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The international debate on the wisdom of fiscal austerity has being heating up.    Since the onset of the crisis, the consensus seems to have gone through different stages: initially there was widespread support for fiscal stimulus, followed by concerns that fiscal policy needed to tighten as debt to GDP ratios rose in many countries to worrying levels, followed more recently by concern that fiscal policies may tighten too much given the persistence of the crisis-induced recessions.  

A useful aspect of the recent debate is greater differentiation between countries facing serious sovereign creditworthiness challenges and those that do not.   Countries facing immediate creditworthiness problems face a dilemma: fiscal tightening tends to further weaken the real economy; but allowing deficits and debt to stay on a higher path further weakens creditworthiness.  The fiscal council has been grappling with this dilemma in its first two reports (see here and here).  

Drawing on recent work with a number of co-authors, Giancarlo Corsetti provides a useful framework in this VOX piece for thinking about the dilemma.  He makes the important point that the appropriate fiscal stance can be quite different for countries facing a large market risk premium (e.g. Ireland) and those that don’t (e.g. the UK).   Countries facing a large risk premium face a dilemma in setting the fiscal stance between supporting demand and supporting creditworthiness – a trade off that is absent or at least much less pronounced in countries with low long-term bond yields.   Corsetti’s framework has the additional element that increases in the sovereign risk premium can feed through to the risk premium facing the private sector though the entwining of bank and sovereign balance sheets.   While he does not believe that this additional element makes fiscal contractions expansionary, it does tend to reduce fiscal multipliers.   On the other hand, for countries not facing an elevated risk premium, multipliers are likely to be large for countries in deep recessions with policy interest rates constrained by the zero lower bound, suggesting the appropriateness of a more stimulative fiscal stance. 

Alan has a look at what might have been done to reduce the taxpayer’s exposure to Anglo’s losses in the indo here.

Alan’s point is pretty simple, but I think a lot more could be written on what else the government could (or should) have done in the wake of the 2008 crisis.

Colm’s Sindo wide ranging column this week takes NAMA and the disposal of its assets as its focus but also calls for an inquiry into several important matters. From the piece:

Viewed from behind the desk of an international investor with plenty of options around the world, this is not a pretty picture. The reputation of the country has been damaged and the perception created that Ireland is suffering from an acute outbreak of crony capitalism.

This may be unfair but perception is what matters and the perception needs to be altered decisively if foreign investors are to be re-assured. The sheer scale of the capital inflows required means that portfolio investors new to this country need to be involved on a massive scale. These people are perfectly entitled to be cautious about committing funds to a small country which must appear to them to tolerate a dodgy business and political culture.

In the circumstances the Government must focus on rebuilding reputation and has consciously made this a priority. There are other positives — the Irish commercial courts are seen as thoroughly independent and quite prepared to find against local interests, including the State, should the law and the facts point in that direction.

But progress has been slow under several headings. Four years after the emergence of the banking crisis, and given clear evidence of malpractice in some banks, there has been no definitive inquiry into their governance and behaviour, in particular no review of bank-by-bank lending policies in the years when the damage was done. Despite evidence in the public domain of insider lending, balance sheet window-dressing and share-support operations in some banks, no prosecutorial actions have been taken.

The referendum on restoring investigative powers to the Oireachtas was lost through a weak government campaign, but a parliamentary inquiry is nonetheless desirable. It should cover the Quinn Insurance affair as well as the banking collapse and should delve further into the failures of regulators and the mistakes made in the policy response. A well-resourced inquiry should be seen as helping to restore the country’s reputation.

Eamon Quinn interviews Brian Hayes – article is here.

A group of Irish economists have an interesting joint article in today’s Irish Times.   It is available here.   It usefully goes beyond the rather sterile austerity/no austerity debate to focus mainly on the mix of adjustments.  

Drawing on the available evidence, the article notes that fiscal consolidation measures lead to slower growth and job losses.

The evidence is clear: contractionary fiscal policy does indeed restrict economic activity and employment.

The austerity-focused policies being pursued in Europe and in Ireland will continue to drive down employment and living standards, while embedding high levels of long-term unemployment in the economy.

However, the article does not claim that consolidation is unnecessary (though it does not offer a preferred time path for bringing the deficit down), but rather focuses on the mix of consolidation and financing measures.   The authors argue for a mix that involves higher capital spending and higher taxation aimed primarily at higher income individuals.   (For the medium term, they also argue for higher social expenditures financed partly by increased PRSI contributions.)

Such an investment programme must be accompanied by “smart” fiscal consolidation, focusing on the least contractionary forms of fiscal adjustment. This requires progressive and equality-proofed taxation targeting high-income groups, property assets, unproductive activity and passive income, as well as environmental measures.

In the medium term, we should explore the potential of social insurance and local taxation to broaden the tax base while providing real benefits in return. PRSI can be expanded and combined with general taxation to provide free universal healthcare and earnings-related pensions. Stronger local taxation has the potential to be more accountable while providing investment in services responsive to local needs.

The mix of adjustments is also receiving recent attention in the international debate.   For differing perspectives on the most effective mix from a macroeconomic perspective see Alberto Alesina and Francesco Giavazzi here and Simon Wren-Lewis here.