How Ireland can stage an economic recovery

The Irish Times has a new series on this topic, with articles commissioned from ‘leading’ (always that word) economists.  Today, it is John Fitzgerald: you can read his views here.

A series with a similar theme but a very different set of contributors ran back in August. Here is a partial list:

Sean Quinn (August 11 2008): here.

Derek Quinlan (August 12 2008): here.

Philip Lynch (August 13 2008): here.

Denis O’Brien (August 14 2008): here.

Michael O’Sullivan (August 20 2008): here.

Mark Fitzgerald (August 21 2008):  here.

Price competitiveness deteriorates sharply in December

An indication of the pressures on Ireland’s competitiveness is provided by the Harmonised Competitiveness Index, the December figure for which has recently been released on the Central Bank website. While the real HCI had been falling gradually since the early part of the last year (a rise in the indicator implies a disimprovement in competitiveness, while a fall in the indicator indicates an improvement), the December figure jumped upwards by 4.0% over the previous month, largely due to the appreciation of the euro particularly against sterling. The Dec 2008 value of 126 puts us back where we were at the beginning of last year. Continue reading “Price competitiveness deteriorates sharply in December”

Here we go…

If the Chinese have any sense, they will let their currency appreciate now.

Update: Willem Buiter is also concerned about the looming threat to world trade that this would seem to imply. He displays an extreme scepticism about whether nominal exchange rates ever matter for the trade balance, writing that

only the most bone-headed of ultra-Keynesians believes that a country can influence its effective real exchange rate in a lasting manner by managing/manipulating its effective nominal exchange rate, let alone some bilateral nominal exchange rate.

I guess the key phrase here is “in a lasting manner”, and I defer to Philip about what sort of time scale this implies empirically. I guess that not all economists will agree with Buiter on this particular point. But the broader point, which is critically important, is that we can’t take the maintenance of an open trading system for granted.

Deflationary spirals

It appears that the fear of a deflationary spiral is being used as a major argument against wage cuts. My impression is that the idea is gaining traction out there in the real world, and so it seems worthwhile restating the reasons why it is wrong.

‘The’ price level in the Irish context is the European price level, which is determined by policy in Frankfurt. Nothing that happens in Irish labour markets will move this price level by one iota in either direction, and so nothing that we do here will set off a deflationary spiral. What we can influence is a relative price, namely the relative cost of living and doing business here. This relative cost exploded during the bubble, and it will eventually come down. The only issue is whether this happens quickly, or whether relative Irish costs will be ground down by unemployment and stagnation over the course of many years.

David Begg is right to fear a deflationary spiral, but what will determine whether we get one or not is the relative supply of ideologues and pragmatists in the ECB, not anything that happens here. And the sort of intertemporal logic which explains why deflation is so damaging can be turned on its head in the Irish context: as Philip points out, it implies that wage cuts need to happen all at once, now.

The Government should announce that all public sector wages, which it controls, be cut by x%, where x is determined by real exchange rate considerations. It should strongly suggest that all private sector wages be cut by the same amount. Ideally we would all jump together, and so the wage cuts would come into effect simultaneously on a given date. St Brigid’s Day would seem appropriate.

Did the Euro contribute to the Irish bubble?

Jim O’Leary discusses Ireland’s EMU membership in his Irish Times column today.  An interesting question is whether Ireland would have avoided a bubble had it opted not to join EMU.  The issue here is the relevant counterfactual.  Since quite a number of non-member European peripheral countries that were growing quickly for convergence reasons also enjoyed credit booms due to the global decline in risk aversion and compression of spreads, it is not so obvious that staying outside EMU would have delivered stability (think of Iceland and various CEE countries).

If expectations of price appreciation grip the housing market, small differences in the level of interest rates do not make too much difference.  To the extent that high levels of immigration helped to fuel perceptions of strong fundamentals in the housing market, that dimension is orthogonal to EMU:  the two other countries that were early liberalisers were also not members of EMU (Sweden and the UK).

Accordingly, if the relevant comparison set is composed of other non-advanced European countries (in terms of income levels relative to potential in the late 1990s), then it is not clear that EMU was a fundamental factor.   Rather, key differentiating factors may include the quality of banking regulation and the probity of fiscal policy.

Clearly, this is a very open debate that calls for more research!