The World Bank has produced a new report on global trends in saving and investment over the next 20 years – lots of interesting material here.
Month: June 2013
Daniel Gros writes here.
With advance apologies for a too self-referential post, I think it might be useful to put my response to commenter Shay Begorrah from Tuesday’s thread on the front page. Shay clearly sees me as an unabashed fiscal hawk, where more deficit reduction (and more expenditure-focused deficit reduction) is always better. As this is not at all my view, and given my official role through the fiscal council, it might be worthwhile to explain my actual view a bit.
During 2009 and the first half of 2010, the main thrust of my fiscal policy posts on IrishEconomy was that the fiscal adjustment was too frontloaded (see, e.g., here). At the time I assumed that Ireland’s credtiworthiness was reasonably robust. I underestimated how fragile Ireland’s creditworthiness was in the context of monetary union with an underdeveloped lender of last resort to governments. My basic approach to fiscal policy is Keynesian. But since the middle of 2010 it has been clear to me that fiscal policy must steer a difficult course between supporting demand and sustaining the borrowing capacity of the State. Not least, the latter is essential to ensure that the fiscal adjustment can be phased in any sort of reasonable way, and thus to sustain the essential protections and services of the welfare state.
The idea that there is a trade off between demand and creditworthiness is challenged from both right and left. From the right, the idea of an expansionary fiscal contraction is invoked: discretionary deficit reduction would then increase demand, further enhancing the deficit reduction. I do not read the available evidence as supporting this contention (see, e.g., the important work from the IMF). From the left, the idea of self- defeating austerity is invoked. This comes in different forms: discretionary deficit reduction does not actually reduce the deficit; discretionary deficit reduction does not reduce debt to GDP ratio; and discretionary deficit reduction does not improve creditworthiness. I do not believe that such self-defeating effects are borne out by the Irish experience (see Box C, p. 46 here).
Another thrust (obsession?) of my more recent posts has been the critical importance to more robust creditworthiness of strengthening the crisis resolution mechanisms – and more narrowly the fiscal lender of last resort function – for the euro zone. The political economy of such developments must been seen in the context of weak solidarity between what is an association of nation states, where there is a reluctance to risk transfers and a fear of moral hazard. While I believe the aggregate fiscal stance of the euro zone has been significantly too tight from an optimal fiscal policy perspective, the strengthening of fiscal rules must also be viewed in terms of the political economy of strengthening the LOLR function. The fiscal compact, for example, must be seen in this light.
Finally, on the relative measures of expenditure- and tax-based adjustments, my prior belief around 2009 based on the literature was that expenditure-based adjustments were less contractionary than the tax-based alternative. (Of course, in deciding on the mix of adjustments, other factors besides the macro effects – such as fairness – are important.) From the more recent evidence, I have become much less convinced of the macroeconomic superiority of expenditure-based adjustments. This issue was discussed in the first fiscal council report in October 2011 (see Box 4.1, p. 36, here; a more general review of the multiplier literature is given in Appendix E, p. 93, here). The inconclusiveness of the evidence is the reason that the council has focused on an overall deficit multiplier in our analysis.
here.
Giancarlo Corsetti and Luca Dedola have a really good VoxEU piece on how cooperation between the central bank and the fiscal authority can avoid the “bad equilibrium” problem for sovereign debt. The paper on which the Vox article is based is available here; Paul Krugman discusses it here.
Although the initial focus is on a country with control over its own “printing press”, they also examine how it could work in a monetary union. I won’t try to summarize the subtle analysis, but the key is how the difference between the interest rates on sovereign debt and central bank reserves can be used to lower the cost of funding below the level that triggers the bad equilibrium. In contrast to claims that potential central bank intervention has to be unlimited, a central finding is that limited central bank intervention may be sufficient to avoid a bad equilibrium.
In regard to how it might work in a monetary union, a sting in the tail comes in the last sentence of their closing paragraph.
The analysis here bears key lessons for the current debate on sovereign default in a monetary union:
· Countries in a monetary union could indeed be more vulnerable to debt crises, to the extent that the common central bank cannot count on the joint support of national fiscal authorities;
· The common central bank, however, still has the power to engineer successful interventions.
In doing so, it will have to weigh the benefits and costs of providing a backstop to countries exposed to debt crises, possibly drawing on seignorage accruing to all countries in the union.
“[D]rawing on the seignorage accruing to all countries in the union” raises the familiar political-economy of-transfer-risk problem that has complicated the task of stabilising stressed euro zone sovereign debt markets.