Rollover Risk and the Crisis Resolution Mechanism

Gauged by yesterday’s market reaction, the EU-IMF support package did little to dampen longer-term default worries on Irish debt.   The yield on the 10-year bond rose on Monday after an initial rally, even as the yield on 2-year bonds fell.   Potential buyers continue to have a number of doubts about Ireland’s creditworthiness:  doubts about the political capacity to produce the necessary primary budget surplus; doubts about whether sufficient nominal growth can be generated to stabilise the debt to GDP ratio even with an impressive turnaround in the primary balance; and doubts about how the direct cost of the banking bailout will impact the starting level of debt. 

There has been a lot of discussion of an additional source of doubt that is largely outside of our control: the rules of the new EU resolution regime that will be in place for government debt.   It is not immediately obvious why the arrangements that will be in place from 2013 should have such a bearing on the cost of borrowing today.   However, the new regime will affect the cost and ease of rolling over debts, and so forward-looking investors must look beyond the resolution arrangements that apply to bonds purchased now.    It seems likely that today’s potential investors worry that it will be more difficult for countries such as Ireland to roll-over debts under the new rules. 

The proposed rules reflect a watering down of the tougher arrangements advocated by Germany.   Under the new proposals, a country has to be deemed to have an unsustainable debt to trigger collection action clauses to restructure existing debt as part of any bailout.   Even so, there is an expectation that it will be more costly to raise funds in the future.   

What are the implications for the policy effort to restore Ireland’s creditworthiness?   The nature of the new regime suggests that a country lacking in “fiscal space” could pay a large risk premium in the future.   This could explain why even the expectation of successfully stabilising the debt to GDP ratio at a high level still leaves a country vulnerable to perceived roll–over risk.   Unfortunately, there is no easy solution, but it does suggest the importance of adopting a national fiscal regime aimed at ensuring fiscal space (e.g., putting in place such measures as an independent fiscal council and appropriate fiscal rules).  

I don’t think the report on fiscal governance by the Joint Oireachtas Committee on Finance and the Public Service – and in particular Philip Lane’s excellent background paper for the Committee – received sufficient attention (the report and background paper are available here).   Moving to put the necessary institutions in place may not just be essential to improve fiscal policy in the future, but also an essential part of restoring creditworthiness today in a context where perceptions of future fiscal space are so critical.   

Cancun, climate, and weather

Fokke & Sukke are proud weathermen The outcome of the climate negotiations … can now be predicted months in advance.

The 16th Conference of the Parties to the United Nations Framework Convention on Climate Change and the 6th Meeting of the Parties to its Kyoto Protocol has started today in Cancun. It will last for two weeks. Unlike last year’s conference/meeting in Copenhagen, expectations are low this time. Again, results will be minimal.

The economic crises, the results of the mid-term elections in the USA, climategate, and the deception of Copenhagen are often listed as reasons why Cancun is unlikely to lead to a breakthrough. I would add that the international climate negotiations repeat the same moves over and over again. If something did not work the last 10 times, why would you try it again? I’ve argued elsewhere that the international framework for climate policy is complete, and that we should now focus on reducing national emissions at minimum cost.

There is another similarity between Copenhagen and Cancun. It’s winter. There are slow oscillations in the climate. Experts reckon that cold winters may be with us for another decade or so. After that, trend and cycle will conspire to rapid warming.

Model T politics

It appears that we can elect any kind of government we want, so long as it is black.

As Jacques Chirac might say, il a manqué une bonne occasion de se taire.

Beware of journalists bearing history lessons

Today’s Irish Times contains this gem from Stephen Collins:

Another issue that did not get serious traction in the talks was the simplistic call to “burn the bondholders” for which German chancellor Angela Merkel has to take a lot of responsibility.

The European Central Bank was adamantly opposed to the notion as any such move would threaten the financial stability of Europe. It is ironic that the zealots of the US Tea Party movement and many of those on the left in Ireland share a common belief in “burning bondholders” and damn the consequences.

The lesson of the Great Depression of the 1930s was that taking that kind of approach leads to widespread bank failures and national economic collapse which, in turn, threatens the democratic foundations on which our society is built.

Give me a break.

The bank failures of the 1930s were due to bank runs caused by excessively conservative monetary policies, and in particular by the determination of elites to stick with the gold standard well past its sell-by date. Burning bondholders had nothing to do with it.

Insofar as the 1930s involved debt restructuring (in Latin America, for example), this was part of the solution, not part of the problem — cf. the work by Eichengreen and Portes.

The lesson of the 1930s is that slavish adherence to economic orthodoxy can lead to disaster, and that sometimes you need a radical break with past policy mistakes in order to turn around expectations and prepare the way for recovery. FDR’s abandoning the gold standard was one such radical break; there were other radical breaks with the past that were much less benign, and that were directly caused by previous hyper-orthodoxy.

Finally abandoning the socialization of private losses would not just have made the Irish state more solvent, but would have clearly signalled a new beginning in Irish political and economic life. As things stand, it is hard to disagree with Mohamed El-Erian that the present deal is not the game-changer that Ireland needs.

Forfas: Review of Labour Cost Competitiveness

This report is available here.

Summary:

This report examines the scale of the competitiveness challenge facing Irish firms and considers the reasons and implications for the deterioration in Ireland’s cost base over recent years. It looks at recent labour market developments in terms of employment and earnings trends including setting earnings trends against the international context and wage movements in key competitor locations. The report also provides an overview of the key drivers of labour costs and the impact of a range of factors on Irish wage levels is assessed. Drawing all of this analysis together, the report identifies a set of actions designed to improve the efficiency of the labour market, facilitating employment creation and protecting real incomes.