More on self-defeating adjustment

Ashoka Mody offers another thoughtful perspective on Ireland’s crisis resolution effort on today’s This Week programme on RTE radio (audio here; scroll down to last item).    Although he covers a good deal of ground, much of which I agree with, his main recommendation is that Ireland should consider scaling back its fiscal adjustment effort.   As I note in a piece for the Business section of today’s Sunday Independent, reasonable people can disagree on the optimal speed of the adjustment given the tradeoffs involved.   But Ashoka raises the old issue of the adjustment effort being self defeating.   At the risk of repetition of past posts, I cannot see how the evidence in the Irish case bears this out.   There is, of course, wide agreement that fiscal adjustment lowers growth.  But it is a significant step from here to a claim that the adjustment is self defeating on its own terms of improving the fiscal situation.   I think it is worthwhile to continue to scrutinise this claim.   

The self-defeating hypothesis comes in a number of forms depending on the focal outcome variable.   For convenience I label the main forms as: the strong form (underlying primary deficit); the semi-strong form (debt to GDP ratio); and the weak form (creditworthiness).   Ashoka’s main focus is on the semi-strong version, but it is worthwhile to briefly review the case for each.  

Ireland’s underlying General Government primary deficit has fallen from a peak of 9.3 percent of GDP in 2009 to a projected 2.5 percent this year.   This occurred despite the massive non-austerity related headwinds the economy faced.   All else equal, if there had been no adjustment from 2009, simulations show the underlying primary deficit would have reached 14.5 percent of GDP this year.   The underlying actual deficit and debt to GDP ratio would have been 20.5 and 160 percent of GDP respectively.    Of course, something would have given before these ratios were reached, but it is useful to consider the crude counterfactual in assessing what has been achieved.  (These simulations assume a reduced-form deficit multiplier of 0.5 and an automatic stabiliser coefficient of 0.4.  The underlying model being used is sketched here. ) 

Turning to the semi-strong form (Ashoka’s main focus in the interview), it is well known that for multipliers around unity fiscal adjustment can lead to a short-run rise in the debt to GDP ratio.   The reason is that the negative effect on the denominator can swamp any positive effect on the numerator.   But this static analysis can give a very misleading picture of the impact of the adjustment on the path of the debt to GDP ratio.  

This is most easily seen using the classic equation for the evolution of the debt to GDP ratio: ∆d = (i – g)d-1 + pd, where d is the debt to GDP ratio, i is the interest rate, g is the growth rate, and pd the primary deficit as a share of GDP.   The debt to GDP ratio may rise initially due to the adverse effect on g.   But the effect of this year’s adjustment on g should be temporary while the impact on the primary deficit should be permanent.   The permanent effect should quickly swamp the temporary effect, leading to an improvement in the debt to GDP profile as a result of this year’s adjustment.   (One thing that could overturn this result is that today’s adjustment leaves a long negative shadow on the level of GDP (what is known as hysteresis), but that would again require that today’s adjustment causes the primary deficit to rise rather than fall.) 

Simulations for Ireland show that an additional €1 billion of adjustment in 2014 would only lead to a higher debt to GDP ratio in 2015 for values of the reduced-form deficit multiplier greater than 2.3 – above any reasonable estimate for the highly open Irish economy.   Reduced austerity might well improve growth performance, but it seems highly unlikely that it would improve Ireland’s debt dynamics as Ashoka claims. 

Turning finally to the weak form, it is possible the direct adverse growth effects from fiscal adjustment on investor confidence could swamp any positive effect through the deficit and debt.   This might happen, for example, if investors worry that the deeper recession would undermine political support for the adjustment effort.   It is thus possible that despite the positive fiscal impacts, creditworthiness (as measured by secondary market bond spreads) might deteriorate.  This is ultimately an empirical question.   But the fall in Ireland’s 10-year bond yield from 14 percent in mid 2011 to below 4 percent today hardly suggests that Ireland’s fiscal adjustment effort has been self-defeating on even this weak definition.  

76 replies on “More on self-defeating adjustment”

This is most easily seen using the classic equation for the evolution of the debt to GDP ratio: ∆d = (i – g)d-1 + pd, where d is the debt to GDP ratio, i is the interest rate, g is the growth rate, and pd the primary deficit as a share of GDP. The debt to GDP ratio may rise initially due to the adverse effect on g. But the effect of this year’s adjustment on g should be temporary while the impact on the primary deficit should be permanent. The permanent effect should quickly swamp the temporary effect, leading to an improvement in the debt to GDP profile as a result of this year’s adjustment.

Not to be rude about it, but you are completely wrong here– mathematically.

The equation ∆d = (i – g)d + pd, as a first order linear ode with constant coefficients, has the fundamental solution

d=C*exp((i-g)*t)-pd/(i-g)

The primary deficient only comes into this solution as the constant particular solution pd/(i-g). The equation is in truth dominated by the exponential term c*exp((i-g)*t), which swamps all other effects. Allowing the rates to vary across time (without changing sign) does not alter the fundamental character of the solution.

