Author: John McHale

The paper “Fiscal Policy in a Depressed Economy” by Delong and Summers (from the BPEA conference linked to by Philip) is hugely relevant to the Irish fiscal policy debate.   While the paper ranges more widely, it provides a useful framework for thinking about the question of whether fiscal adjustment could actually be self defeating in terms of lowering “long-run debt financing burdens” in a depressed economy with interest rates constrained by a zero nominal lower bound.   Indeed, the analysis would seem to have even more general relevance for a small economy within a large monetary union, where the nominal policy interest rate is effectively a given.    A key message is that “hysteresis effects” – whereby today’s output level could have long-lasting effects on future output – could make higher deficit spending today pay for itself over the longer term.   In such a world, a slower pace of deficit reduction need not have an adverse impact on creditworthiness. 

There is a kicker on page 40, however, that is very relevant to the Irish debate. 

There remains the question, on which our analysis is mute, of whether temporary fiscal stimulus is inconsistent with a perception of long run fiscal consolidation. There is no necessary inconsistency. There is experience with temporary expansions, and also with phased-in long-run deficit reductions (e.g. The 1983 Social Security bipartisan agreement of the Greenspan Commission). But it is possible that short run fiscal expansion undercuts the credibility of long-run fiscal consolidation. It is also possible that, in a world with limited political energy and substantial procedural blockages, that effort towards one objective compromises the other.  On the other hand, as Cottarelli (2012) warns, if countries that have committed themselves to short-term deficit reduction as a down payment on a move to long-term sustainability find that “if growth slows more than expected… [they are] inclined to preserve their short-term plans through additional tightening, even if hurts growth more” then: “my bottom line:… unless you have to, you shouldn’t.” His fear is that fiscal austerity will be counterproductive because “interest rates could actually rise [even] as the deficit falls” if “growth falls enough as a result of a fiscal tightening.”

We do not see a good way to address this issue analytically or empirically. Clearly, the risks of short run fiscal stimulus having adverse effects on long-run credibility will be greater in settings where government debt already carries a significant risk premium. Clearly, it will be larger when there is evidence that deficit fears are impacting on stock market valuations and on investment decisions. But even in the absence of such evidence, there is always the risk that market psychology can change suddenly.

The Cottarelli VOX piece is available here.   See here for a related and much discussed blog post by Olivier Blanchard.  This post by Simon Wren-Lewis is also complementary. 

I would be interested in people’s views. 

The European Commission Representation in Ireland is supporting a special one day conference in Galway for social media practitioners entitled “Challenges facing the Irish Economy “.

When: Saturday 24th March at 11.00 am, with registration from 10.30 am

Where: Aras Moyola Building, National University of Ireland, Galway

This conference is aimed particularly at social media practitioners and will bring together journalists, academics, politicians, and business people with an interest in web-based technologies to look at some of the complex issues facing Ireland’s economy.

The internet is a powerful tool in communicating the economic challenges Ireland is currently facing. Social media and special web based tools all have a role to play in communication between the public and key decision makers. The general public has become much more economically-literate and informed since the beginning of the crisis – how much of this can we put down to increased accessibility of economists and their ideas online? And has it changed how academics and the world of politics interact?

These and other questions will be put on the table and some well-known economists have kindly agreed to kick off the discussions:

Professor John McHale
Professor and Head of Economics at the National University of Ireland, Galway

Presentation Slides 

Dr Aidan Kane
Lecturer in economics at the National University of Ireland, Galway

Presentation Slides

Seamus Coffey
Lecturer in economics at the University College Cork

Presentation Slides

Ronan Lyons
Economist at daft.ie, DPhil candidate at Balliol College, Oxford & adjunct lecturer at Trinity College, Dublin

Presentation Slides

 
Margaret E. Ward, financial journalist and author will host the conference.

In articles over the last couple of days, Simon Carswell reports/speculates on the technical discussions that are on-going on the promissory notes question.    See here and here.

