Category: Bailout

Beware of journalists bearing history lessons

Today’s Irish Times contains this gem from Stephen Collins:

Another issue that did not get serious traction in the talks was the simplistic call to “burn the bondholders” for which German chancellor Angela Merkel has to take a lot of responsibility.

The European Central Bank was adamantly opposed to the notion as any such move would threaten the financial stability of Europe. It is ironic that the zealots of the US Tea Party movement and many of those on the left in Ireland share a common belief in “burning bondholders” and damn the consequences.

The lesson of the Great Depression of the 1930s was that taking that kind of approach leads to widespread bank failures and national economic collapse which, in turn, threatens the democratic foundations on which our society is built.

Give me a break.

The bank failures of the 1930s were due to bank runs caused by excessively conservative monetary policies, and in particular by the determination of elites to stick with the gold standard well past its sell-by date. Burning bondholders had nothing to do with it.

Insofar as the 1930s involved debt restructuring (in Latin America, for example), this was part of the solution, not part of the problem — cf. the work by Eichengreen and Portes.

The lesson of the 1930s is that slavish adherence to economic orthodoxy can lead to disaster, and that sometimes you need a radical break with past policy mistakes in order to turn around expectations and prepare the way for recovery. FDR’s abandoning the gold standard was one such radical break; there were other radical breaks with the past that were much less benign, and that were directly caused by previous hyper-orthodoxy.

Finally abandoning the socialization of private losses would not just have made the Irish state more solvent, but would have clearly signalled a new beginning in Irish political and economic life. As things stand, it is hard to disagree with Mohamed El-Erian that the present deal is not the game-changer that Ireland needs.

Central Bank PCAR Statement

The Central Bank’s new PCAR statement hasn’t yet been linked to on the site so here it is.  This is the most detailed statement released yesterday in relation to the future of the Irish banking sector.

Government Statement on Joint EU-IMF Programme

The Government’s statement on the joint EU-IMF programme for Ireland is available here.

Update: See here for joint EU-IMF statement; here for IMF press release.

Migration, the limits of internal devaluation, and the bailout

It is time to dust off old ways of thinking about the Irish economy that were useful in the past.

In the long run, migration sets a floor to Irish wages. It has been thus ever since the Famine of the 1840s, and I don’t believe that the Irish have become less mobile in the last 20 years. Now, a lot of Irish wages are still high by international standards, but eventually as ‘internal devaluation’ proceeds, and as peoples’ living standards are lowered as a result of tax hikes and cuts to public services, it seems inevitable that the ‘migration constraint’ will start to bind again.

Once this happens, then very roughly speaking the size of the Irish economy will be largely governed by relationships of the following sort:

w(1-t) + b + P = E

where w is the wage (which determines employment and output, for given levels of the capital stock and technology); t is the tax rate; b is the value to workers of the public services they receive; P is the premium we enjoy as a result of living in Ireland; and E is the living standard which we can enjoy overseas. If the left hand side of this equation falls too far below the right hand side, people will leave until equilibrium is re-established.

Once we hit this constraint, either because w falls, or t increases and b declines, adjustment in the economy will be more quantity-based and less price-based than it has been to date.

And it gets worse, since t and b depend inter alia on the levels of output and employment. There are fixed costs to running a state, and the debts we are now being saddled with are not population-dependent. You don’t have to be Paul Krugman to see the potential for some pretty nasty feedback loops here.

What can politicians do? The most obvious thing to do is to minimize the debt overhang facing this State, so that t is not higher, and b is not lower, than they otherwise would have to be. Less obviously, if politicians — not the existing ones, obviously, but an entirely new political class — can increase P, by providing people with a political project for national renewal that they can buy into, this might also help convince some people at the margin to stay at home. This is not just essential for our democracy, but for the economy as well.

Taking Stock

It is a day for taking stock after an extraordinary week.   On Wednesday, the Government unveiled its four-year plan for stabilising the debt ratio with about as much political acceptance as could be expected.   Yet by the end of the week the expected probability of default on sovereign debt implied by bond yields had increased, and that was despite the imminent announcement of the details of an international rescue package.    It was also a week in which those advocating sovereign default—on State guaranteed bank debt and State bonds—were advancing, while those arguing that creditworthiness could still be restored were in retreat.   I think it is worthwhile to reflect on the two broad views. 

Continue reading “Taking Stock”