And the dominant part of this exponential term is the rate (i-g). This and only this term is of any interest in the long term. Changes in the primary deficient — positive or negative — are ultimately transient in the face of exponentially growing debt.

Having read the article earlier in the day, the sentence that struck me as best summing up the situation is that the Government “must tread a narrow path between supporting spending and securing its ability to borrow. This ability to borrow is in the end critical to being able to phase the adjustment over time”.

The players on the pitch are,in reality, in no particular order, (i) the troika (ii) the relevant DOF, NTMA and CB officials – who have now,hopefully, gained the necessary expertise – and (iii) the markets.

The politicians would like to get back into the game. While this would be desirable in terms of democratic values, it is doubtful whether the country can, literally, afford it at this critical juncture.

As the SBP put it in a two-page spread today; “Twelve important things that mattered while everyone was watching the abortion debates …”. Maybe the political class can keep up the pursuit of pointless discussion a little longer. The country needs it! And, on the evidence, can afford this particular luxury.

@OMF

You appear to miss the fact that the debt/GDP stabilising primary surplus is ps* = (i – g)d, where ps* is -pd*. For primary surplus levels (as a share of GDP) above this level, the debt/GDP ratio falls exponentially rather than rises.

Now the actual equation should also include various stock-flow adjustments. A key adjustment at present is for the build up and run down of cash balances. Taking into account these effects, the debt/GDP ratio for Ireland is projected to peak this year and then fall. Of course, these are just projections, and time will tell what actually happens. But the level of the primary balance is critcal to the outturn.

It is true that the system is unstable for a constant primary surplus. It rises exponentially if above the critical level and falls exponentially if it is below it. In reality the primary balance will adjust over time, with greater room to reduce it as the debt/GDP ratio falls. But it is nonsense to suggest that the level of the primary balance is irrelevant to debt/GDP ratio dynamics.

By Post Author

I read posts like this with great interest and I do my best to be hopeful that the various equations produce outcomes which are likely and reasonable. And then I take a look at a graph of the money supply going back 5 decades and I can’t help but conclude that this is a very unique recession and all bets are off as we witness the end of the current system of money creation/destruction which cannot be sustained.

For prior to the 1960s a much higher proportion of the money supply existed as publicly created cash issued without a matching debt.

When we developed computers the electronic money supply grew exponentially, doubling about every decade. All of this electronic money has a matching debt and is deleted as debts are repaid and so today’s business world is fundamentally very different from that of the 1960s. It seems a ‘decade doubling’ of the money supply is what’s needed to keep this system somewhat fit for purpose but such a rate of expansion is unfeasible for the foreseeable future, not least because mortgages have approached their natural limit of duration in taking two incomes around 30 years to repay.

I think the current crisis will only be resolved when the central banks create some electronic money for their Governments which doesn’t come with a matching debt. And as such this is a very unique recession, the end of which cannot be predicted by referencing previous ones.

I didn’t suggest it was irrelevant. I said that in the long run what matters is the rate (i-g). If growth remains below the interest rate forever ( or until 2020 or whatever movable figure the government is suggesting now), then deficits/surpluses will become irrelevant and Ireland is heading for an inevitable default.

Maybe i-g will suddenly become negative, but I am extremely skeptical of this happening.

I think we need to think of self adjusting defeats. We could have gotten away with this if it wasnt for the lunatic lumping of bank debt on/by us. We could have still gotten away if we got some growth. We keep snatching defeat from the jaws of possibility

Is debt to GDP not a kind of a distraction.
Either you can pay debt or you can’t.
John – how much do we take in(a)? How much do we spend(b)? How much in billions will we grow in a year (x)? And how much in billions will we pay servicing debt(y).
If a<b and x<y we’ve kinda had it.
It’s not exact but its right

@ Eureka: “If a<b and x<y we’ve kinda had it.”

Bingo! You cannot finagle the math. 😎

Arguments about austerity being ‘self-defeating’ have more relevance for big economies and to those who would cry over spilt milk, wonder who should have bailed out Anglo’s deposits of €50bn+. Besides, the wise Finns came into 2008 with net debt of -73% of GDP – yes minus!

…and to show that we have competition for the claim to be the Most Oppressed People Ever (MOPE), the Finns in 1944 had to agree to pay $300m in reparations (at a 1938 dollar rate) to Russia to pay the latter for the cost of invading its former colony.

Ashoka Mody made two points about the future: he said 1) “innovative alternatives” to austerity should be explored and 2) five years of crisis and two recent years of no growth needed “deep thinking” on whether this was the right course of action.

