 3 to 5 years at least. Then in Dublin there are so many tigeens that the cost of running a transport system would be high. Private investors withdrew some $900bn from Greece, Ireland, Italy, Portugal and Spain in the 3 year to June 2012. So lots of cash to make up: http://www.finfacts.ie/irishfinancenews/article_10256588.shtml http://www.voxeu.org/article/eurozone-macro-orthodoxy-options-coming-reversal “Periphery economies: National governments must be prepared to provide stimulus….. •Governments could legislate to enable Ministries of Finance (not the independent central bank) to create new local legal tender currency to be used to finance on going budget deficits, and any increased budget deficits judged necessary to provide economic stimulus.” Ollie Rehn claims he is a Keynesian.. http://www.ekathimerini.com/4dcgi/_w_articles_wsite3_1_03/03/2013_485499 @ Fiatluxjnr He was always a Keynsian don’t you know? “Ahead of this weekend’s G-20 summit in Toronto, Europe’s exit from stimulus mode and shift toward fiscal consolidation has been criticized as a threat to the still-hesitant economic recovery. Some even claim that Europe is condemning itself to a long period of slow growth and high unemployment by excessive spending cuts and tax increases. I cannot but disagree. “What Europe has put in place is a carefully timed, scaled, and differentiated fiscal-policy strategy to transform the current cyclical upturn into sustained growth. “First, the overall fiscal-policy stance in Europe is still slightly expansionary this year by standard measures. Only in 2011 will the fiscal policy turn tighter. Even then, this contraction will only be on the order of 1% of European GDP, while the overall fiscal deficit is forecast to remain around 6%. By then, though, the growth rate is projected to accelerate to 1.75%, taking into account all but the most recent consolidation measures. So, there is really no way these additional fiscal measures could derail recovery in the European Union.” Olli Rehn, Wall Street Journal, June 2010. http://online.wsj.com/article/SB10001424052748704911704575326421944964834.html @Gavin “What Europe has put in place is a carefully timed, scaled, and differentiated fiscal-policy strategy to transform the current cyclical upturn into sustained growth.” A differentiated fiscal-policy strategy! Wow. Turning corners? Btw. I see he is now referred to as Ollie the Enforcer. How long does Rehn and Barrosso have to go. I think I read somewhere that their terms are up in 2014. “Not a single problem in the currency zone has been definitively resolved” http://www.spiegel.de/international/europe/fears-of-return-of-euro-crisis-plague-central-bankers-and-imf-a-886681.html. Ireland gets a mention for cunningly circumventing monetary financing “The IMF (2013) has recently demonstrated that fiscal multipliers are higher than previously estimated and, with austerity policies in place, this means, ceteris paribus, that the current contraction will be deeper than previously anticipated. De Grauwe and Ji (2013) [the focus of this thread] have also fairly convincingly shown with simple cross-country comparisons that the stronger the austerity policies are, the greater is the related economic contraction. They also demonstrate that the stronger the austerity policies, the greater is the related increase in public debt burdens. These are important and compelling results.” Richard Wood from link supplied by grumpy 9.36bam .. er .. from panic driven austerity to panic driven stimulus ..? Italy has a black economy that has been estimated to be equivalent to up to 18% of GDP. http://www.economist.com/blogs/schumpeter/2013/01/tax-evasion-italy @ All FYI http://blogs.ft.com/ft-long-short/2013/03/04/ireland-poster-child-for-austerity/ It seems a pretty reasonable review of the situation. It misses, however, some elements with regard to the Irish economy, notably the exceptionally high share of GDP taken by wages in the public sector as identified by Richard Curran of the SBP which is being corrected by CPA II; not totally but to the extent that is manageable in the context of the broader economic situation, especially in relation to private indebtedness. The other major issue unique to Ireland is that of households “with low work intensity” (a Eurostat euphemism if ever there was one!). Trespassing again on the contributions of Seamus Coffey, this extract from a recent post illustrates the point. “Here is another graph from Eurostat, this time covering the proportion of the population aged under 60 living in households where the working-age adults (excluding students) have a very low work intensity. People aged less than 60 living in households with very low work intensity cf. also this extract from the Taoiseach on “together we have turned the tide to recovery” in today’s IT (a good trick if you can manage it!) “We will do more to help people back to work, including through further reforms to the welfare system to activate jobless households and by establishing NewERA and the Strategic Investment Fund on a statutory basis to invest €6 billion in strategic sectors.” It would also be useful to try and identify the reasons that have given rise to the extraordinary statistic of jobless households in the first place apart from agreeing the coalition trade-off implicit in this formulation. @ Flj Very interesting link. It is probably time to bring back the old WWII expression SNAFU. @ All Link to Eurostat. http://tinyurl.com/cn4od8j @DOCM as you have failed to provide a single word on the focus of the thread: – a little reminder in the spirit of sympathetic collegiality that permeates the blog towards agenda driven spinning trolls: “The IMF (2013) has recently demonstrated that fiscal multipliers are higher than previously estimated and, with austerity policies in place, this means, ceteris paribus, that the current contraction will be deeper than previously anticipated. De Grauwe and Ji (2013) [the focus of this thread] have also fairly convincingly shown with simple cross-country comparisons that the stronger the austerity policies are, the greater is the related economic contraction. They also demonstrate that the stronger the austerity policies, the greater is the related increase in public debt burdens. These are important and compelling results.” Richard Wood from link supplied by grumpy 9.36bam Comments are closed.