From Simon’s reporting, one proposal seems to be along the following lines:  AIB/Permanent TSB would swap their trackers for a long-term government bond.   (There is no magic value creation there; presumably the value of the bond would match the value of the trackers.)   The trackers would be moved to IBRC, where they would be used as collateral for a long-term, low-interest, Government-guaranteed loan from the EFSF/ESM.   (The loan might have to be provided directly to the Government given EFSF/ESM rules.)   The funds would be used to pay off the ELA and the promissory note would be cancelled.   I would guess that the ECB would welcome this, as the promissory note/ELA arrangements have a more than a whiff of monetary financing of a government.   The various swaps would be designed to be “capital neutral” for the various entities involved. 

Of course, this is all speculation, and might not even be one of the multiple options under consideration.   But I think the Government needs to proceed carefully if it is.   For all the criticism of the promissory note/ELA arrangement, stripped of the complexity it amounts to an interest-free loan from the euro-system to the Irish State.   (I say interest free because the Central Bank of Ireland’s profit on the ELA goes to the Exchequer.)    The advantage of restructuring the promissory notes is that it reduces the heavy near-term funding requirements facing the Exchequer.   Such funding requirements will complicate the return to the bond markets.   But any improvement in the funding situation would need to be weighed against any higher ultimate interest rate cost.   (One complicating factor could be the dependability of ongoing ELA.)

Holders are low-interest trackers are told to be wary of giving them up.   The Government needs to be similarly wary in any complex multi-swap deal.   An arrangement that leaves the EFSF/ESM out but extends the maturity of the promissory notes looks preferable. 

In comments on Philip’s Sunday Business Post article, Bryan G raises a number of important points about what actually changes as a result of the Fiscal Compact.   I think an important role for this forum is to discuss what the Compact actually does, so thanks to Bryan for focusing on the question.    For one thing, it may reveal areas where clarifications from the Commission are required so informed decisions can be made.  

Bryan G identifies what he sees as the major consequences of the Compact:

(a) requiring rapid convergence to MTO [Medium-Term Budgetary Objective]
(b) limiting the scope for temporary deviations due to exceptional circumstances
(c) requirement for an automatic correction mechanism
(d) requirement for Member States that have been made subject to the excessive deficit procedure to put in place budgetary and economic partnership programmes
(e) the ex ante reporting of public debt issuance plans.
(f) defining the scope and procedures for Euro Summit meetings

Points (d) and (e) are the subject of the proposed two-pack.   Point (f) seems uncontroversial.    I think Bryan G is right that point (c) is a — indeed I would say the — critical element of the Compact, and relates to the requirement to put a correction mechanism into “binding and permanent” national law.   From my reading of the proposed Compact and the revised Stability and Growth Pact (SGP), I do not see the case for (a) and (b) being real innovations.  

Willem Buiter writes in the FT on the odds and consequences of Greece exiting the eurozone: see here. 

The piece draws on a longer article by Buiter and Rahbari from last week. 

From the longer article:

[T]he positions of the main EA policymakers seem to have evolved and now suggest a greater willingness by EA creditors and the ECB to support vulnerable, but compliant EA member states under attack. In our view, EA leaders have come to the understanding that the financial, economic and political cost to the whole EA (and indeed to the EU and the global economy) of material EA break-up (that is exit of other nations than Greece) is substantially larger than the cost of extending conditional support. But EA creditor countries have also made increasingly clear that they no longer believe that the costs to the creditor countries of EA break-up or EA exit by one EA country would exceed the costs of creating a one-side fiscal union, a transfer-Europe without a commensurate quid pro quo as regards fiscal austerity and structural reform in the beneficiary countries, underpinned if necessary by far-reaching and unprecedented transfer of fiscal and wider economic sovereignty by the beneficiary countries. The EA creditor countries undoubtedly view the cost of providing unconditional and/or unlimited or open-ended fiscal and financial support to fiscally vulnerable EA countries as a price not worth paying to keep a single non-performing EA member state in the club.