Innovative alternatives and deep thinking would be surprising developments in Ireland and my mother’s peasant dictum comes to mind: “Blessed are those who expect nothing, for they shall not be disappointed.”

http://www.finfacts.ie/irishfinancenews/article_1026310.shtml

At least Professor Mody has opened the debate on the correct course forward. Listening to RTE now..some government guy describing the professors suggestions as nonsense.
I wonder how qualified he is to pronounce.
Hayes now saying he is one man with one opinion….he doesn’t say that it is a highly qualified opinion.
Lots of waffle from Brian Hayes. Quote ” the domestic economy is improving” Really.
I think I will go with Professor Mody on this one. Funny how all our guys now recognize that austerity dampens growth…but only after the IMF did a mea culpa.
Growth is the key..and there is precious little of same.

These numbers seem to reflect the effects of austerity…

Another point on today’s eurozone government borrowing figures (see 10.27am onwards) — the countries suffering the biggest rise in debt, as a percentage of GDP, are all in bailout programmes or trying desperately to avoid one.

Over the last year, the highest increases in the GDP/debt ratios were recorded in Greece (+24.1%), Ireland (+18.3%), Spain (+15.25%), Portugal (+14.9%) and Cyprus (+12.6%)

Fiat,
On other threads you are posting endlessly about the size and unsustainability of our debt, now you latch onto a strategy that would make the debt pile bigger. Do you not see the inconsistency there.
Who would lend us the money?

I should start by saying that I attribute Ireland’s lack of growth this long after the crisis started to the Government’s suppression of internal devaluation. As an SOE, we had the option to restore growth through an aggressive programme to drive down business costs and consumer prices, and we flunked it. A more aggressive approach to austerity would have been a necessary part of this.

That said, now that we are where we are, I see merit in what Mody says. We seem to be stuck in a very poor equilibrium that somehow makes the triple bogey of low growth, high debt and poor competitiveness stable. IMF research apparently shows no cases where our our current strategy of austerity (presumably meaning austerity with no debt write-downs) has worked.

A sharp lessening of austerity stands a good chance of breaking us out of this equilibrium one way or the other – either by kick-starting growth or by making our debt burden so obviously unsustainable that the international community cannot avoid sanctioning steep write-downs. Mody does not mention the latter outcome, but as he does not express much confidence in the former it is surely implicit in what he says.

@Tull
On the contrary…I’m not latching on to a strategy which would make the debt pile bigger. It is now obvious that austerity alone make the debt pile bigger…look at the figures above. As a former mission chief to ireland the professor is a unique position to assess the Irish situation and I believe we should listen. Five years on and the debt pile keeps rising…something is wrong.

How is stimulus funded? Do we not already have a stimulus in terms of social welfare payments and public sector salaries that we cannot afford? My children will have to pay for this stimulus.

The situation is a mess. Stimulus will not help. I think it will require a range of measures which need to be implemented on a global scale but which won’t. All in all not a good situation

@ John McHale

“The fall in Ireland’s 10-year bond yield from 14 percent in mid-2011 to below 4 percent today hardly suggests that Ireland’s fiscal adjustment effort has been self-defeating on even this weak definition”

Are you seriously suggesting that those with the capacity to shape finance markets have reduced the price they charge on Irish debt because of the adjustment pursued since 2008? If so, I would be curious what empirical evidence you are using to make this conclusion (as opposed to a logical-deductive one). You only have to read the press releases of rating agencies over the past few years to see what they really care about: the actions of the ECB and the economic growth model being pursued. Irelands trade surplus has more of an impact on the reduction in bond yields than cuts in public expenditure because it sends a signal that Ireland has improved its long term capacity to pay off debt.

Finally, and perhaps more importantly, most empirical analysis on the self-defeating effects of austerity on economic growth do so because of the impact on one variable you completely omit from your analysis: employment. A democratic state with an economy that is growing and generating full employment is in a much better position to reduce its debt than cuts in spending to reach an arbritary fiscal deficit target of 3 percent. This draws attention to the normative as opposed to technical differences in our economic analysis. The models you use give moral priority to low fiscal deficits whereas the ones I use give priority to full employment. Lets call a spade a spade – this is a political not a technical difference.

@ Aidan R: “A democratic state with an economy that is growing and generating full employment is in a much better position to reduce its debt than cuts in spending …”

Correct. Except continuous growth (hence ‘full’ employments) are not attainable for any economy embedded within a physical system and with politicians who like to get elected now and again.

So, we are faced with an unpleasant reality. Growth will (maybe has) stop(ed). And its resumption although possible, is unlikely – a level of growth that would pull us out of our current economic regression, that is.

Someone better have a plan B. Plan A is not ‘working’.

@ Eureka: Yes we have had various ‘stimuli’ since 2008. Think performance enhancing supplements! You do perform better for a while, but later …. I think we may just have caught up with ‘later’.

