The Perils of Partisan Commentary

I don’t doubt Krugman’s right to suggest we’re in the early stages of a Third Depression. The last few years have been a first instalment in what will prove to be a drawnout, volatile and painful downturn. I also agree it’s “primarily [about] a failure of policy”. Where we differ is on the nature of these failures.

First though, some points of agreement.

Krugman was vocally unhappy about much of what took place during the boom years. He railed against the excesses of the financial system, and the deregulatory zeal that allowed it to run so completely out of control. He expected it all to end badly, although perhaps not quite to the degree it has. He’s also consistently argued that deflation, not inflation, is the greatest danger for the foreseeable future.

No argument, from me at least, on any of this. Nor do I really want to argue with his critique of the simplistic view put forward by those he terms “the apostles of austerity”; namely, that cutting spending and/or raising taxes won’t bring on further short-term pain. It will. To pretend otherwise is disingenuous at best.

The real question is whether there’s any way to avoid this pain that doesn’t bring even more disastrous consequences in its wake. After all, it isn’t hard to make the case that our current impasse is the direct cumulative result of decades of repeated refusals to wear short-term pain. This, in my view, is where the true policy failures occurred (although there’s been no shortage of errors in the various responses to the crisis as well). For anyone with a similarly obsessive interest in these matters, they’re explored in greater depth in “Money, Credit and Financial Systems: Are Crises Built into Their DNA?”.

I don’t share Krugman’s passionate belief in the benefits of more spending but governments do have a critical role to play in the face of this kind of crisis: first, to spread the pain as fairly as possible; second, to care for those who are most vulnerable; and, finally, to facilitate the necessary adjustments rather than standing in their way. Given that so many resources (with labour foremost amongst them) tend to be both plentiful and cheap during crises, it probably also makes sense to embark on carefully chosen investment projects with a realistic chance of being profitable .

Trying to return economic activity to pre-crisis levels, however, is definitely not amongst those useful roles. Much of the output gap that many, including Krugman, are so eager to fill is illusory. Boomtime patterns of demand (and the supply capacity that arose to meet it) were heavily shaped by the ceaseless flow of credit, not only in their extent but also in their nature. Today’s patterns are different and, in the absence of rapid credit growth, much smaller. Tomorrow’s are likely to be even more so. Adjusting our productive capacity to these shifts is one reason why the aftermath of credit booms tend to be so painful and drawnout.

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Yesterday, in “A Terrible Ugliness Is Born”, Krugman took Liz Alderman’s portrait of Ireland for the NY Times as the departure point for a fresh assault on the “apostles”.

It’s been a constant theme of his that much of the rationale for austerity rests on the presumption that markets must be appeased, that a failure to do so will bring things tumbling down. Two things, in his view, argue strongly against this idea. First, the continuing ability of high deficit countries like the US and the UK to borrow at historically low rates suggests the bond vigilantes aren’t exactly saddled up and ready to go. Second, he maintains that those countries who have signed up for the bread and water regime, like Ireland and more recently Greece, have been treated no more kindly by the markets than those who, like Spain, have been more reluctant.

The first, I think, is a bit of a furphy. CDO’s could also be funded at relative rock bottom rates prior to the crunch, and it’s only a couple of years since CDS spreads for Greece and its unhappy compañeros were cruising along at not much over 50 basis points. This despite (to take Greece as an example) a long, largely uninterrupted period of current account deficits averaging over 10% of GDP, government deficits averaging about 5% of GDP and negative net national savings (that’s before net investment is taken into account). Definitely not good in other words. So a serious crisis in Greece was already baked in for many years but ignored by the market. Truth is, when it comes to the markets facts don’t matter until suddenly they do. Who’s to say something similar isn’t happening with the US and the UK?

As for the second, that austerity isn’t bringing any benefits to its practitioners, here Krugman is either being worryingly simplistic or letting a desire for rhetorical effect push the inconvenient bits (aka reality) aside.

