Wednesday, 2 February 2011

Where did it all go wrong?

Michael Burke: The Central Bank’s latest Quarterly Bulletin contains a sharp reduction in its growth forecasts.

It is now forecasting 1.0% GDP in 2011 and -0.3% GNP. Previous forecasts were 2.4% GDP and 1.7% GNP. The media coverage of the downward revision almost completely neglected the reason for the increased pessimism, and over at the Irish Economy blog there has also been a discussion of the Bulletin without ever referring to the cause of the lower forecasts.

So, here is the Central Bank’s own rationale for lowering its forecasts:
"These projections represent a significant downward revision to those published in the last Quarterly Bulletin, which were compiled on the basis of a much smaller €3bn fiscal consolidation in 2011 than the one currently budgeted, and on the basis of continued market access to funding on reasonable terms.”

The point on reasonable funding terms seems misplaced. The average interest rate on the EU/IMF debt to bail out Europe’s banks is no greater than market rates that obtained when he prior Bulletin was published. On 1 October 2010 Irish 10yr yields were 6.6% and 4yr yields were 5.25%.

Therefore, the real change in circumstances is the much larger ‘fiscal consolidation’ in 2011; €6bn in spending cuts and tax increases rather than the anticipated €3bn. This is a rare explicit official admission that the cuts’ policy has a depressing effect on activity, with obvious implications for the entire logic of the policy. If an extra €3bn in fiscal measures can depress GDP by 1.4% and GNP by 2%, what will be the impact of a €15.8bn ‘fiscal consolidation’? In reality, as the central bank points out €700mn of the 2011 measures are non-recurring asset sales and similar (p.29) - which will not affect growth.

Therefore the additional measures affecting growth amount to €2.3bn. And the impact on the economy? GNP will be €2.6bn lower than previously forecast (Table 1).
Now, of course this doesn’t mean that the central bank has joined the investment, not cuts camp. The intellectual contortions required to accept that cuts are necessary even while identifying the damage arising from them is not confined to the central bank.

But what is the fiscal impact?It is commonplace to assert that lower growth will lower taxes by 30%, as that is the proportion of tax revenues relative to GDP. This nonsense is recycled by many who should know better. First, total government revenues (including social security and other items not in the Exchequer Statements) are overwhelmingly derived from GNP and in 2010 were 43.8% of it. Secondly, the sensitivity of taxation revenues is greater still. Sensitivity is not taxation/output but the change in taxation revenues/change in output.

Some leading commentators – advocates of ‘fiscal consolidation’ – seem wholly unaware of this sensitivity of taxation, which the DoF puts at 0.6. Thirdly, the sensitivity of government finances also includes outlays, ie of output falls and unemployment rises social welfare outlays will rise even if welfare entitlements are cut. Usually, these are neglected in the debate but they are about half the size of the tax impact.

So, we reach a situation where, according to Central Bank analysis, a €2.3bn fiscal tightening leads to a fall of €2.6bn in output. According to DoF analysis this will lead to a €1.56bn in fall in tax revenues. Standard assessments of the impact on government outlays would suggest a rise of €780mn, for a total deterioration in government finances (combining falling taxes and rising outlays) of €2.34mn. That’s €4mn more than the ‘fiscal consolidation’.

So, the deficit is being entrenched and consolidated, along with Depression and unemployment. That’s how we got here. Getting somewhere else still requires a different path.


paul sweeney said...

It is remarkable to read the Central Bank quarterly and to see no admission that the reason why they got their forecasts wrong might be the staggering deflationary policies, which they support. The deflationary mindset is remarkable. But does this attitude call into question the independence of the Bank from Government?
Probably not..... most of the economists still believe that deflation and exports will do the job.

Paul Hunt said...

@Paul Sweeney,

Let's, for the sake of argument, say that a €10 bn haircut can be applied to bank debt. This will reduce the debt mountain by that amount and cut interest payments by, say, €600 mn. So, where do we go from there? Increase taxation across the board to reduce the fiscal deficit? Borrow more to invest in infrastructure, schools, training/education etc?