The troubles of Detroit are a classic example of unrealistic expectations (continuous growth) and a failure to recognize reality. Lets just see if Detroit gets ‘bailed’ – how and by whom!

Fiat,
Without the tax and spending adjustments which sum to 32bn according to CORI the budget deficit would now be of the order of 30% of GDP and the debt GdP ratio would be around 140% unless the economy would have responded to your stimulus. BTW, who would have lent us all the money? Austerity is not an option when you are bust.

@ John McHale

“The underlying actual deficit and debt to GDP ratio would have been 20.5 and 160 percent of GDP respectively. Of course, something would have given before these ratios were reached”

Last week the CSO released that our Debt to GDP at the end of March was 125% I would assume it’s close to 130% by now.
At what point between 130 and 160 do you think something will give?

Even using rosy scenarios the GGGD is not going to stop growing till well past 160% unless Germany agree to burden sharing on the bank debt.

@ Eamonn

“I would assume it’s close to 130% by now.”

Its actually less now. That you casually assume it has continued to move higher underscores that people dont understand why its so high in the first place, and why it is a somewhat pointless statistic absent context.

Ashoka Mody last February wrote on an issue that I have raised myself several times, that the global growth experience of the years to 2007 is unlikely to be replicated anytime soon:

Faith in renewed growth is an ill-advised policy strategy. At its core, the global economic crisis is a growth crisis. Financial institutions and markets assumed productivity would continue to grow at the pace of the late 1990’s, which fostered an asset-price boom that conveyed an illusion of well-being; those not directly involved in the financial bubble were coopted through buoyant international trade. European growth, with its heavy dependence on trade, received a special boost, as did emerging markets.

http://www.project-syndicate.org/commentary/the-false-assumption-of-a-pre-crisis-growth-recovery-by-ashoka-mody

Tullmcadoo is right to say: “Austerity is not an option when you are bust.”

Outrage isn’t enough.

Ireland has no divine right to a high first world standard of living. It was possibly an abberation in crazy period.

Brian Lucey is not alone in expecting Germany to eventually to pick up the tab for Ireland’s standard of living.

However, it would be foolish for people like Ireland’s high paid medical consultants in such a situation to regard minimum payments of €250,000 as Mickey Mouse money.

The Troika today is lending money not providing gifts. Different terms would surely apply?

@ BEB and Seamus Coffee
I take your points that there are some mitigating factors and the fact that the NTMA have been busy is part of the Story.
But my general point is that that the GGD has been raising fairly consistently since the start of the crisis.
As per the graph on the bottom of this page.
http://www.cso.ie/en/releasesandpublications/er/gfsq/governmentfinancestatisticsquarter12013/?utm_source=twitterfeed&utm_medium=twitter#.Ue1SFG0bhi5

BEB
I am not sure how you would know that it has come down for the most recent quarter, but if you are correct it would be the first decline Q on Q in over 4 years.

Would either of you be prepared to say where you think it will peak?

The rule of 3% deficit target in Europe was made when long term growth at that rate was realistic. I don’t see europe returning those growth rates anytime soon.

@ eamonn moran

In GNP terms, the levels of both public debt (net of cash) and household debt are high or maybe alarming.

Irish household debt as a ratio of GNP is 155% compared with Greece’s ratio of 55% of GDP.

Even though Ireland and the Netherlands have similar levels of household debt, over 40% of Irish owner-occupied homes are without a mortgage compared with teh dutch level of about 12%.

Italy has high public debt and low household debt.

http://www.finfacts.ie/irishfinancenews/article_1026194.shtml

@ eamonn moran,

Due to stock adjustments it is difficult to pinpoint the quarter when the debt ratio will peak. The NTMA will be keen to get another 10-year bond issued this year and that will increase borrowing regardless of flow dynamics with the deficit.

In Q1, gross debt rose by €11.6 billion but net debt rose by €2.7 billion – the difference being accounted for by the €9 billion rise in cash reserves alluded to above. The likelihood is that some quarter in 2013 will represent the (local) peak of the debt ratio. In that range Q1 is probably as good a guess as any.

In Q1 2014 there is a €7.6 billion bond falling due for redemption. The whole point of building up the massive cash reserve was to have the funds on hand for this payment (and to be able to finance the deficit after exiting the bailout if full market access proves difficult).

With the cash reserves now accumulated there is little need to borrow additional funds. However, the sketched rules outlined for OMT suggests that a country needs market access in order to be eligible, which is part of the reason for the keenness to issue another 10-year bond later in the year.

Using the accumulated cash reserve to meet the Jan 2014 bond redemption will see the gross debt ratio fall. This will have no impact on the net debt ratio and I would not be surprised to see a switch in commentator emphasis from the gross debt measure now to the net debt measure debt in Q1 2014.

The 3% of GDP deficit rule was set when 5% nominal growth was assumed typical and allowed consistency with the 60% of GDP debt rule. Maybe the EU should set someone a target to combine real growth and inflation to allow 5% nominal growth to be achieved???

