Predictably, if sadly, Sarkozy’s idea of a Berlin summit to discuss what should be done if a Eurozone member were to get into trouble has been dismissed by Berlin. Discussing such things ex ante, on a purely theoretical basis of course, will turn out to be preferable to discussing them ex post, if ex post ever arrives. The German reasoning is that some things just shouldn’t be talked about in public:
A Berlin, un porte-parole du gouvernement, Thomas Steg, a estimé qu’une telle rencontre n’est “pas nécessaire dans l’immédiat. L’expérience nous a appris qu’il y a certains sujets relevant de l’Eurogroupe dont il vaut mieux ne pas discuter en public”.
Whether saying publicly that there are certain things that you shouldn’t talk about publicly is in fact reassuring, is probably something that one could debate.
For those of you who have let your subscription to Le Monde lapse, here is a very interesting piece, which may or may not be relevant to Ireland. Whether relevant or not (the article mentions Greece, not ourselves), we should clearly be backing Sarkozy.
L’Europe est sans capitaine, alors que la crise financière est loin d’être achevée et menace la cohésion de la zone euro. C’est le diagnostic de Nicolas Sarkozy, qui veut organiser une réunion exceptionnelle des chefs d’Etat et de gouvernement de la zone euro courant février, sans attendre le Conseil européen des 19 et 20 mars. Objectif : afficher la solidarité de l’union monétaire et s’engager à un minimum de rigueur budgétaire pour dissuader les marchés financiers d’attaquer les Etats les plus faibles, comme ils l’ont fait à l’automne avec l’Islande et la Hongrie.
Un mois après la fin de sa présidence, le chef de l’Etat juge que l’Union européenne (UE) est devenue invisible. La présidence tchèque est jugée passive, tout comme la Commission européenne, qui pourrait faire preuve de plus d’imagination. Son président, José Manuel Barroso, est accusé de ménager les Etats, pour s’assurer d’un second mandat. M. Sarkozy est ressorti très préoccupé de sa conversation téléphonique avec Barack Obama, lundi 26 janvier. Le lendemain, devant les leaders de la droite, il a expliqué que la crise bancaire américaine en était plus à ses débuts qu’à sa fin. Il a fait part de ses inquiétudes sur la vulnérabilité des pays les plus faibles de la zone euro, citant explicitement la Grèce.
Après les banques, ce sont les Etats qui sont victimes de la défiance des marchés financiers. Les agences de notation ont dégradé la note de l’Espagne, du Portugal et de la Grèce. Pour s’endetter à dix ans, l’Etat grec doit verser un intérêt de 5,8 %, l’Irlande, 5,5 %, contre 3,8 % pour la France et 3,3 % pour l’Allemagne. Des écarts jamais vus depuis la création de l’euro. Les taux d’intérêt s’étaient alors alignés sur ceux du pays le plus vertueux, l’Allemagne.
La Grèce ne connaît pas de crise de liquidité puisqu’elle vient de lever 5,5 milliards d’euros et est loin de subir le sort de la Hongrie, qui doit verser un intérêt à dix ans de 9,5 %. Les Allemands et les spécialistes financiers s’exaspèrent à l’idée que Nicolas Sarkozy puisse évoquer le sujet à froid et à haute voix, ce qui risque d’alimenter la spéculation. “Il ne faut pas créer des prophéties autoréalisatrices”, s’afflige un diplomate.
M. Sarkozy, qui devrait s’exprimer à la télévision jeudi, souhaiterait élaborer une doctrine ou un mode d’emploi en cas de crise, pour ne pas être pris au dépourvu. Il a le souvenir douloureux du sauvetage hongrois, réalisé en catastrophe sous l’égide du FMI, et veut s’assurer que les Européens resteront maître chez eux. “Imaginez l’air goguenard du représentant américain du FMI, ricanant sur l’euro et expliquant que si les Etats-Unis avaient un problème en Californie, ils le régleraient eux-mêmes”, explique un haut responsable français. “L’intervention du FMI pourrait être interprétée comme le premier pas vers l’éclatement de la zone euro”.
