Travelling a Circuitous Route Around the Blindingly Obvious
Michael Burke, writing on Progressive Economy today draws our attention to an important debate about Ireland and the contrasting views from some economic heavyweights about whether or not ‘markets’ approve or disapprove of austerity measures. The point was raised by Paul Krugman in a recent blog post that while the Wall Street Journal praised Ireland’s austerity measures, stating that the ‘markets’ are being kinder to Ireland than to Spain, the opposite is in fact the case.
“Krugman points out that Irish 10yr bond yields are higher than Spanish ones, despite the fact that the latter had to be recently strong-armed into fiscal austerity and there has been a public backlash against the measures. He also points out that Irish Credit Default Swap rates are higher than Spanish ones. Although these are less reliable guides than bond yields, because they are smaller, more illiquid markets, they do indicate that more speculators are betting on an Irish default than on a Spanish one. Helpfully, Krugman provides links to Bloomberg charts, so the facts at least cannot be contested. In neither case can it be argued that the fiscal austerity here has provided greater reassurance to the markets.”
This is all very confusing - a bit like a snake eating its own tail. Imposing austerity measures increases the cost of repaying your debt because the imposition of austerity reduces your ability to pay it back. However, you are told that you will have to impose more austerity in order to avoid the cost of repaying it increasing further.
Or as Michael Burke puts it:
“All the crisis-hit countries in Western Europe, Greece, Spain, Portugal and Italy are suffering a fate that has already befallen Eastern Europe. International bodies such as the ECB, European Commission, IMF, etc. insist on austerity policies to reassure financial markets. Sometimes local governments are happy to oblige, others need arm-twisting. But the austerity doesn’t reassure financial markets, so more of the same is demanded, and yields rise because bond investors think that the risk of default is rising, as Krugman points out.”
And I’m not the only one who’s confused, or so it appears to me.
Discussing the Krugman’s post on Irish Economy Karl Whelan agrees with the Nobel Laureate about the damaging effect “of imposing fiscal austerity too soon” on bond yields. One can question this ‘too soon’ remark as up to now Whelan has supported the government’s austerity measures. However, he then says that the Irish Government has no choice but to impose these measures because the bond markets, which are reacting unfavourably to imposed austerity plans as an indication that we might not be able meet our medium to long term debt obligations, would punish us if we decided to reduce our austerity measures.
He then says, referring to Krugman’s 2009 Erin Go Broke column that Krugman agrees with him. And he’s right, because in that piece Krugman completely contradicts what he said in last Sunday’s blog post “Does Fiscal Austerity Reassure Markets“.
“But there isn’t much disagreement about the need for fiscal austerity. As far as responding to the recession goes, Ireland appears to be really, truly without options, other than to hope for an export-led recovery if and when the rest of the world bounces back.”
To make matters more confusing, Karl Whelan’s article in Business & Finance which he posted on Irish Economy last Thursday seems to contradict his concession today about the rightness of Paul Krugman (modulated by the cavet that there are “few cross-currents here”) and his own point in that post:
“I noticed Leo Varadkar of Fine Gael saying on TV that he thought this planned adjustment was too large. However, sovereign bond markets have become far more nervous in recent months and a failure to stick with our announced plan for adjustments could very possibly see the Irish government shut out of this market, thus becoming reliant on the EU\IMF stabilisation fund. The price of accessing this fund would almost certainly include a more rapid pace of adjustment than is currently planned. Hopefully this represents a solo run from Deputy Varadkar, as a cross-party consensus on the need for the government to stick to its planned path of fiscal adjustment has been one of the key elements distinguishing Ireland from countries like Greece.”
Emphasis mine.
While all these contradictions abound among the wise owl of orthodox economics it seems that the ‘markets’ themselves, those human spirit of international commerce, seem clear and unequivocal. Austerity measures in a recession don’t work. They make matters worse. Now try something else.
In his B&F post Whelan challenges the cost effectiveness of the FF/Green ’stimulus’ measures to date. That the government reduced excise duty on alcohol and brought in a car scrapage scheme which suited strong business interests is now being used as a reason why stimulus doesn’t work.
This ignores completely the well documented advantages of directed stimulus. As chance would have it on the same day that Karl Whelan posted his B&F ‘in the next budget the government should remove all references to ’stimulus” article TASC and the Foundation for European Progressive Studies (FEPS) held a seminar called ‘Stimulating Recovery’. Michael Burke presented a paper detailing how a focused stimulus could lead to economic recovery. In it he cites studies which illustrate the economic benefits of fiscal stimulus:
The most authoritative recent work on the effects of fiscal stimulus brings together seven different econometric models from the Fed (2), OECD, IMF, European Commission, ECB and Bank of Canada, (The Effects of Fiscal Stimulus in Structural Models, IMF WP/10/73). The main conclusion was that “the multipliers from government investment and government consumption [general government spending+…are clearly larger than…” all types of tax cuts and only “….targeted transfers *to the poor+ come close to having the same multipliers as government spending” (p.16). The researchers found that the fiscal multiplier from government investment was a cumulative 3:1 over 2 years.
Rather than the multiplier effect being an abstract or theoretical notion which can’t or should not be applied to Ireland (because of the problems of ‘leakage’, being a small open economy or for the other reasons often cited) we have hard evidence of exactly how it works in Ireland through the National Development Plan.
All the objections to fiscal stimulus cited above must have been in force when the NDPs were implemented, if at all. Yet all evaluations of the NDP show that the multipliers are extremely large.
The average multiplier in these estimates is just under 1: 2.4. In addition, the Mid-Term Evaluation places the average annual return on investment at between 14 and 18 per cent, depending on the composition of the investment. These returns are net of any effects arising from being a SOE, leakage, etc.
It is this kind of argument that our influencial economists need to take seriously rather than tying themselves up in knots while rubbishing a plan knocked together by a justifiably vilified government who are only fulfilling their traditional role of appeasing the Licenced Vitners Association and other sundry business lobby groups.
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