Let me copy and paste for Mr Coffey.

Memo item:

31/03/13 Balances of €33,049m (31/12/12: €23,997m) were held in Departmental Funds & Other Accounts, including the Exchequer A/C.

Of this thirty three billion Euro about four are HFA guaranteed notes (?) and nine and a half billion is “other stuff”. I presume the extra cash is intended as emergency operating capital in the event of yet more Euro-disaster.

It is included in these slightly more up to date and groan inducing numbers:

http://www.ntma.ie/business-areas/funding-and-debt-management/debt-profile/

A nice little article from Progressive Economy on trying to locate information on the composition of the budget deficit.

http://www.progressive-economy.ie/2013/05/irelands-secret-deficit.html

@BEB and Seamus
So borrowed cash to be used to create the illusion of static /reducing Debt /GDP in 2013……In the longer run however, eamonn is correct that it continues to rise. Numeric timing differences don’t change reality, despite the averaging down plan that appears to be what the Govt is partly relying on to engender “confidence” with investors.

John – you have been talking growth now for a long while. Still no sign of anything meaningful. Also, your definition of insolvency remains incorrect. Lower interest rates reflect proxy EU support i.e. reflect reduced refinancing risk due to official support. Watch out for some external (big) bumps however e.g. China is looking sicker by the moment, and Europe’s core is grinding down more and more….And all the while, Ireland continues to “move forward” on hope and a prayer., borrowing more and more.

Aidan @ 1.23pm
+1
Very succinct.

@Aiden R
Yours 1.23 +1
To which I would add…bond yields have also been influenced by Mr. H of Templeton who has gambled 8% of his funds money on the mother of all bets and now owns 10% of Irish bonds. It’s a bit like the George Soros punt against sterling. Coupled with this is the green jersey bond buying by Irish State owned banks. Of course Michael Noonan didn’t tell them to buy.

@ Eamonn

We repaid a bond in April (Q2), so it’s come down for that reason. No major funding raised in Q2 either. As Seams suggest, net debt is important to understand, especially if a large cash element involved (25bn = 15% of GDP)

Also

“The rule of 3% deficit target in Europe was made when long term growth at that rate was realistic.”

Not sure what the suggestion is here? That with lower trend growth we should be running higher typical deficits? Wouldn’t a lower trend growth rate require lower deficits and therefore more austerity?!

Mr Bond,
What is our sovereign debt excluding cash balances, CB portfolio and Stuff owed to European rescue funds. That is the real measure as that will be what is left in the event of another restructuring.

@ Tull

Cash = 25bn
CBI = 28bn
European rescue funding = 38bn or so I think

Netting these out leaves around 125bn

But if u sell off state assets like banks, utilities, other semi states, and run down cash balances, even current debt/GDP, with moderate growth (obviously not everyone foresees this), gets below 100% by 2016, with a 4% cost of funding on it and an over 10yr average maturity. Not exactly a great case for a restructuring there.

Mr B,
I am trying to figure out why our yields are where they are. Assuming a bust in China, the ECB will be forced to print and the EU stuff gets termed out to judgement day, then the underlying sovereign debt is money good. If on the other hand, the growth fairy shows up, the cash gets run down, the banks get sold, NaMA makes money and the debt/GDP ratio comes down. Either way, IGBs are money good.

On balance, I lean to the former outcome. In that case we should institute proper austerity cut all social and professional welfare and over inflated public sector pay and give ourselves the options of giving the Churchillian solute to Berlin.

@ All

I would suggest that the real lesson is that the bean counters (not meant in any pejorative sense!) are back in charge. It is a great pity that control was lost to the “when I have it I spend it” brigade in the first place; not that they have gone away (or are confined to FF!).

As to why markets are behaving in the manner that they are currently behaving in relation to Irish government debt, the quest for an explanation seems to me to be a rather pointless exercise. The simple conclusion is that adverted to by John McHale; we must be doing something right!

@Bond Eoin Bond
Your figures are puzzling. According to the CSO our gross debt is 204b or 125.1% of GDP. We have 25 of that in cash or equivalent. The banks owe 36 b to the ECB in LTR. And according to NTMA the “directed investment” in the banks is worth 8.6b.
We have supposedly drawn down 94% of the Troika facility which I think was originally set at 68b or so.

It’s keeping the Irish banking system alive.

Ambrose has a good article tonight where he states…
“Ireland’s policy of austerity cuts and “internal devaluation” has done wonders for the trade account, but only at the cost of an even deeper debt-deflation crisis. This is the fundamental contradiction of EMU crisis strategy in every high-debt country. The more these economies deflate wages, the more they raise the real cost of debt.
In Ireland’s case — as in Spain — this debt burden is the legacy of an almighty credit boom that was itself caused by EMU and years of negative real interest rates. The details are spelled out in a study entitled “What went wrong in Ireland” by Patrick Honohan, now central bank governor.”