Pour s’affranchir du FMI, deux solutions se présentent. Soit on laisse l’Etat en question se redresser lui-même, en lui imposant un plan de rigueur draconien. C’est la thèse allemande, adepte du “aide-toi, le ciel t’aidera” “C’est le marché qui forcera les Etats à être plus raisonnables. C’est la juste peine”, explique un spécialiste.
Soit l’on est contraint d’organiser un sauvetage entre Européens, ce qui pose de graves problèmes juridiques et politiques. L’article 101 du traité de Maastricht interdit explicitement que les banques centrales se renflouent les unes les autres et volent au secours des Etats. Cette exigence avait été formulée par l’Allemagne qui ne voulait pas financer les pays dits du Club Med (Italie, Espagne, Portugal, Grèce), accusés d’être incapables de maîtriser leurs finances publiques, et résumée par l’ancien ministre-président de Bavière Edmund Stoiber : “Une Union européenne faite de transferts financiers est aussi probable qu’une famine en Bavière”. Aborder ce sujet en pleine campagne électorale allemande est jugé plus que maladroit. Toutefois, précise un ministre français, “si on s’en tient à la lettre des traités, on va dans le mur”.
Le président de la République est en contact avec le président de la banque centrale européenne Jean-Claude Trichet qui a déclaré qu’il ne croyait pas à un éclatement de la zone euro. Interrogée, la BCE indique qu’elle travaille “exclusivement dans le cadre des traités”. L’expérience a montré que les Européens savaient faire preuve d’imagination. L’hypothèse d’une agence européenne chargée d’émettre des emprunts d’Etat, ce qui mutualiserait les risques et réduirait le coup du crédit pour les Etats les plus faibles, est une hypothèse parmi d’autres. Elle est rejetée par les Allemands. Or, M. Sarkozy veut parvenir à un accord préalable avec la chancelière allemande Angela Merkel, qu’il rencontrera à Munich samedi 7 février. La réunion de la zone euro pourrait se tenir à Berlin autour du 22 février, quand Mme Merkel réunira les dirigeants européens conviés à la réunion du G20 de Londres du 2 avril, censée refonder le capitalisme mondial. Le britannique Gordon Brown serait dans les parages, ce qui permettrait de le convier discrètement alors qu’il ne fait pas partie de la zone euro. La tenue d’une réunion à Berlin permettrait de ménager Mme Merkel qui craint les ambitions de M. Sarkozy et a affiché ses réticences sur les réunions de l’Eurogroupe, susceptibles d’exclure les autres pays européens.
The Guardian has an article today on a topic which we will be hearing a lot more about in the months to come, the ways in which many corporations exploit the possibilities afforded them by globalization to minimise their tax burden. It followed a short piece in yesterday’s Tribune on reports that Ireland is on a list of tax havens currently doing the rounds in Washington. According to the paper,
The Department of Finance told the Sunday Tribune the list had been rejected by the previous Bush administration, which said it oversimplified the issue. It said that it shared the Bush administration’s assessment of the list.
So that’s alright then.
I realise that at this stage it is probably academic over here, since the government seems to have decided to do whatever it is that it is going to do. But: what did people think of this suggestion, again (a) in general and (b) in the Irish context?
This is very worrying.
Jim O’Leary had a piece yesterday in the Irish Times which was worth reading for a couple of reasons. First, he has a nice account of the incentives facing economic forecasters. Second, he draws attention to a truly astonishing forecast, or assumption, in the Central Bank’s recent Quarterly Bulletin: that, while domestic demand will collapse in 2009 (which makes sense: the Central Bank assumes that gross domestic expenditure will fall by 7.6%), our exports will only decline in volume by 0.7%. If true, this would obviously mute the overall fall in Irish GDP, and the Central Bank is forecasting a decline of just 4%.
