The Irish Economy

It can be hard to get an intuitive sense of potential evolution of Ireland’s budgetary situation post-2015.   With this in mind, readers might be interested in seeing a hypothetical scenario for the period 2016-2020.   I hasten to add that this is neither a forecast nor a recommendation.  

The scenario begins with the Government’s projections out to 2015 as recently published in the Stability Programme Update.    To limit the number of assumptions, I focus on the actual budget balance rather than the structural budget balance.   The post-2015 scenario assumes: (1) an annual nominal GDP growth rate of 3.5 percent (which, for reference, compares to a forecast in the SPU of 4.5 percent nominal growth in 2015); (2) an average interest rate on outstanding debt of 4.9 percent for 2015-2020 (equal the projected interest rate for 2015 in the SPU); (3) total General Government  Revenue grows at the same rate as nominal GDP;  and (4) non-interest (or primary) General Government Expenditure grows at half the rate of nominal GDP.   Of course, a faster rate of primary expenditure growth would be possible for the same evolution of the budget balance with the tax system not fully indexed to nominal GDP. 

The evolution of the key aggregates (measured in millions of euro) are shown here; these aggregates as a share of GDP are shown here.   The debt to GDP ratio is shown here. 

Under this scenario, the actual deficit as a share of GDP would fall from the projected 2.8 percent of GDP in 2015 to -0.4 percent of GDP in 2020, a change of 3.2 percent points of GDP.   (The improvement in the underlying structural deficit should be broadly similar, starting from a projected 3.5 percent of GDP in 2015.   The rate of improvement is above the minimum required rate of improvement in the structural deficit of 0.5 percentage points of GDP per year along the adjustment path to structural balance.)   The debt to GDP ratio would be falling at a rate of 3.5 percentage points of GDP in 2019 and 4 percentage points in 2020, within the requirements of the one-twentieth rule, which comes into force after 2018.   

In Saturday’s Irish Times, Alan Ahearne does a good job laying out the dangers of unfolding events in Greece (see here).    Political support for the adjustment programme has been lost, with the Greek population understandably perhaps blaming much of their disastrous economic performance on the conditions of the programme.   While the austerity measures have certainly played a role in the growth performance, they are just one component, with the confidence-sapping effect of the fear of a melt-down situation itself playing a major role.   The correlation between austerity and weak growth is now deeply established in the minds of many Greek voters – whatever the actual contribution of the austerity measures.   A rejection of the programme in the elections is a real possibility.   So too is a tough response from official creditors to an unwillingness to meet the programme conditions.

A Greek exit from the euro zone could be containable with sufficient will.   However, there is a likelihood that moral hazard concerns could lead the response might be too halting, leading the crisis to easily spin out of control.    As Alan argues, even with a successful containment, the precedent of a country leaving the euro would fundamentally change the stability of the monetary union, making it more prone to the runs that plague fixed-exchange rate regimes.  (See also Martin Wolf here.)

Is there room to give Greece more time, providing at least some political counterweight to the massive anger at the programme?   The stronger euro zone countries are understandably concerned about the moral hazard problems of any backtracking on the conditionality being applied to Greece.  

This is where the weaker countries could play an important role.   They could do so by making it clear that they see no interest in seeking relief through default or in a relaxation of formal/informal commitments, regardless of any additional accommodations for Greece.  This need not include measures currently under discussion for strengthening the overall crisis management, including the lengthening of the maturity of the promissory notes, direct injections from the ESM into undercapitalised banking systems, or relaxing the aggregate stance of the Excessive Deficit procedure (especially for countries with fiscal space).    I think this goes with the grain with the approach of governments in Ireland, Italy, Portugal and Spain.   (Indeed, in the case of Spain, their unwillingness to accept a one-year extension for reaching the 3 percent target under their Excessive Deficit Procedure (EDP) may show excessive unwillingness to accept the easing of conditions, given that it can be viewed as part of broader easing of the aggregate stance of the EDP on the basis of the aggregate euro zone considerations.) 

I don’t want to exaggerate the impact of leadership of the weaker countries on this issue, but it could help tilt the steering wheel from what looks now like a very dangerous course.   Greece has got itself into a mess, much of it of its own making.   Greece has no choice but to make tough adjustments, but giving more time may be the only way to prevent political rejection.   Solidarity – but most of all self interest – should lead all euro zone countries to work hard at finding a workable way out. 

Simon Wren-Lewis widens the debate about self-defeating fiscal adjustment here, considering in particualr the cases of Spain and Greece.  I take a (very initial) stab at some of the analytics in this brief note.

