The Global Crisis

VOX has launched a new initiative that is intended to act as a central forum for an open-format discussion of the global crisis.  This promises to be quite interesting  (I am acting as moderator for the macroeconomics theme; Luigi Zingales on regulation;  Francesco Giavazzi on institutional reform; Dani Rodrik on development; and Richard Baldwin on open markets).  You can read more about it here.

Irish canaries in the global coalmine: the threat to international trade

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?

Cross-Country Learning

The generalised nature of the international slowdown and financial crisis means that it is especially useful to keep track of developments in other economies, in order to learn from the variation in policy choices and economic developments across countries.  To this end, the Eurointelligence project is an excellent source of news briefings on the various European economies.  It produces a free daily newsbriefing that arrives in  your email inbox at the start of each day: you can sign up for it here.

Today’s edition features two especially interesting stories: (a) the sacking of the Greek finance minister (and former economics professor) George Alogoskoufis;  and (b) the failure of this week’s German bond auction.

Ten Years of the Euro

We now have a full decade of evidence concerning the impact of European monetary union on Ireland and the other member countries. While my view is that the euro has been beneficial in many ways, the next year or two will be highly revealing about the capacity of member countries to undertake economic adjustment while operating within the constraints of a common currency area.

The Economist has a nicely balanced article in its most recent edition: “Demonstrably Durable“, while John Hurley had an op-ed giving the local central bank view in the Irish Times on December 30th.

I gave my own view on the impact of the euro on Ireland in an article for the Sunday Business Post back in May: you can read it here.

I have also recently written a couple of academic survey papers on different dimensions of the euro:

EMU and Financial Integration,” IIIS Discussion Paper No. 272, December 2008. Prepared for the 5th Central Banking Conference of the European Central Bank.

The Macroeconomics of Financial Integration: A European Perspective,” IIIS Discussion Paper No. 265, October 2008. Prepared for the 5th Annual Research Conference of DG-ECFIN (European Commission).

Free riding

Nice article in the Irish Times today by Jim O’Leary. I particularly liked the following unusually honest section:

The case for borrowing more to fund an attempted stimulus package would be more difficult to rebut if there was a high probability of it being successful, but fiscal stimulus is notoriously difficult to effect in a very open economy like Ireland. The reason is that a high proportion of any increase in demand leaks out through imports.

From our point of view, the best sort of stimulus package are those put in place by our trading partners since these boost demand for our exports without costing us anything. And here, the good news is that most of our main trading partners have announced reflationary fiscal measures of one sort or another in recent weeks/months. What we need to do is ensure that we are well-positioned to avail of the opportunities that will flow from these and what that means, first and foremost, is reducing our production costs to competitive levels.

It is hard to disagree with the logic. If the amazingly profligate government we have had over the past decade had listened to people like JOL on issues like benchmarking, then we might have tried to pull our weight as part of a Europe-wide reflationary package, but as things stand, we are going to have try to free ride. Not very glorious (and rebalancing the books will obviously make a bad recession worse) but there you are.

But let’s hope that too many others don’t also take a similar view! The thing about free riding is that what is individually rational can be collectively disastrous. Dani Rodrik is gloomy here.