Jim convincingly shows why the assumption regarding exports is implausible. Here are a few more facts. According to the CPB Netherlands Bureau for Economic Policy Analysis, the volume of world trade fell by 6% last November. That’s right: by 6%, in one month. US imports fell by 7.8%; Japanese exports fell by 10.8%.
The CPB cautions that monthly world trade figures are volatile, and that one should focus on moving averages. Of course, that becomes a less useful strategy when one has just passed the peak! More evidence of the extraordinarily rapid collapse in world trade comes from IATA, which reports that the volume of international cargo shipped by air was 22.6% lower in December 2008 than in December 2007 (HT Calculated Risk).
By way of comparison, the volume of world trade fell by a little more than a quarter over the 3 years 1929-1932.
As Jim says, it seems safe to assume that exports will contract by a lot more than the Central Bank is currently forecasting, and that the same will therefore be true of GDP and employment as well.
I found this quite depressing. He doesn’t want to cut interest rates further for fear of falling into a liquidity trap???
In addition to harming the overall Eurozone economy, this sort of attitude, if it prevails, will be particularly damaging to Ireland because of its implications for exchange rates. And it will I think set in motion serious protectionist forces in this continent, with the potential to do great damage to the international economy in the years ahead.
Here is a picture, taken from a paper by Ben Bernanke, which anyone resisting wage cuts in the Irish context today needs to take seriously. These are countries which (mistakenly) stuck to gold until the bitter end. Like ourselves, therefore, they did not have the option of devaluing. (No, I am not saying we should leave EMU.) The more wages fell, the less output declined. (And yes, the result comes through in regressions which control for other stuff.) The question today is, do we want to end up looking more like Belgium, the Netherlands or Poland, or like France and Switzerland?
This is interesting.
If the Chinese have any sense, they will let their currency appreciate now.
Update: Willem Buiter is also concerned about the looming threat to world trade that this would seem to imply. He displays an extreme scepticism about whether nominal exchange rates ever matter for the trade balance, writing that
only the most bone-headed of ultra-Keynesians believes that a country can influence its effective real exchange rate in a lasting manner by managing/manipulating its effective nominal exchange rate, let alone some bilateral nominal exchange rate.
I guess the key phrase here is “in a lasting manner”, and I defer to Philip about what sort of time scale this implies empirically. I guess that not all economists will agree with Buiter on this particular point. But the broader point, which is critically important, is that we can’t take the maintenance of an open trading system for granted.
It appears that the fear of a deflationary spiral is being used as a major argument against wage cuts. My impression is that the idea is gaining traction out there in the real world, and so it seems worthwhile restating the reasons why it is wrong.
‘The’ price level in the Irish context is the European price level, which is determined by policy in Frankfurt. Nothing that happens in Irish labour markets will move this price level by one iota in either direction, and so nothing that we do here will set off a deflationary spiral. What we can influence is a relative price, namely the relative cost of living and doing business here. This relative cost exploded during the bubble, and it will eventually come down. The only issue is whether this happens quickly, or whether relative Irish costs will be ground down by unemployment and stagnation over the course of many years.
David Begg is right to fear a deflationary spiral, but what will determine whether we get one or not is the relative supply of ideologues and pragmatists in the ECB, not anything that happens here. And the sort of intertemporal logic which explains why deflation is so damaging can be turned on its head in the Irish context: as Philip points out, it implies that wage cuts need to happen all at once, now.
The Government should announce that all public sector wages, which it controls, be cut by x%, where x is determined by real exchange rate considerations. It should strongly suggest that all private sector wages be cut by the same amount. Ideally we would all jump together, and so the wage cuts would come into effect simultaneously on a given date. St Brigid’s Day would seem appropriate.
I find this unbelievable.
Barry has a nice piece on Vox today. He is clearly right: we need the ECB to move to zero interest rates now, and match London and DC when it comes to quantitative easing. On the latter point: is this easy to do in the Eurozone context, or does it require institutional reform? Can a banking expert set me straight here?
