Economists Constantin Gurdgiev, Brian Lucey, Stephen Kinsella, Ronan Lyons, Karl Deeter, Shane Whelan, David Madden, Brendan McElroy, Valerio Poti and John D Masson suggest a way to provide relief to stressed mortgage holders.
Author: John McHale
With the 10-year yields heading towards 8 percent and the 5-year CDS cost surpassing Argentina’s, Ireland has very definitely lost the confidence of potential lenders. Morgan Kelly’s Irish Times article offers an explanation: the combination of the cost of bailing out the banking system and the dismal underlying rate of nominal GDP growth makes it impossible to avoid a default.
While the situation is clearly critical, I do not agree with Morgan’s starkly pessimistic conclusion of default inevitability. Given how influential his analysis is, however, I think it is useful to recap the argument using the IMF’s fiscal-space model as an organising framework (see here). The model shows that default results when a country’s debt to GDP ratio passes a critical point. This critical point depends on gap between the nominal interest rate and the nominal growth rate and also the economic and political capacity for generating a primary surplus (a country’s fiscal space is then the gap between the debt to GDP ratio and the critical point). It is easy to see how continued creditworthiness might be beyond a country’s capacity when facing the combination of a very high bank bailout cost and a very low underlying nominal growth rate.
Morgan argues that this is the case for Ireland. But I do not see things as being as dire as he makes out. Even taking his high €70 billion estimated cost of the bank bailout, a large gap between the nominal interest rate and the nominal growth rate of 4 percentage points means that the bailout cost would add €2.8 billion to the required primary balance (just under 2 percent of GDP). This could well push a country over the edge, but it hardly seems decisive. Moreover, Morgan argues that Ireland cannot afford a nominal interest rate greater than 2 percent. To get an interest-growth gap of 4 percent, this means that the nominal growth rate would be just negative 2 percent. While I share his concerns about the effects of Ireland’s balance sheet recession on growth, I think a medium-run nominal growth rate of positive 2 percent is actually still quite conservative. But this means the nominal interest rate could be as high as 6 percent and still yield the 4 percent interest-growth gap assumed above. Of course, this is all just illustrative, but the bottom line is that there is a clear enough path out of this crisis provided the political will is there.
But do we have the political will? This is where I have become more pessimistic watching an apparent failure to prioritise the national interest by our political leadership – government, backbenchers, opposition, independents, social partners. Unlike Morgan I think default is avoidable. That would make it even more of a shame if it happens. I remain hopeful that we will all get the message.
That squelching we hear is the sound of political heels digging in. It is hard to know whether the effort to shift the burden of the fiscal adjustment to others is better symbolised by Mary O’Rourke’s staking out a no-go area on behalf of pensioners, or Jackie Healy–Rae’s latest demands for Kerry pork. Pat Leahy captures this depressing scene well today in the SBP (article here):
There are many other aspects of the way we run our affairs that outsiders such as Commissioner Rehn might wonder about.
What, for instance, will Rehn and his friends in the square glasses from Frankfurt make of the fact that the government can pass this budget—which they consider necessary for the continued economic independence of the country—only if they agree to build the Tralee by-pass and open a new ward (or whatever) at Kenmare Hospital, in order to keep Jackie Healy-Rae happy?
The capacity of Irish politicians to always put their own local interest over the national interest is astonishing. It is true that this is precisely what they have been instructed to do by their voters, but at this time of extreme national crisis, it is still remarkable.
Not surprisinly, the delay of stabilisations has been a central focus in the literature on the political economy of economic reform. A classic paper in this literature is Alberto Alesina and Allan Drazen’s, “Why are Stabilizations Delayed?” (1991). [The paper is available from JSTOR here; a non-technical summary along with empirical evidence is given is Alesina et al. (2006), “Who Adjusts and When? The Political Economy of Reforms” (available here).]
The essential idea is that the burden of the stabilisation will not be equally shared in a polarised political system. How unequally depends on a parameter, alpha. The higher is alpha the larger is the share of the burden borne by the “loser”. Each group has the Healy-Rae like power to veto stabilisations that are not in their interests. With uncertainty about the costs of delay for other vested interests, stabilisations tend to be delayed in a “war of attrition”—notwithstanding the collective costs of such delays. (See pages 3-4 of Alesina et al. for an accessible non-technical description of the model.)
I have written in earlier posts about the importance of the overall adjustment being viewed as fair. One element of this boils down to alpha being viewed as small, so that the various vested interests don’t have to dig their heels in quite so firmly to avoid being the ones ending up bearing a disproportionate share of the burden. Broad political leadership is required to create the necessary trust.
Pat Leahy concludes grimly on where our broader policital system seems to be:
The problem is that there is no certainty that the government is capable if of implementing a fiscal programme that would achieve such an outcome [i.e. avoid an EU bailout/IMF intervention]. The opposition remains generally resigned to the targets, but against the measures that would achieve them. Civil society appears to be mobilising against the cuts.
One wonders what Rehn will make of it all.
Dan O’Brien concludes the excellent Irish Times series on policies to tackle the jobs and unemployment crisis (article here). He makes substantiive proposals in each of the areas focused on over the week: activation, training, and the benefits system. Interestingly he calls for a small focused team with appropriate expertise to examine blueprints for a more effective policy regime.
Putting together a joined-up jobs policy is a big task, but blueprints are available from other small northern Europe countries. A three-person team with a remit to report on policy in three months could do this. It would require a labour market expert, an organisational change specialist and a capable former civil servant who knows the system.
The two papers referenced in the article are available here (Grubb et al (2009), “Activation Policies in Ireland”) and here (Forfas, 2010, “Review of Labour Market Programmes”).
Brian Nolan addresses interactions between the benefits system and unemployment in the fourth part of the Irish Times Jobs Crisis series (article here). Among the topics: unemployment traps due to high overall replacement rates; the relative importance of labour demand and supply factors in the rise in unemployment; the (limited) need to adjust social welfare benefits in line with changes in other incomes; and the importance of providing meaningful work opportunties as part of soical employment/benefit conditionality schemes.