Today’s FT has a piece which indicates nicely how we are now perceived abroad. The accompanying video is also worth a look.
Author: Kevin O’Rourke
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?