Fiat,
AEP strategy requires more austerity in Ireland rather than less. We would have to get to primary surplus pronto.

Any comment which starts with “Ambrose has a good article tonight” should be immediately disqualified…

@ seamus coffey

‘ Maybe the EU should set someone a target to combine real growth and inflation to allow 5% nominal growth to be achieved???’

No solutions in that quarter, I am afraid.

‘http://www.prudentbear.com/2013/07/inflationphobia.html

Err Mike H
Im not wanting the rhein und oder landers to pay for my sybaritic lifetime. Im noting that whatever way Tis done they pay. I guess from rhe shadow if the Petronas towers reality is obscured? What is option five? mm yyiakisa

@ Bond

Fiatluxjnr Says: July 22nd, 2013 at 8:10 pm

You did not answer his questions you diverted to AEP.

@ BEB
You are coming across as very self interested (John is very much so also…hidden behind “the classic equation for the evolution of the debt to GDP ratio”…stuff he feels comfortable with). NTMA perhaps? If not that self interested, then one of the Irish Govt book runners e.g. BNP, etc?

We could also get into the 160bn of contingent PS pension liability (increasingly “real”), the need to further recap the banks (mortgages, SME debt, personal debt, etc).

All the spin of those that are self interested (under the Green Jersey banner….Seamus also does this,”consistently”, I agree) make me, an outsider Irishman, living abroad, ashamed……All while a large section of the population suffers and the hole for the country gets bigger. Amazes me that the likes of John and Seamus are “absolute experts”, never having managed a real live debt book & related in their lives….their academic credentials are unquestionable, but they have never had the pressure of losing anything based on their decisions…they are academics. John reliane on “simulations” without real experience is depressing. His statement “It is thus possible that despite the positive fiscal impacts, creditworthiness (as measured by secondary market bond spreads) might deteriorate. This is ultimately an empirical question.”….is incredible and only worthy of derision.

John – your argument that things would have been otherwise worse is laughable. How the hell do you know? This constant harping of the status quo is just that…comfort food to the academic. As someone who lives in the real world, I must say that your opinion has significantly become meaningless, except it appears in the academic context. You shoould stay to that sphere.

Surprised that John Moran (strong, smart guy and real market experience) hasn’t made a greater impression. He is certainly capable of the task, as it appears is Fional Muldoon (hi guys). As you know, it is only actual, successful performance that matters…….How good are ye? As you well know, if you don’t actually succeed in the real world, you are firing fodder.

@ Bond
“But if u sell off state assets like banks, utilities, other semi states, and run down cash balances, even current debt/GDP, with moderate growth (obviously not everyone foresees this), gets below 100% by 2016, with a 4% cost of funding on it and an over 10yr average maturity”

But you’re still left with the deficit? So the figure starts to climb quickly again.

@ Paul W
Your analysis bleak but consistently solid IMHO. The diaspora can sometimes see things that are harder for the home birds to get.

I don’t think that being an academic is a problem per se, because academics have made many brilliant contributions in all spheres of life. It is good that John, Seamus, Brian et al set out their various stalls, especially when they are doing it pro bono. We are all learning.

I would say it is more the dead hand of the academic establishment which is the problem. Academics cannot really make the required contribution unless they take a stance which is consistently critical. That is not popular in-house. Gurdgiev is an outstanding example of independent thought, but he is too uncompromising to be a ‘suitable’ government adviser or faculty man. We will all praise him when he is dead, or at least emigrated, instead of collaborating with him when he is right here amongst us.

The main reason that the DoF was not able to stop the bubble is that it is penetrated by a whole set of bubble-invested private interests. One the one hand, we had/have banks and financial entities trying to shape the institution to their needs, while on the other we have well entrenched bureaucrats and PS TUs making sure that all of the gravy doesn’t flow out to the private sector. It’s still a bag of cats, which is too complex for the Troika even to consider.

I am sure some good stuff happens in the IFSC, but the bonfire of the domestic banks is pretty sobering. Too many smart guys and gals got sucked into the masters of the universe bollocks. All those flights to the Big Apple. People mistook the world of finance for the real world, just because the zeros, and the kudos were accumulating on those accounts.

That is a pretty strange sort of success, and I doubt it is the right background for leadership in our DoF. There is more to Ireland than the IFSC. On your own cold-eyed analysis, the clock is ticking for the incumbent, but it will all go on the CV anyway, FWIW.

As @DOCM says, we have politicians, but no statespersons. We have academics but not enough critical thinkers. We have financial players but no Whitakers. This mother is going to have to go down, IMHO, before the next generation of leaders emerge.

The safe bet is that current official forecasts of Irish debt in 2016 will be shown to be optimistic.