Michael Burke said...

Why stop at €10bn?

Paul Hunt said...

You're free to pick whatever number you like, Michael, because the Irish Cenetral bank and the ECB have taken the place of many of the bondholders you might like to burn.

And it might also be worth bearing in mind that the European Council is meeting today, ostensibly on energy, but really to push ahead on resolving the EZ crisis. Much of the heavy lifting will be done before 24/25 March when some final decisions will be made on the size and function of the EFSF and on co-ordinated (i.e. directed by Germany and France) fiscal governance in the EZ.

This game will be over before Ireland will have a government properly in place (assuming that the likely combo of FG and Lab will be able to get their act together by then).

Ireland is a problem to be solved and not a proper party to these deliberations.

Michael Burke said...

The bank-related debt is over €50bn and rising. It should be returned to where it properly belongs- the private sector agents who incurred it.

This would, using your maths save €3bn per annum (as well as improving the country's credit worthiness). It could be used to reverse most of this year's cuts and revive the economy.

Paul Hunt said...

Once again the normative 'what should be' over-rides the positive 'what is possible in the current circumstances'. This is the classic failing of the progressive left (though it may attract some emotion-driven popular support in the upcoming election).

We shouldn't be facing into far-reaching deliberations in the European Council having lost our sovereignty and represented by a Taoiseach who doesn't even lead his own party, but we are.

Michael Burke said...

From the central bank's analysis it can be seen that current policy is damaging the economy. This in turn widens the deficit.

A long-winded version of 'We are where we are' obscures the central fact that where we are being led is an even worse place.

An increasing number of us would like to reverse this course.

Paul Hunt said...

Are you suggesting that those of us who focus on what 'can and will" be done - and who query the rational basis of your "would and should" - do not wish to find a way out of this disaster?

What we are seeing is the forces of capitalism suborning governance and subverting markets to protect its interests at the expense of ordinary citizens everywhere. The almost intractable problem Ireland is confronting is that many voters in the core EZ countries bought in to the fantasy perpetrated by their governments that they had developed governance and market arrangements that ensured capitalism would generate economically and socially useful outcomes - and, indeed, for some time it did and voters everywhere benefited. But it was an unsustainable fantasy and, when the wheels started to come off, the capitalist elite was able to apply the extent to which they had bought governments and subverted markets to ensure their interests were protected.

Governments in core EZ countries - in particular Germany and France - live in dread of confronting their voters with the implications of the collapse of the fantasy they have sold them. Their banks are as dodgy, if not more dodgy than, those in Ireland - and their municipal bodies are in even worse financial shape. They have been able to hold off the day of reckoning by 'warehousing' a lot of the debt overhang, but this is not sustainable indefinitely.

What they do not want - and will do their best to prevent - is Ireland, where, unfortunately the full extent of the debt has not been 'warehoused' (mainly because it's too large in relation to GDP), making any solo runs.

The other factor is that core EZ voters in the past were prepared to contribute to help lift Ireland out of backwardness (and a form of dictatorship) and Greece, Spain and Portugal out of backwardness and the legacy of dictatorship as they benefitted as well. They are adamantly opposed to paying again to rescue these countries from the implications of their misgovernance. Claiming that it was their savings and their banks that fuelled the lunacy in Ireland and in the other peripherals is unlikely to persuade these angry voters. In Ireland's case the low corporate tax rate convinces them that Ireland is depriving their governments of revenue and that Ireland did not contribute as it should to the EU when it was booming. They also have the view that Irish public servants - both elected and appointed - are paid far better than their counterparts in these countries.

It may be possible to come up with rational arguments to debunk these notions, but, unfortunately we are now dealing with perceptions that have become deeply ingrained and they are being reinforced by politicians in these countries seeking to conceal the extent to which they have been bought by the capitalist elite.

What we need is a government with a strong popular mandate to speak calmly and reasonably, but firmly, to our EU partners - both in public and in private. I fear that, by the time one is formed, it will be multiheaded and fractious and the deals will be done at the EU level.

