Krugman and Layard on a manifesto for economic sense

Paul Krugman and Richard Layard put forward a case for a coherent and evidence based approach to the crisis. Essentially they argue that a strategy of focusing on the reduction of public debt levels exclusively in order to regain market confidence makes no sense, and has been falsified empirically. They also argue that structural imbalances shouldn’t prevent the use of discretionary fiscal policy for stabilization purposes when it is available.

This chart of the drop in domestic demand from the recent Nevin Institute quarterly report (page 4) is particularly striking as a motivating factor in discussing Krugman and Layard’s piece.

Final Domestic Demand

Krugman and Layard have a manifesto you can sign up to (I did).

There are lots of things in this piece I agree with, but two big ones are:

1. Placing the blame for the crisis at governments’ feet makes no sense. The crisis didn’t start in the public finances, it began in the private sector(s).
2. The confidence argument and its attendant strategy is completely wrong headed at this juncture, Ireland in particular shouldn’t be held up by anyone as the role model for austerity, either in the 1980s or today.

There are also aspects I don’t see as pertinent to the Irish case.

Krugman and Layard write:

A second argument against expanding demand is that output is in fact constrained on the supply side – by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations.

But in Ireland, in the IT sector for example, and especially in really high end tech jobs like online video gaming and such, they can’t get people. (Obviously in other sectors like services and construction their argument holds.) There are other examples but I think in a small open economy like Ireland this argument isn’t that important.

The key question from an Irish point of view is: to what extent is the Krugman-Layard prescription possible in a country with so little fiscal room for maneuver? Translating the argument down a bit, if Ireland is somewhere between Greece and Spain in terms of it’s problems, even if Enda Kenny et al bought the Krugman/Layard prescription lock stock and two smoking barrels, given where we are right now, are our options severely limited in any event? I’d welcome your thoughts on this.

Call for papers – conference on bank resolution mechanisms, Spring 2013

Call for Papers

Bank Resolution Mechanisms

A joint academic-practitioner conference with the theme Bank Resolution Mechanisms wil be held in Dublin, Ireland on Thursday May 23rd, 2013, organized by the Financial Mathematics and Computation Cluster (FMCC) at University College, Dublin and the Department of Economics, Finance & Accounting at National University of Ireland Maynooth.

Austerity games

Kevin and Philip have been keeping readers of this site up-to-date with economic analysis of Grexit, problems with EMU and other big picture items over the last few days.

If I may, I’d like to bring things back down to the level of Ireland and the upcoming referendum on the Fiscal Compact. To my mind, a few important concepts have gone out the window as the debate in Ireland about the referendum on the Fiscal Compact has descended into political games. Perhaps the first victim was cause-and-effect, with the mere correlation of banking debts and government deficits being translated by many into iron-cast causation.

A close second in the casualty list was the concept of opportunity cost: in other words, there’s not really much point focusing on how bad or economically illiterate the Fiscal Compact is in and of itself. We need to ask how attractive it is relative to the other options. As of now, the most important attribute of the Fiscal Compact is its ability to get Ireland the funding that it otherwise would not be able to get, to allow the country to gradually close the deficit. By 2020, that may be completely unimportant and we may want to ditch the Compact. But we are voting in 2012, not 2020.

With that in mind, I’ve developed “Austerity Games”, as a basic guide to voters on deficits, debt, fiscal policy and the EU’s Fiscal Compact (below, click to enlarge). Hopefully it’s useful to some readers.

choices for Irish voters
Austerity Games: choices for Irish voters

For a fuller exposition on why the IMF will not be a panacea, Karl Whelan has an excellent blog post here.

Access to EU Funding

At the EU summit of the 21st of July last the leaders’ statement said that:

“We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes. We welcome Ireland and Portugal’s resolve to strictly implement their programmes and reiterate our strong commitment to the success of these programmes.”

This was reiterated as recently as the EU summit of the 30th of January when the statement of the EU leaders said that:

“We welcome the latest positive reviews of the Irish and Portuguese programmes which concluded that quantitative performance criteria and structural benchmarks have been met. We will continue to provide support to countries under a programme until they have regained market access, provided they successfully implement their programmes.”

These both seem pretty unequivocal to me and have not been contradicted in any subsequent EU statements I have seen.

In the event of a NO vote

Michael Moore of QUB raised an interesting point with me last week.  A NO vote would not affect our membership of the IMF.  Presumably, Michael asked, we could still turn to it if/when we need a second bail-out?  And recall that the troika – the coalition of the willing – was just put together because it was considered demeaning for the EU that a member state should seek a bail-out from entirely external sources.  Given all the indications of how much the IMF has changed in the wake of the Stiglitz critique, they might even have a better deal to offer than our EU partners.

Michael, of course, likes to lace his stews with chili.  But still… 

Then, though, it would be up to our American partners.  A senior IMF official confirmed to me over the summer the veracity of Morgan’s account of the Geithner veto.  Soundings to be taken over St Patrick’s Day at the White House?