Adjusting to the End of a Housing Bubble: Lessons from Spain

Ireland is not the only country undergoing a sharp contraction in housing and it is interesting to learn about the policy debate in other countries (especially fellow members of the euro area). This new article on VoxEU gives a good overview of the current debate in Spain:

The Spanish trade-off: Bricks vs. brains

VAT Cut Won’t Halt Cross-Border Shopping

This website got a plug today in Alan Ahearne’s “Short View” column in the Sunday Independent. The article asked whether the Government should heed calls for a fiscal stimulus plan for this country. Ahearne concludes that the answer is an unambiguous no.

Cuts in VAT rates, along the lines introduced in the UK, would do little to bolster economic activity in this country. Part of the tax cut may not be passed on to consumers. Moreover, a substantial chunk of Irish households’ spending is on imported goods. Increased spending on imports provides only limited support to our economy. The bang for the buck from a VAT cut is small in an open economy like ours because much of the impulse leaks out through higher imports.

A stimulus proposal might be effective at boosting transactions if it were huge. But the country can’t afford such a plan. Claims that a VAT cut could be self-financing are baseless. The Dept. of Finance estimate that the 0.5 percentage point hike in the standard VAT rate in Budget 2009 will raise €220 million. A crude extrapolation would suggest that slashing VAT to the UK rate of 15 per cent would add another €3 billion to the State’s already enormous borrowing requirement. As argued previously on this website under the post “On Deficits and Debts” (3 December), there’s a limit as to how much the Government can comfortably borrow on international markets.

A cut in VAT would also likely do little to stem the flow of shoppers across the border with Northern Ireland. Price differentials between the Republic and the North largely reflect the weakness of sterling and differences in business costs.  A fiscal stimulus won’t solve these problems. A focus on improved competitiveness and realistic wage-setting would be much more valuable. Meanwhile, budgetary policy should aim at avoiding national bankruptcy.

Free riding

Nice article in the Irish Times today by Jim O’Leary. I particularly liked the following unusually honest section:

The case for borrowing more to fund an attempted stimulus package would be more difficult to rebut if there was a high probability of it being successful, but fiscal stimulus is notoriously difficult to effect in a very open economy like Ireland. The reason is that a high proportion of any increase in demand leaks out through imports.

From our point of view, the best sort of stimulus package are those put in place by our trading partners since these boost demand for our exports without costing us anything. And here, the good news is that most of our main trading partners have announced reflationary fiscal measures of one sort or another in recent weeks/months. What we need to do is ensure that we are well-positioned to avail of the opportunities that will flow from these and what that means, first and foremost, is reducing our production costs to competitive levels.

It is hard to disagree with the logic. If the amazingly profligate government we have had over the past decade had listened to people like JOL on issues like benchmarking, then we might have tried to pull our weight as part of a Europe-wide reflationary package, but as things stand, we are going to have try to free ride. Not very glorious (and rebalancing the books will obviously make a bad recession worse) but there you are.

But let’s hope that too many others don’t also take a similar view! The thing about free riding is that what is individually rational can be collectively disastrous. Dani Rodrik is gloomy here.

CSO release: Institutional Sector Accounts: Financial 2001 – 2007 (Revised)

The Central Statistics Office, Financial Accounts Division, National Accounts has released “Institutional Sector Accounts: Financial 2001 – 2007 (Revised)”.

An e-copy of the release is available on the CSO Website.

An Excel version of the tables from the release is also available on the CSO Website.

St Stephen’s Day entertainment

In case you can’t wait for blogger PH’s rivetting radio lecture: “The Financial Crisis: Ireland and The World” (recorded yesterday before a live audience but not being transmitted until St Stephens Day), you can get the text here.

It’s mostly an interpretation of the causes of — and policy reaction to — the global crisis, and corrects several common fallacies or half-truths.

The Ireland-relevant take-away: Our banking problems were caused by globalization…but not in the way you may think.

It was the fall in interest rates on euro adoption that triggered much of the bubble; easy access to international funding that fuelled it.

(Irish banks’ net foreign borrowing 2003-7 amounted to 50 per cent of GDP; Icelandic banks didn’t do any net foreign borrowing!).

On Deficits and Debt

Colm McCarthy provides an interesting analysis in the Irish Times today (December 3rd 2008) about the poor November tax returns.  A key issue raised by Colm is the market’s appetite for sovereign bonds, in view of the projected rapid increase in issuance across the advanced economies. Since there is a general increase in risk aversion, it will be important to ensure that Ireland is perceived as a low-risk sovereign. To this end, it is important for the government to establish a new multi-year fiscal programme that shows how the growth in public debt will be managed, with a clear plan to return the debt to a sustainable path once economic recovery takes hold.