Martin Wolf writes on “unorthodox” fiscal and monetary policy responses to the recession in this morning’s FT. The article highlights the work of Agustin Benetrix, Kevin O’Rourke and co-authors (IIIS Discussion Paper version here).
Category: Fiscal Policy
The idea of establishing some kind of fiscal council seems to be gaining momentum. Minister Lenihan expressed interest in this idea last week; it featured in speeches by Eamon Gilmore and Joan Burton last week; it is also Fine Gael policy. An editorial in today’s Irish Times also endorses the idea – you can read it here.
Economic policy advice on reducing the risks to macroeconomic and financial stability from the housing market, restoring competitiveness and preparing to adjust in a downturn was available to the Government prior to the financial crisis.
In a research paper which I presented in the plenary session of the Annual Economic Policy Conference in Kenmare on 13 October 2006 (attended by a good number of senior civil servants), after discussing the adjustment mechanisms available to Ireland as a member of the European Economic and Monetary Union, I pointed out four main challenges facing the Irish economy and suggested a combination of policy measures to respond to these challenges. The four challenges that I identified were as follows:
a) maintaining a high potential output growth rate
b) restoring competitiveness
c) managing potential risks to macroeconomic and financial stability from the housing market
d) adjustment to a slowdown in the United States and an expected appreciation of the euro against the dollar
The policy measures suggested to respond to these challenges included the following:
a) fiscal tightening to reduce domestic demand pressures
b) a wage restraint in the public sector
c) fiscal measures to reduce the risks to macroeconomic and financial stability such as phasing out the tax relief on mortgage interest payments, a tax on imputed rents, a broader capital gains tax, or a property tax on vacant of secondary dwellings (as options available to the Government)
d) limits on the use of real estate as collateral to protect the banking system against over lending and bad loans
e) running a large fiscal surplus during the current boom to prepare for a downturn in the world economy
The Irish Times of 14 October 2006 covered extensively my main points. The paper was published in the Quarterly Economic Commentary in March 2007.
Paul Krugman continues his campaign against the expansionary fiscal contraction hypothesis here. In making his case, he links to a 2007 paper by UCC’s John Considine and University of Portsmouth’s David Duffy. I don’t think the paper provides the slam-dunk evidence Krugman contends, but it is a very interesting read.
Abstract:
It is ironic that the potential expansionary effects of fiscal contractions have become known as non-Keynesian effects. This paper highlights the fact that Keynes and his contemporaries were aware of such potential perverse effects. It is clear that the important indirect effects of budgetary policy via expectation were known in the 1930s. Moreover, the economists of the time recognised the possibilities before they occurred. This paper supplements the existing research on the Expansionary Fiscal Contraction hypothesis by comparing two periods in economic history, Britain in 1930/1 and Ireland 1986/7, and the accompanying economic thought.
Amid all the coverage of the banking reports and the other ongoing political stories, very little coverage has been devoted to the fact that the bond markets are again turning less and less positive about Irish sovereign debt.
Today’s NTMA bond auction (press release here) saw it borrowing €1.5 billion, equally split between a bond maturing in 2016 and a bond maturing in 2018. The NTMA press release stresses the fact that the auctions had bids of three times the amount offered. However, look at the yields. As the RTE website points out “The average yield on the 2016 bond rose to 4.521% from 3.663% at the last comparable auction in April and the 2018 bond had a yield of 5.088% from 4.55% last August.”
On the secondary market, the yield on ten year bonds has now given up most of the large decline that occurred after the May 9 announcement of the EU stabilisation fund. In fact, the FT are reporting that, as of yesterday, the spread over bunds stood at 281 basis points, relative to 319 basis points on Friday May 7, and yields are up another 20 or so basis points so far today.
What’s odd, of course, as Paul Krugman has been pointing out is that these developments have not stopped the constant references, both here and abroad, to how well regarded Ireland is by participants in international financial markets.
To be fair, I think there are a few cross-currents here that go beyond the essential point that Krugman is trying to make. I would echo Krugman’s concerns about the effects of imposing fiscal austerity too soon. The budget deficit for the Eurozone as a whole is projected to be 6.6 percent of GDP this year, so to my mind the need for generalised fiscal contraction today is overstated in light of the weakness of the Euro area economy. However, the bond market’s attitude to Ireland’s position is such that the Irish government has little choice but to adopt an austerity program, a point that Krugman has conceded before.
Furthermore, I’m sure that financial market participants are impressed by the fiscal retrenchment obtained so far. But, at the end of the day, the bond yields give us their judgment on the sustainability of our situation and it’s a thumbs down. The high yields being imposed on us reflect the scale of the initial hole we dug for ourselves as well as policies that maximized the cost to the state of the banking crisis.