Shay said...
This comment has been removed by the author.
Shay said...

@Paul Hunt.

I am genuinely confused as to what your policy prescription is - wait for an even bigger crisis in capitalism and then escape in the ensuing confusion?

At the core of our current problems seem to have been an almost magical piece of financial chicanery where we converted lead we needed to dispose of to gold we owed people.

We made a very large amount of private debt sovereign to protect wealth.

Being unable to afford to repay this new consolidated sovereign debt we borrowed money from the EU/IMF to do so and converted our debt from private investors to a larger one to other states (or effectively so).

Now we have a level of debt that we can no longer support or default on.

I would agree that at the heart of the problem lies the way that the European economy (and EU politics) is configured but our policy has to be more then praying for a debt jubilee, especially since we serve the current centre right EU quite well as an example of what severe punishments await misbehaving countries as well as being a useful feckless foreigners punching bag for Merkozy.

Our best choice might be to escalate the European political crisis until actually punishing us is more damaging to the euro and EU wealth holders than pretending to help us.

I would argue, and strongly, that the more radical (and "naively" left progressive) the new government is the more possibility there is of the current EU consensus on protecting private investment and the euro being challenged.

Paul Hunt said...


I know it may be tempting, like Samson chained to the pillars in the temple of the Phillistines, to pull the temple down, but I think we all know who would be the first victim of the falling masonry.

We seem to have no concept in Ireland of the extent to which our politicians and institutions (both public and private) have lost the trust of our EU partners and of the investors of 'good money' in the sovereign bond markets whom we will need to provide the additional financing of economic activity.

I gave you the 'voice of our permanent government':
This shows how irrelevant the posturing and shape-throwing in the current election camapaign is.

I find it ironic in the extreme, but I'm inclined to put my faith in the right-of-centre daughter of a Lutheran pastor from the former East Germany. She, at least, seems determined to clip the wings of the unelected Eurocrats in the Commission and to bend the forces of financial capitalism to serve the requirements of duly elected governments and the voters they represent.

Shay said...


No Samson defence intended, I just think that our current interests are directly at odds with those of Germany and the ECB so we are better off escalating the issue in the public/political sphere rather than engaging in "quiet diplomacy" where we are effectively begging for mercy from people who now have utter contempt for us.

We serve best as a bad example.

I have not read Mr White's article on how we need to remain calm and carry on. Fool me six times, etc.

I agree that Merkle's initiative on risk sharing, late as it is, is a good one but I am wary of her plans for moving outside the structures of the EU for fiscal cooperation - Ireland would have even less influence and I see no reason that this new intergovernmental group, ad hoc or otherwise, would be less in thrall to the forces of financial capitalism, any more transparent or that we not find our limited influence gone altogether.

Paul Hunt said...


You have put your finger on the key dividing line in this election: 'escalating the issue in the public/political sphere' v. 'engaging in "quiet diplomacy"'.

I understand the basis of your reservations but we may need to consider some additional factors:
1. We need to undertake major reforms to try to regain the trust of our EU peers in our legislators, government, institutions and governance. Perhaps their 'utter contempt for us' is justified. Without doing this we lack any credibiity.
2. While we were distracted by the property bubble there has been a change from a European Germany to a German Europe. Germany has a strategic vision for the EU as an exporter of high value, high knowledge-content goods and services to the BRICs and the emerging economies following in their footsteps. Its neighbours are content to be aligned - or see no alternative to not being aligned - with this strategy. It would make sense for us to see how we can engage.
3. I agree Chancellor's Merkel's attempt to seize control of the EU Project agenda from the Commission runs counter to key EU principles but it has been driven by the extent to which the Commission has driven through ill-designed initiatives with the Euro being the prime candidate - but energy and climate change policies are also candidates.

Britain is in terminal decline and the US is struggling (but has an impressive ability to rejuvenate itself)so it would make sense to consider how we can respond to the changing balance of political and economic power in the EU. I still it would be better than doing a solo run.

