Tuesday, 9 March 2010

The debate begins

Michael Burke: The Open Letter is being discussed over at Irish Economy.

Two interesting counter-thrusts, which are not entirely new. One is that the government's slash and burn approach has stemmed the rise in long-term interest rates. Philip Lane says, "If the government had not undertaken a sizeable fiscal adjustment, the spread on sovereign debt would surely be much higher than the current elevated level and the upward movement in interest rates (influencing the funding costs for the banking system as well as for the government) would have had an even more contractionary impact on the economy.”

But, as previously argued here, this does not accord with the facts. Government austerity policies have widened Ireland’s yield premium over other Euro Area borrowers.

This can be established by comparison with a host of European sovereign borrowers, all of whom adopted reflationary measures in 2009. The most obvious comparator is Belgium, which (by dint of having higher debt and lower deficits) had almost exactly the same 10-year yields as Ireland for well over a year before the crisis occurred. They were within a bps or two of one another.

The Belgian authorities engaged in significant reflationary measures- Ireland had its own unique contractionary experiment. The yield spreads began to part company precisely when Ireland adoped the first of the austerity packages in late 2008. From a zero yield premium over Belgium, this diametrically opposed policy has pushed out the yield premium to 77bps currently, and has been over 100bps. Even in its own terms, the Irish government policy of ‘reassuring the financial markets’ has failed utterly.

The second argument, also familiar to readers of this blog, is that Irealnd's uniquely severe fiscal position ruled out borrowing to invest. But Ireland's fiscal postion wasn't unique, although the response was. It has made matters wose.

The Irish slump was a year earlier than that of the Euro Area as a whole. Ireland’s budget deficit was 7.2% of GDP in 2008 (net general government borrowing). That is not qualitatively different from the Euro Area average the following year, when their recession kicked in. The average deficit that year was 6.4% of GDP, with France a whopping 8.3%. However, the overwhelming bulk of those countries adopted fiscal stimulus packages, with France one of the biggest of all (hence the scale of the short-term blowout in the deficit). So, Ireland's fiscal position did not preclude borrowing to invest, only its polices did.

The EU Commission forecasts French net GGB this year at 8.2% in 2010 and falling to 7.7% in 2011. Similarly, Belgian GGB is expected to be 5.9%, 5.8% and 5.8% (incidentally, one of the reasons that Belgium is a useful comparator, aside from previously identical yields, is to overcome criticisms that the this does not apply to a small open economy, or to lay the yield blowout at the door of Ireland's bank bailout; Belgium is 2nd in the Euro Area behind Ireland for both).

For the Euro Area as a whole, the profile of GGB forecasts is 6.4%, 6.9% and 6.5% out to 2011, whereas Ireland’s is 12.5%, 14.7% and 14.7%. The Euro Area adopted fiscal stimulus; Ireland a Thatcherite slash & burn. The Euro Area is expected to stabilise and lower its deficit. Ireland’s deficit is expected to increase and then ’stabilise’ at that higher level.

The architects of slash & burn need a Plan B, soon, and a little top-up of investment, ‘financed’ by more slash & burn won’t pass muster.


Mack said...

Michael -

"The most obvious comparator is Belgium, which (by dint of having higher debt and lower deficits) had almost exacty the same 10year yields as Ireland for well over a year before the crisis occurred. They were within a bps or two of one another."

You have to be kidding?

Belgium over -
Portugal ?
Italy ?
Greece ?
Spain ?

Really ?

Paul Hunt said...


If you desire debate, I think the best place to start would be Constantin Gurdgiev's comprehensive rebuttal (already linked by an anonymous commenter). We have to tackle what's in front of us. This Belgian fetish adds little. As a core member of the EU the extent to which the Belgian economy is integrated with the surrounding economies is significant but not surprising. And the surrounding economies seem to indulge the extra cost it incurs to hold itself together as a country.

What worries me is that the economic (and political) illiteracy exhibited in this latter is still capable of attracting sufficient popular support to deflect attention from the fundamental problems of democratic governance and the formulation of sensible economic policies.

Eoin O'Mahony said...

And it is astonishing to me how narrowly focussed 'the debate' has been over on irish economy. There is nothing else but to get arguing over 'bond yields' and 'debt spreading'.

Michael Burke said...

@ Mack

I'm not sure your incredulity has allowed you to address the argument. Ireland and Belgium had more or less identical yields (for the reasons stated) over the course of 2008 and before. But then Ireland engaged in Thatcherite economic policies and Belgium adopted stimulus. Immedately its spread over Belgium widened. Now Ireland's yields are 77bps above Belgium's and have been over 1% higher.