Buiter has a nice piece today comparing Iceland with the UK. It is implicitly a scathing criticism of Irish government policy to date.
We went to see Roddy Doyle’s Playboy at the Abbey this weekend. I recommend it to anyone who hasn’t yet been.
It sparked two thoughts. The first was: boy, do we do theatre well in this country. I often leave the Abbey or Gate feeling this way, and my wife tells me I am getting boring on the subject. But it is nice, amid all the ‘world class’ blather we are subjected to, to go to something in Dublin that really is world class.
The second was this. Doyle’s reworking of the Playboy is very Celtic Tiger, not just because of the Nigerian Christy Mahon, but because of its underlying cultural assumptions. Synge has Mahon enter a typical Irish peasant community, and because they are a typical Irish peasant community, they look up to someone who has broken the law to the extent of having killed his father. I guess Doyle didn’t think that he could plausibly carry this off in a play set in modern Ireland, and so he has Mahon show up on the doorstep of a Dublin gangland family. In the context of an Ireland which has had its own state for 80 years, in which there are no post-colonial hangups about the law, and in which we no longer look up to people who cheat the system in various ways, since we are a Republic now, and are all in this together, this was a very clever move.
Interestingly, the Anglo-Irish Bank corporate logo was prominently displayed on the programme.
It is just as well that Simon Johnson didn’t read this Sunday’s Irish newspapers, since they would have spoiled his weekend.
He also calls for more coordination within the Eurozone. After what happened in September so should we all.
Willem Buiter has a thought-provoking piece arguing for full nationalisation of all banks here. What do those of you who understand banking think about his arguments in (a) the British context, and (b) the Irish one?
Today’s RGE monitor has a feature, or whatever you’d call it, bringing together recent articles on yesterday’s IMF rumours, on intra-EMU government bond spreads, and on the possibility of exits from the Eurozone. The fact that these topics are being linked tells you something about how people are thinking. However, the Buiter and Eichengreen articles linked to by RGE are helpful in stating the case as to why Eurozone membership is so helpful now for countries like us: the counterfactual is pretty scary. The implication of EMU membership however, as many of you have pointed out, is that nominal wage cuts are badly needed (so what on earth are the ESB thinking of?).
I have been reading and enjoying www.thepropertypin.com for a few years now. You learn a lot about the Dublin property market, and sometimes about other stuff too.
I recently came across this post which alerted me to recent Eurostat industrial figures that ought surely be getting more airplay. As you can see, in the year to November 2008, industrial output dropped by 7.7% in both the Euro area and in the EU as a whole. There was a wide range in performance across countries:
Among the Member States for which data are available for November 2008, industrial production fell in nineteen and rose only in Ireland (+2.6%). The most significant decreases were registered in Estonia (-17.6%), Spain (-15.1%), Latvia (-13.9%) and Luxembourg (-13.8%).
Now, the question is, are these big numbers or small numbers? Here is a table giving changes in industrial output between 1929 and 1937. Looking at the three-year declines between 1929 and 1932, and comparing these with the one-year declines from 2007 to 2008, my answer is that these are frighteningly big numbers. Industrial output is not declining at the rate experienced in the US or Germany during the Great Depression, but that is setting the bar pretty low. It is declining more rapidly than the average falls experienced in Europe as a whole during that period (although those average falls are unweighted, and thus have a large health warning attached to them).
Today’s FT has a piece which indicates nicely how we are now perceived abroad. The accompanying video is also worth a look.
A propos of my previous post, there is a nice article today in the FT making similar points. Since Ireland is a very open economy, the stakes for us are high.
Two recent statements by Irish government ministers deserve to be quoted at length, since they illustrate very nicely two of the broader threats to the international economy going forward.