Six months ago on this blog I made a quasi-prediction that the number of new residential mortgages in Ireland might shrink to zero-plus-noise. Arguably this has now happened. I claim no great insight and concede that it might have been dumb luck. My quasi-prediction was based on some informal liquidity-risk analysis of the Irish banks. The banks are in a corner solution with respect to long-term illiquid assets. There is little good reason for an Irish-domiciled bank to issue a new residential mortgage, rather, they might be keen to sell any of their existing long-term illiquid assets at a loss. This has only second-order policy importance relative to Greece, etc., but is worth documenting.

Andy Borowitz proposes a solution for Greece here.

My opinion piece in today’s Irish Times points out that the disbanding of the Better Regulation Unit in the Department of the Taoiseach risks reducing the capacity for effective oversight of regulatory institutions and strategies and for learning about and acting on regulatory successes and failures elsewhere in the OECD member states. A fuller policy brief on the topic, “W(h)ither Better Regulation?” is available here.

I hope there is no problem about my linking to the article I wrote.

This really is one for the textbooks.

His analysis piece is here.

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.

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.

Lorenzo Bini Smaghi is fond of the word “irrational”. It appears several times in the article that Philip linked to yesterday. In particular, it seems that LBS thinks that Greek voters are irrational. Given that Greece is the birthplace not only of democracy, but of Euclid and the rest of them, it seems worthwhile querying the notion that Greek voters are irrational.

One evidence of their irrationality that is sometimes advanced is that while they have overwhelmingly rejected the current austerity measures in a democratic election, polls also show that they would like to remain in the euro.

What is irrational about this?

I guess the first best solution for Greeks is for Greece to stay in the euro, but for the current programme, based on multilateral austerity and internal devaluation, which has failed and indeed has no chance of succeeding, to be replaced with a programme which involves more debt forgiveness and more fiscal transfers from the centre. What is irrational from a Greek perspective about wanting this? That it probably isn’t going to happen is of course an important fact, but there is nothing irrational about wanting what is best for you.

Then there is the question of whether it is irrational to vote for Syriza. Let us assume that if Syriza forms a government with like-minded parties, and refuses to implement the current austerity programme, Greece is somehow ejected from the Eurozone. Knowing that this is a likely outcome, is it irrational for Greeks to vote for Syriza?

I’m not so sure.

If they vote for the two parties that have brought Greece to this sorry state of affairs — and why on earth would they? — then what is the likely outcome? The programme continues, and what Greece has lived through for the past few years continues for the next few years. This would offer zero hope for ordinary Greeks; no prospect of anything changing in the foreseeable future which might improve their lives. And in the end the strategy will probably fail, anyway.

If they vote for Syriza, perhaps Greece will leave the Eurozone. In that case, what happens? There is the certainty of a major economic crisis in the short run, but then what? Some commentators argue that the result will be hyperinflation. Given that the Greek primary deficit is very small, I am puzzled by the certainty with which this prediction is sometimes made. I suppose there is a certain probability of a very bad outcome like this occurring, but the probability is surely much less than one. On the other hand, there is also the possibility of default and devaluation leading to a recovery in two or three years. Again, the probability of this scenario occurring is less than one, but it is surely rather greater than zero.

And then there is the possibility that the Europeans will blink, and that the Greeks will get something like their preferred solution. I think this probability is vanishingly small myself, but perhaps I am wrong.

So, Greek voters can do what Europe’s elites are now urging them to do, and vote for the two establishment parties. In this case, they know with certainty that nothing will get better, and indeed that things will continue to get worse. Or, they can roll the dice. I don’t think it’s irrational for them to roll the dice. And thankfully, they seem to be gambling on Syriza, not Golden Dawn.

Of course, with a certain probability, which may be less than one, but is certainly much bigger than zero, a Greek Eurozone exit will lead to financial chaos elsewhere, and possibly even the collapse of the single currency. But that will primarily be our problem, not a problem for Greek voters.

So I am unconvinced by the argument that Greek voters are irrational, even if one only considers the economics of the situation they find themselves in. And this argument is strengthened when you consider non-economic factors. Everywhere in Europe you hear ordinary people saying that they feel powerless, that voting changes nothing, that they feel disenfranchised. In Greece, voters may be about to really change things, regaining some control over an agenda which has up till now been dictated by people like Lorenzo Bini Smaghi. I guess that many voters will derive utility from this.

Knowing all of this, leaders in other European countries should surely be trying to offer Greek voters something that the status quo excludes: hope. Instead, they are offering warnings about dire consequences, and statements to the effect that the rest of us can handle a Greek exit. You do have to ask: who is it that is being irrational here?