Ireland has only come to be regarded in the same group as these other countries since it adopted slash & burn, not before.

But, since you insist on that comparison now, let's also make it then, before austerity was adopted in Ireland. These were the 10yr yield spreads (in basis points) in Jan 31 2008 between the following countries and Ireland (current yield gap in brackets)

Belgium +4 (-77)
Portugal +5 (-13)
Italy +15 (-51)
Greece +14 (+159)
Spain -7 (-56)

Aside from Greece, where prior deficit data was a lie, all the other countries in the group you would have Ireland compared to have in fact experienced falling yields relative to Ireland over that period.

The two countries that are engaged in slash&burn are Ireland and Greece. The others had some fiscal stimulus, ranging from Italy's very little to Spain's significant reflation.

The verdict is clear as to who has actually reassured the finacial markets, and achieved lower borrowing costs for taxpyaers- and it isn't Ireland.

@ Paul Hunt
As a regular contributor to both PE and IE, you know that I and other supporters of the open letter have been enaged in debate on both blogs.

Perhaps you could encourage your champion du jour to contribute either to PE or IE, where his views can be tested by a wide range of contributors.

I warmly recommend to all those who haven't a reading of 'King Leopold's Ghost' by Adam Hochschild. It would cure any sensible person of a Belgian fetish.

Mack said...

Michael, this comic may help explain some of my thinking on this -


On the 31st of January 2008, Lehman Brothers was still in existence and Anglo Irish Bank weas a private entity. In fact they'd had a remarkably profitable 2007 and went on to post a profit of €784m for the year to September 2008. We all know that situation changed radically towards the end of 2008 with the international banking crisis and the virtual collapse of the Irish banking system.


How severe was the banking crises in Belgium?

Before Christmas, if my memory serves me, Ireland was the international / European whipping boy and the worst performer in Europe.

The Greeks AFAIK had to be dragged kicking and screaming to fiscal consolidation. Are you saying that the Greek Socialist Party should tell Germany and France where to stick their bail out, not implement any cuts, and as result they could watch the interest they have to pay on government debt fall baby, fall?

Mack said...

Probably also worth pointing out that the period of divergence with Belgian bond yields also includes the point in time at which the Irish government took leave of it's senses and decided to guarantee all Irish bank liabilities.

Surely, if all else where equal, a government that underwrites 400-900% of GDP worth of liabilities in a bust banking sector could expect to have to pay a higher yeild on money it borrows? After all they are in effect asking the lender to take on the risk that the guarantee will be called in and the state as a result become insolvent...

Paul Hunt said...


I think Constantin's critique is as much in the public domain as any links that are critiqued on this site. Amd I don't hold any brief or torch or banner for Constantin. On a number of fundamental issues I would disagree with the stance he adopts, but in this instance I think he hit some targets. But, of course, I can't compel you or your co-signatories to engage.

Anonymous said...

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Anonymous said...

Did Belgium have a property bubble that represented 27% of GDP in 2007Did it makes its taxation system entirely vulnerable due to its reliance on the continuing existence of the bubble. Have all its major banks failed due to lending activities stoking the bubble? In other words, does it have the massive hole its economy left by, arguably, the biggest property bubble the world has ever seen for a country of our size?

Slí Eile said...

@All thanks for openning up this debate. A noticeable feature of the discussion elsewhere so far - specifically in regard to the letter by the 28 - has been a marked reluctance to engage with data and instead to resort to labelling. Some commentators pour scorn on the claim that we are a low-tax, low-spend country. This was true up to 2008 on both counts and this explains our social deficit to a large degree. Spend has increased in 2009 and 2010 as % of GDP due to automatic stabilisers (adjustment notwithstanding) while total revenue is still a good 20% points below spend and a good 5% points at least below the EU average (which is too low in my view). That said, yesterday's cartoon in the Irish Times, which refers to the letter, is subtle and thoughtful provoking as well as very funny. The car (in the cartoon) is stuck. We need to find a new vehicle.

Michael Burke said...

@ Anonymous II

Ireland's building and construction was 8.5% of GDP in 2007, not 27%. Table 1.

Belgium's was 4.9% (OECD). Is Ireland the same as Belgium? No. Is Ireland exactly the same as anywhere else? No. Did Ireland have a common problem, slumpig ecoomy and rising deficit? Yes. And there is a clear verdict as to which remedy for that problem actually works; and it isn't Ireland's slash&burn. Ireland's yields, and it deficits have risen, whereas those who adopted fiscal stimulus have stabilised their deficits and their yields.