On Sunday, Willie O’Dea wrote the following passage, which will have seemed somewhat familiar to readers of this website:
We tried the fiscal stimulus approach in response to the oil shock in the late Seventies. The increased spending power given to the Irish consumer largely leaked out on increased imports and left us in an even worse position. There is absolutely no evidence to suggest that the same thing would not happen again…From Ireland’s point of view, the best sort of fiscal stimulus are those being put in place by our trading partners. Ultimately these will boost demand for our exports without costing us anything. What we need to do is to ensure that we are well positioned to avail of the opportunities that result from our trading partners’ actions.
This is precisely the problem that Martin Wolf, Dani Rodrik and others have been highlighting recently: governments worried about this leakage abroad may well combine fiscal stimuli with import restrictions (governments bigger than our own, that is). The obvious solution is to have a coordinated fiscal reflation, and in that light the fact that the G-20 is meeting in London in April is obviously positive. Unfortunately, the history of the 1930s suggests at least two reasons for caution here. The first is that leaders then also realised that cooperation was in principle desirable, and organised a World Economic Conference in London in 1933. That conference failed. The second reason for caution is that one reason why cooperation was so difficult to achieve was that leaders in different countries disagreed about what the economics of the situation required. Notably, the gold bloc centered around France continued in its orthodox gold standard beliefs until 1936. It is crucially important that the Germans today abandon their resistance to Keynesian solutions to the Keynesian crisis we find ourselves in (which may in fact be gradually happening, as the bad news in Germany continues to mount up); and that the ECB be as proactive as the Bank of England and Fed, and as open to the possibility of quantitative easing.
The second Irish ministerial statement that has historical resonances is that of Brian Lenihan quoted this morning. He apparently said:
It is a question for all of us in the EU as to the extent to which a competitive devaluation can be used as any kind of a weapon…The fall in sterling is causing us immense difficulties…They have in effect produced a devaluation of the pound through expansion of the money supply. That has put us under immense pressure
History shows that exchange rate misalignments have been one of the most common reasons why countries resort to wholesale protectionism. The French-led gold bloc of the 1930s found itself with a progressively more and more overvalued currency, as other countries abandoned gold and cut interest rates. Its response was to impose far more stringent import controls, in particular quantitative import controls, than comparable economies elsewhere. The question today is what an undervalued remnibi, or an overvalued Euro, or other similar misalignments, could imply for global trade policies going forward.
Within Europe, the current decline in sterling, if unchecked, will provide future scholars with a fascinating case study. Recall that one of the main arguments for EMU in the 1990s was that the Single Market would in the long run not survive fluctuating exchange rates between EU member states — this was Barry Eichengreen’s view, for example, expressed in the wake of Hoover’s decision to transfer a plant from France to Scotland. I was sceptical at the time and still am; the shared political commitment to the European acquis can’t be overestimated. But there is no doubt that Ireland is incredibly exposed, and that we urgently need the ECB to match whatever is being done in London and DC. Time for a helicopter drop of Keynesians over Franfurt?
Is this analysis by Paul Krugman a sign of debates to come in Europe?
I don’t particularly like the political implications, but if states like Ireland can’t use fiscal policy at a time like this, then the case for fiscal centralisation for EMU members has just gotten a lot stronger, especially from a small country perspective.
Alan made a comment in response to John Fitz that I think people need to think carefully about: wage cuts will be deflationary in that they will increase the real burden of debt. The Latvian piece Philip linked to talks about this, and Paul Krugman has been writing about this also.
I suppose that unlike in Latvia and other countries, most Irish household debt is owed to Irish financial institutions. As Krugman says, this implies that if we could adjust the real exchange rate by devaluation, that would be preferable to doing it through domestic deflation. However, devaluation is not an option for us. So, Alan is right: writing down the debt would seem like the best solution, assuming it were possible. Of course, you would like the banks rather than the taxpayer to take the consequent hit, and there is a fat chance of this with our current government.