Shay said...

@Paul Hunt

Firstly Irish governance needs to be reformed because it failed Ireland, not Europe. Europe was failed by its adherence to market orthodoxy and devotion to the finance "industry".

Secondly as you describe it Chancellor Merkel's European project sounds entirely reasonable for middle Europe, particularly the bit that is Germany.

That does not mean it is reasonable for us or many of the less industrialized states, the terms of this new more Christian Democrat German EU include no significant debt restructuring, no capital controls, no losses for investors and a strong Euro. These are terms which will leave us too financially crippled to be other than a site for call centres and suffering from increasing damage to the fabric of society, such as it is.

Therefore we have no choice but to try and change the terms of the new, unspoken, EU project and quiet diplomacy seems doomed to failure. Political engagement may not yield results but it at least has the advantage of transparency and ceasing the official pretence that all is well with the EU's structure, governance and goals.

Paul Hunt said...


Many thanks for maintaining this exchange which addresses issues of importance beyond immediate tactical responses - and certainly beyond the posturing and shape-throwing in the general election campaign. I agree that Ireland needs to reform its governance firstly in its own interests but also to engage effectively with our EU partners.

As to the 'German Project', we may not be aware of the extent to which Ireland became a key element of the US's economic engagement with the EU - this offshore, low-tax, export platform into the EU for, mainly, US MNCs. Instead of seeking to leverage this further, although I accept there has been considerable growth in indigenous tradable services, we fuelled a domestic property bubble. I'm merely posing a question about the future sustainability of this model - and highlighting the strategic shift that seems to be taking place in the EU.

As to the 'Christian Democrat' consensus that seems to be emerging, I, perhaps, am less sceptical than you. Like any team we have to play what's in front of us - not what we'd like to have in front us (and certainly not some fantasy game that we can play ourselves). I just sense that many senior EU politicians (and not just Chancellor Merkel) believe that the grandiose schemes of the unelected Eurocrats - pushed through over the heads of voters - need to curtailed and reformed. And that the forces of financial capitalism, left run riot by these Eurocrats, need to be brought to heel. There is, of course, no shortage of the pursuit of national advantage or of low politics in all of this, but this is the way the game is shaping up. It might make sense to see what advantage Ireland might be able to secure, as any resolution of the current mess will have to be implemented on an EU-wide basis and the EU collectively might have some clout to bring the financial capitalists to heel. Ireland on its own could so easily be crushed.

Doing a solo run could mean Ireland having to finance itself from its own resources for a considerable perod of time. Not sure if many people fully realise what this might mean.

Shay said...

@Paul Hunt

Thanks for your thoughts on this, I will steal some of them and make them my own.

The fact we are now principally a vehicle for bank debt (135% GDP is it?) does prevent us from returning to the bond markets in a "solo run". Its sad that we have reduced ourselves, one way or another, to such dependence.

My reluctance to go the route of inconspicuous pleading is partially because I just can not help feeling that our sacrifice to the new consensus does not bode well for the nascent EU 2.0.

On a final cheery note I read that the UK seems set on continuing the corporation tax rush to the bottom we encouraged, just in case we thought that our low taxes would remain unique and protect us.

See the references at:

If I understand the implications correctly this means we will not be stealing any more corporate headquarters from blighty.

Paul Hunt said...


Feel free to pillage; ideas tested in debate have more value in wider currency.

Thanks also for the link - I already have some affection for George Monbiot, but I think that Blighty is moving ever further out of the loop in the EU. Empire is long gone, but it still hasn't found a role - apart from being a supplier of mercenaries to the US neocons and purveying financial activities that even Wall St would disdain.

Culturally, historically and geographical we are in the trans-Atlantic economic space defined by the US and the UK. In the '90s we took full advantage of being at the intersecion of this space and that defined by the single EU market. That has not been lost, but we failed to leverage it further. The question is: how can we build on this in the context of the strategic economic shift in the EU?

Thank you for your willingness to debate these issues. Perhaps others here might give some thought to this question.