Here is an Italian estimate of the fiscal multiplier, which doesn’t have to rely on military expenditures as other authors (including myself) have done.
And here is an account of the German current account surplus which resonates with older theories of capital exports: it is, according to the author, anything but a testament to German ‘competitiveness’ (whatever ‘competitiveness’ means).
Wolfgang Münchau has an interesting take on the bailout/default debate that is relevant to recent posts (see here).
John McHale has kindly posted an article I wrote for today’s Sunday Independent below. I would like to expand here on what secondary market Irish bond prices are actually saying.
The benign outcome expected, publicly at least, by our European partners is that, if Ireland ‘sticks to the programme’, things will work out OK. Working out OK needs to be defined. Here’s a working definition.
1. Ireland is able to return to the sovereign market in about eighteeen months.
2. This means the bond market, not just bills or CP.
3. It must be able to sell bonds, in large quantities, at medium duration. That means five-year at minimum, ideally ten-year and longer.
4. Yields don’t have to be as comfortable as Germany or even France, but can be no worse than say Spain.
5. Ten-year bonds at 5% would be, to coin a phrase, manageable, with five-year at say 4.5%.
If you believe that sticking to the programme, plus an average run of luck, will do the trick, without any compromise with bank creditors or sovereign default, you must also believe that bond market re-entry, on something like the above basis, is on the cards before the end of 2012.
The bond market does not believe that this outcome is likely at all. Both five- and ten-year bonds were yielding over 10% on Friday. Conveniently, the coupon on the five-year is 4.60. If the price is to exceed 100 in eighteen months time, the total return offered for the period is a capital gain of at least 23 plus about 8 in accrued coupons, total at least 31 versus Friday’s price of 77. The five-year will be a 3.5-year by then, target yield even lower on a normal curve, and the required return even higher. If you sincerely believe that this outcome is likely, buy while stocks last.
Note that a return to the bond market which takes this jaundiced view is a part of the programme, as Karl Whelan repeatedly points out. When sovereign debt gets junked by the market, it does not recover over short horizons like eighteen months. You go down in the elevator and come back up the stairs.
None of this suggests that we should not stick to the programme. The fiscal adjustment makes sense in any scenario and there is a case for doing it faster. What it suggests is that preparations need to be made for a long-haul, including sovereign re-structuring or re-scheduling, just in case the markets might have it right this time.
Colm McCarthy has yet another important article in the Sunday Independent: see here. I would be somewhat more positive about what was achieved this week with the stress tests (and associated recaptialisations), and also the strengthened commitment from the ECB to continue to act as lender of last resort. But Colm is right that the critical next step is to demonstrate the capacity to push through with the fiscal adjustment.
Ireland has lost the capacity to borrow and has been forced into rescue by official lenders. Any country in this desperate position should be making every effort to get the deficit down as quickly as possible.
The decision by the coalition partners for a relaxed programme of deficit reduction is a cop-out on, critically, the one dimension of macroeconomic policy entirely within our own control.
There is no shortage of wishful thinkers offering snake-oil solutions, including unilateral default or leaving the euro. There are no useful unilateral options available to my knowledge but the surging debt mountain is controllable.
A relaxed timetable for deficit reduction means the eventual debt will be higher, and the debt service costs costlier, for the debatable benefit of postponing adjustments which cannot be avoided. Government revenue must increase, and government spending must fall, in any plausible scenario, which means higher taxes and further spending cuts. Higher taxes are coming, everyone knows it, and no useful purpose is served by pretending otherwise. The 2011 levels of current and capital spending cannot be sustained even with large further tax increases. The soft option of borrowing indefinitely is not available unless the IMF/EU, the only lenders, decide that Ireland should be financed into further insolvency.
Readers of this Blog will want to keep up with LBS’s thinking on how the new banking rules will affect the real economy. See his recent address to an Italian conference here. (Surely the correlation coefficient of +0.95 for Ireland in slide 18 is a mistake?) Overall, it seems, there will be little adverse effect on the real economy in the long run.
He is quoted in today’s Italian papers warning the banks that they must use their profits to bolster their reserves.