If debts cannot be written down, then wage cuts will depress the economy still further through this mechanism. As will tax increases, and expenditure cuts, whether people like it or not. And thus the adjustment mechanism for our economy is most likely to be emigration. Which will of course further reduce economic activity, and asset prices, and increase the losses suffered in principle by banks, and in practice, one fears, by taxpayers. (And reduce GDP and the number of taxpayers, thus increasing the tax rates required to service a given level of debt.)
None of this is to disagree with John, but to point out how bad our options are right now.
Speaking personally, I would really appreciate a detailed debate in the next few weeks about two issues. First, what is the optimal timing of a return to 3% deficits? I am completely convinced by the argument that we are once again living in a Keynesian world, which on its own suggests doing this over a number of years, especially since we are starting with a low stock of government debt. (What else is a low stock of government debt for, one might ask.) The key questions then are: how rapidly will the stock of debt escalate to levels that are unacceptable? What are unacceptable levels of debt? How binding are the constraints which we will face due to increasing demands by governments for loans on world markets? How worried should we be about possible linkages between increments to and the stock of public debt, on the one hand, and the credibility of the government’s bank guarantee scheme on the other?
Second, what does the real exchange rate or labour market evidence suggest about the size of wage cuts required to get the real exchange rate back to some sort of sustainable non-bubble level? Can we do better than picking numbers out of the air?
Was I the only one to find the following snippet from the Irish Times astonishing?
It has emerged that the Government increased the size of its planned investment in Anglo by half in the final hours of talks. Mr Lenihan was offering €1 billion up to lunchtime on Sunday but raised the offer to €1.5 billion in the face of tough negotiation by the bank.
Everyone agrees that the Irish economy needs to restore competitiveness. Absent the possibility of devaluation, this either requires freezing nominal wages, and letting inflation erode their real value; or reducing nominal wages. The former course of action seems insufficient, since it will take too long, and we may even be heading for deflation.
So, the old Calmford Driffill literature from the 1980s may be relevant. (I couldn’t find their 1988 Economic Policy article online, but a survey article is here.)
Remember the basic point: if labour markets are very competitive, then wages will fall by themselves. If there are strong sectoral unions, on the other hand, then they may all play a game of ‘after you, my dear Alphonse’, and wages may not be cut. In that case, moving to central bargaining can help in coordinating wage cuts, in that no-one feels that they are falling behind in relative terms. Some would say that the introduction of social partnership in the late 1980s is a good illustration of that mechanism in practice. (OK, it involved wage restraint, not wage cuts, but that was useful in itself at the time, especially in the context of devaluation.)
The question for you all is: how flexible are private sector labour markets in Ireland today? We have all read about particular firms cutting wages, but how common is that? Are there studies on this? Will private sector wages fall sufficiently on their own, or is there a role for government coordination here?
Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.
So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.
Nice article in the Irish Times today by Jim O’Leary. I particularly liked the following unusually honest section:
The case for borrowing more to fund an attempted stimulus package would be more difficult to rebut if there was a high probability of it being successful, but fiscal stimulus is notoriously difficult to effect in a very open economy like Ireland. The reason is that a high proportion of any increase in demand leaks out through imports.
From our point of view, the best sort of stimulus package are those put in place by our trading partners since these boost demand for our exports without costing us anything. And here, the good news is that most of our main trading partners have announced reflationary fiscal measures of one sort or another in recent weeks/months. What we need to do is ensure that we are well-positioned to avail of the opportunities that will flow from these and what that means, first and foremost, is reducing our production costs to competitive levels.
It is hard to disagree with the logic. If the amazingly profligate government we have had over the past decade had listened to people like JOL on issues like benchmarking, then we might have tried to pull our weight as part of a Europe-wide reflationary package, but as things stand, we are going to have try to free ride. Not very glorious (and rebalancing the books will obviously make a bad recession worse) but there you are.
But let’s hope that too many others don’t also take a similar view! The thing about free riding is that what is individually rational can be collectively disastrous. Dani Rodrik is gloomy here.