The recent ESRI medium-term scenario of overall stagnation in Europe through to 2020 is the most likely of three scenarios and that has low Irish growth.

Since 2010 I have expected no or low growth for the period to 2015.
There was no growth in 2012 and likely none this year: will there be a spurt in 2014? No.

This is the fourth summer that the US economy has drifted into neutral from a more optimistic start and the Republicans are preparing for another debt ceiling showdown in the autumn despite a sharp improvement in the deficit.

The earnings season has been iffy and sales at restaurants—which added more than 150,000 positions over the past three months—plunged last month, suggesting consumers could be pulling back on discretionary spending.

US growth in Q2 is expected to be an annualised 1.5%; Europe will remain on a respirator into 2014; China’s pullback will hit German and US exporters and commodity demand from Latin America, Africa and Australia.

So expects many more Irish job schemes in coming years

However, Christian Noyer, Banque de France governor, wrote words recently on France that could have been written for the auld sod:

“The underlying objective is growth. Not just a temporary spurt, sustained artificially by public spending, but strong and lasting growth that creates jobs and is based on the development of modern and competitive production capacity. This kind of growth cannot just be summoned up. It requires a profound change in public policy.”

@ Eureka

deficit forecast to be 4.2% or so next year, and continuing to fall thereafter. With a 4% nominal growth (2+2), the debt stabilises as % of GDP. Yes, 4% nominal growth is far from easy or certain, but its not exactly aggressive either (Troika forecasts expect something between 4.5-5.0% as long term trend nominal growth).

@ Robert

he didnt specify what part of the numbers he didnt agree with, and then he threw in some ECB repo numbers which confused the hell out of me – they aren’t included anywhere in our sovereign debt, debt/GDP etc.

But anyways, let me take a stab at it

Starting point end-2013 (lets try and extrapolate to year end, given deficit, bond redemptions, Troika drawdowns etc that we can reasonably expect with good level of confidence) – debt 203bn, GDP 168bn, cash (at that point) 23bn, debt/GDP ratio 121%

Over the next three years (ie to end 2016)

“income”

Sell the banks for say +10bn
Sell semi states and others for +5bn

–> this income of 15bn used to pay down debt

“Expenditure”

Bond/Troika loan redemptions = 7.7bn in ’14, 4.3bn in ’15, 12bn in ’16 = -24bn
General Govt Deficits = 7.5bn in 14, 4bn in 15, 2.7bn in 16 = -14.2bn

–> obligations of 38.2bn

15bn in income, and 23bn of cash, meets, almost exactly, these obligations, so in theory no new debt is required (in practise, due to timing issues and need to run a buffer, we will of course issue quite a bit, but we’re talking net figures, so new debt either leads to cash buffer or retention of state assets – either way we end up with the same “net” figure)

Economy grows, from end 2013, at nominal rate of 4% pa, bringing GDP to 188bn

So debt of 203bn vs GDP of 188bn. Net Debt/GDP ratio of 108%.

Alternative scenarioes:

Sell the banks for 12bn and economy grows at 5% nominal -> debt 201bn, GDP 194.5bn, ratio 103% in 2016.

Sell the banks for 8bn and economy grows at 3% nominal -> debt 205bn, GDP 183bn, ratio 112% in 2016.

In either case, these are not debt levels which would constitute unsustainable or irretrievable.

@BEB + Seamus Coffee
“Not sure what the suggestion is here? That with lower trend growth we should be running higher typical deficits? Wouldn’t a lower trend growth rate require lower deficits and therefore more austerity?!”

My suggestion is that the idea that once Ireland reaches 3% deficit target is based on an old idea that we wiill have growth rates of 5% (thanks Seamus). As people like Moody and MHennigan are pointing out Europe is very unlikely to see 5% growth in the medium term. So this target is wrong.
Even at 3% deficit our debt to gdp will continue to rise.
The reason I mentioned it is because I was trying to see if you commit to a peak level for debt to GDP.
@Seamus
“The likelihood is that some quarter in 2013 will represent the (local) peak of the debt ratio. In that range Q1 is probably as good a guess as any.”
That is a brave call.
Probably newsworthy if the press had reported the 125% figure in the first place.
I have have massive doubts. If the insolvency program starts then there is expectation of the banks needing another 10+ billion. Our interest payments are already at 5 billion per year and this years deficit is going to be at least another 7 billion on top of the interest.
I see it continuing to grow by about 10% per year for the next couple of years. By then as John McHale says something will intervene.

As for cost of borrowing in the market. This has become almost completely political. If we were to reject Austerity the rates will rise dramatically as they have done in Portugal.
I see only one possible outcome and it is the same one I saw back in 2009. Debt forgiveness/default/ ECB taking our bank debt.

