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.

Monday’s Conference ‘Responding to the Crisis’.

There has been a big response and Stefanie Feicke will be emailing all those who sought places today. There is almost no capacity left.

Authors are preparing papers late, and we will not be able to photocopy and distribute at the conference. However, the presentations will be posted on this website as they become available.

Ireland’s painful adjustment

After the benefits of EMU, now come the costs. I discuss economic adjustment mechanisms in EMU and what they mean for the near-term outlook for the Irish economy in a new EMU Monitor piece. You can find it here.

The main point is that recovery here depends on the so-called “competitiveness channel” working. For this mechanism to work properly, two things must happen. First, wage and price inflation have to ease to rates below those in our largest trading partners. That probably implies deflation in this country. Second, the improvement in competitiveness must affect trade performance.

The problem is that recovery will be complicated by the depressing effects of the “interest rate channel” of adjustment. Deflation implies high real interest rates, which will further depress domestic demand, assets prices, and the property market.

Why are Irish Government bond spreads so high?

Well this might not seem like a mystery at all, given the ballooning budget deficit and the overhang of banking problems. But I do want to ask what others think about the potential role of the overfunding/prefunding of the government deficit.

The NTMA’s recent Preliminary Results highlights the fact that there was additional borrowing of 8 per cent of GDP in 2008 over and above what was needed to cover the Government’s borrowing requirement for 2008. This extra amount has been banked (safely I am sure).

Of course this should all be transparent to an efficient market, but could it be that such a large volume of gross borrowing might have contributed to market sentiment against Irish paper and increased the spread over bunds?

After all, this additional borrowing affects the General Government Debt to GDP ratio driving this to 41 per cent. (Though it does not affect the traditional National Debt ratio which is around 31 per cent of GDP).

Why is Ireland’s tax collapse so severe?

Publication of the Exchequer Returns today provides more hard evidence on an aspect (previously mentioned by myself and others) which helps unravel this mystery.

Much of the answer lies in the systematic shift towards cyclically sensitive taxes over the past two decades.  There has been more and more dependence on corporation tax, stamp duties and capital gains tax (in that order).  These three saw their share in total tax revenues rise steadily from about 8 per cent in 1987 to 30 per cent in 2006 before falling to 27 per cent in 2007 and just 20 per cent as soon as the economy turned down in 2008.

This has been an almost automatic albeit unintended consequence of the combination of Partnership with an almost unbroken period of rapid growth.  At each pay round, Government negotiators offered concessions in those taxes that are felt by the working person — Income tax and expenditure taxes.  These concessions could be afforded because of the steadily soaring revenues in the cyclically sensitive taxes.  But each notch in this ratchet made the tax system more vulnerable to an economic downturn.

In 2008, tax revenue fell by almost 14 per cent — but the percentage fall in the cyclically sensitive taxes was much larger, at 36 per cent.

Had Ireland’s tax structure been less cyclically sensitive, the fall in revenue would have been much lower.  Indeed, if cyclically sensitive taxes had been back at their 1987 share of total revenue, the fall in revenue last year would have been much lower: 8 per cent instead of 14 per cent.

The medium-term policy implications are clear. The tax structure must be rebalanced in favour of non-cyclical taxes such as income tax, VAT and excises.  Politically painfully of course but ultimately inevitable, I would say.

The Fed’s Ballooning Balance Sheet

With a return to growth for the Irish economy heavily dependent on economic recovery in the world’s major economies, we must hope that the monetary policy actions being taken by the Fed and other leading central banks will be successful.   Unfortunately, it’s a bit hard to judge what’s going on at the moment, particularly at the Fed.  

I’m teaching a module at UCD this semester on central banking.   I last taught the course in Autumn 2007 but already I’m going to have to rip up many of my old lecture notes, so dramatic have been the changes in monetary policy procedures, most notably at the Fed. 

There have been a number of profound changes at the Fed, including a move away from targeting the Federal Funds rate and towards paying interest on reserves.  But the most notable change has been the massive expansion in the size of the Fed’s balance sheet.  The most useful summary of this development that I have found is this recent post by Jim Hamilton.  Commenting on the huge expansion in the Fed’s balance sheet, Hamilton notes “The bottom line is that Bernanke has made a gamble with something approaching 2 trillion.”

Conference Announcement: Responding to the Crisis

Below are details of a conference on the Irish economic situation. Admission is free, but spaces are limited. Places can be booked by email to stefanie.feicke@ucd.ie, telephone (01) 7168335.

The conference website is here.

Responding to the Crisis

The UCD School of Economics, in association with the Dublin Economics Workshop, has arranged a half-day conference on the current economic crisis at the Royal College of Physicians, 6, Kildare St., Dublin 2, on January 12th. 2009.

Programme

14.15 Introductory Remarks

Rodney Thom (UCD)

14.20 Session 1: Fiscal Consolidation

Chair: John Fitz Gerald (ESRI)

Philip Lane (TCD): Fiscal Policy Options in the Euro Area

Ciaran O’Hagan (SocGen Paris): How Much Can Small Sovereigns Borrow?

Colm McCarthy (UCD): Expenditure Control and Fiscal Consolidation

Discussant: Karl Whelan (UCD)

Coffee at 15.45

16.00 Session 2: The Property Bubble and the Banking Crisis

Chair: Brendan Walsh (UCD)

Patrick Honohan (TCD): Resolving the Banking Crisis

Morgan Kelly (UCD): The Irish Property Bubble and its Consequences

Robbie Kelleher (Davy): Bank Solvency, Basle II and Accounting Standards

Discussant: Alan Ahearne (NUI Galway)

Conference concludes at 17.30.