@ BEB
That 4% growth figure for 2014-2015 and 2016 is a joke.
See Kevin O’Rourke’s post
“This is where dodgy GDP forecasting becomes so pernicious: no matter how much of a basket case the Eurozone becomes, over-optimistic forecasts — notice how good we expect 2014 will be!! — will always make it possible for discredited politicians, central bankers and eurocrats to cling on to the hope that good times are just around the corner.”

@ Bond
Thanks for the figures.
Think deficit reduction and growth targets are off though (deficit reduction will drag on growth)

@ Eamonn

“That 4% growth figure for 2014-2015 and 2016 is a joke.”

You know thats nominal GDP growth, right? So 2% real growth, 2% inflation. Not exactly outlandish, even if higher than some people estimate it will come in at.

@ John G

call it what u want. It reduces down debt in the period in question. Not claiming it reduces deficit levels (as quite clearly stated).

@BEB,no investement pro would call it income,unless say other similar versions off ESB, Bord Gáis, EirGrid, Bord na Móna, Coillte,are lurking under a bed somewhere.
Eoin it’s not income,sorry w/o being pedantic,ok ok I’m am it’s not income.

@Hi Eoin,agreed just having a bit fun,your sale proceeds,sorry “income” may be a tad optimistic,but time will tell.
Is NewEra up to the task,not going dispute the valuations you ascribe right now,rushing to lunch,but lets not ignore the political implications too.
Was there not some talk off redeploying that “income” from flogging the family silver into job creation,if I’m not mistaken,50% ?
Will Labour write its obituary here on this?

@ Bond
If there’s 2% inflation does that mean that expenditure is pressured up by 2% more so than income.
It’s the interconnectedness I find hard. For example if the economy grew at 0% but inflation grew at 4% that’s a nominal growth rate of 4% but a fairly bad picture overall.

Ok – bottom line is I don’t think you can reduce the deficit to the levels you say without restricting growth. And don’t forget the politics too.

So I think the sums are good on paper but divorced from real life

@ Eureka

“If there’s 2% inflation does that mean that expenditure is pressured up by 2% more so than income.”

All else being equal, they’d both go up in tandem, no?

The path of austerity pursued in Ireland since 2008 will eventually be written into history books as a gross and uneccessary market intervention that completely distored the economy with irreparable social consequences.

@Aidan R

The path of austerity pursued in Ireland since 2008 will eventually be written into history books as a gross and uneccessary market intervention

I wonder if the history books may be more concerned with how the structure of the EU evolved to undermine European representative democracy by taking areas of policy out of public national dialogues and into privately negotiated intergovernmental deals and how the inherent neoliberal bias of the supposedly “technocratic” economic policy making apparatus of the EU restricted political choice about the role of the state?

Government by the European political and technocratic class for the European political and technocratic class.

I am reminded of Richard Curtis’s The Trap

@ Bond
I don’t know.
Income is related to tax. The only tax (I think) that would go up with inflation is VAT. But then you wonder if the same amount of money gets spent on fewer things so maybe no increase there either.
I don’t know but I don’t think it’s straight forward. Does any economist know? Does inflation effect govt income and expenditure to the same extent?

@ Eureka

inflation affects a lot of tax returns somewhat automatically as the underlying value increases – VAT, income tax, stamp duty, corporation tax (assuming inflation leads to higher nominal profits – not always the case obviously). While not always the case at the moment given the recession, many companies are still giving pay increases based on inflation increases, for example.

inflation will also impact on the nominal GDP, ie the denominator in the debt/GDP ratio. All else being equal (again, simplistic assumption), higher inflation = higher nominal GP = reduce debt/GDP ratio. Thats why the current crisis is so difficult in comparison to previous ones – although the fiscal adjustment as % of GDP is not disimilar to that undertaken by Ireland in the 80s/90s (and likewise, Denmark, Sweden, Finland, Belgium around the same time), nominal growth back then was more of the order of 7-8% due to the higher underlying inflation (Irish inflation averaged around 5% between 1982-1992, meaning real average GDP growth of 3.5% gave nominal GDP growth of 8.2% for almost a decade – the nominal size of the economy more than doubled)

@ OMF

Just stumbling on this little piece of math. John’s posts tend to bring that out.

You should have followed the math through and solved for C using the initial conditions. You will find that C = D0 +pd/(i-g).

Therefore on substitution you will get the following equation:

D = (D0+pd/(i-g))exp(i-g)t + pd/(i-g)

The progress of the exponential term depends on the relationship between D0 and pd as follows (assuming i>g, i>0):

if pd -D0(i-g) then it decreases/increases exponentially
if pd = -D0(i-g) we have sustainability

I think John made the same point.

The common sense fact is that it is possible to manage your debt, one is not a helpless rabbit in the headlights of the exponentiation factors of i and g.

@John
Seems to me that there is huge room for variability in your equation. It may be a useful tool for simulation purposes, but is highly unlikely to be accurate in predicting reality. Make sue to stress the model….the real vale in such models is to observe their break point.

Comments are closed.