He has, for example, made much of the fact (most recently here a couple of days ago) that Spain’s risk spreads are less than Ireland’s. As it happens, that difference is narrowing with Spain now only one basis point below Ireland. More importantly, however, comparing CDS spreads on two countries without considering their fundamentals makes no more sense than doing the same thing for two companies.

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Ireland is certainly no specialty of mine but I did run across an intriguing piece from Professor Morgan Kelly of University College, Dublin. He divides the 15 year period of growth from 1991 to 2006 into two distinct periods: the 1990s with increased competitiveness, rising employment and an extraordinary growth in exports; and the first half of the last decade when things morphed into a frenzied boom in construction and (of course) an equally astonishing growth in credit. A couple of charts from his article illustrate the extent and some of the consequences of the latter.


In 10 years, bank lending to households and non-financial corporations more than tripled, from about 60% of GNP to over 200%. Most of it went to finance mortgages and development activity. The results weren’t pretty.


Amongst the many figures and comparisons provided by Kelly, one stood out: “By 2007, Ireland was building half as many houses as Britain, which has 14 times its population.”

When the bubble finally burst, Ireland was left with an extraordinarily overextended financial system (even by the rich standards of the last decade) and a very tough decision. Should the government back the banks all the way or let bank creditors (other than depositors) suffer the consequences of their folly? Unfortunately, it chose the former.

With total bank assets in Ireland equal to almost ten times GDP (about 40% of them international in scope)[1] this was a momentous, and possibly fatal, choice. I’d wager that most of the concerns swirling around Ireland, the sort that keep its risk spread as high as it is, stem from this sword now hanging over its head. Kelly sums it up in his closing paragraphs:

“Ireland is like a patient bleeding from two gunshot wounds. The Irish government has moved quickly to stanch the smaller, fiscal hole, while insisting that the litres of blood pouring unchecked through the banking hole are “manageable”. Capital markets may not continue to agree for long, triggering a borrowing crisis which will start, most probably, with a run on Irish banks in inter-bank markets.

Ireland may therefore present an early test of the EU bailout fund. However, in contrast to Greece, Ireland’s woes stem almost entirely from its banking system, and could be swiftly and permanently cured by a resolution which shares the losses of Irish banks with the holders of their €115 billion of bonds through a partial debt for equity swap.”[2]

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Spain also had a boom, both in real estate and in credit, but in relative terms, at least compared to Ireland, it was a piker. At the end of 2008 its banking system had liabilities equal to about three times GDP, high enough to be sure, but well within the current exaggerated range (here in Australia, by way of comparison, the ratio is just a touch over two).

At any rate, I’m sure you get my point. Ireland is in the doghouse for some highly idiosyncratic reasons, ones that as Kelly suggested above, it could change. Until and if it does, comparisons such as those made by Krugman are of little or no value. Even less, if that’s possible, than would normally be the case.

Nor are his comments about Greece’s failure to be rewarded for its new-found parsimony much more relevant or useful. Until I looked at its national accounts, I had no idea just how badly Greece had run off the rails. As suggested by the few numbers quoted earlier, it truly is an economic basket case. Its austerity measures, however well meant, are almost certainly both too late and too little. Mostly too late.

Truth is, it’s probably not politically feasible for Greece to work its way out of this mess and so, barring some miracle, I don’t see how a restructuring of its debt can be avoided. The market seems to be coming to a similar conclusion; the 5 year risk premium closed last night at 10% over equivalent duration US Treasuries. Higher, for the first time, than the panicky levels hit prior to the EU/IMF bailout package in early May.

These are slow motion tragedies, albeit in part self-inflicted ones, and we’re likely to see many more in coming years. How best to respond  is no straightforward matter and all of us, I think, if we’re honest, know that we’re only feeling our way forward. Although my framework is very different to Krugman’s, I often get real value from his writings as well as thoroughly enjoying them. Providing, that is, they don’t slip across into propaganda.

Of late, it’s felt at times as if he’s been flirting with that boundary.

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1 Countries with disproportionately large banking systems face very real dangers, most vividly illustrated by Iceland’s implosion. When they have their own currency (like Switzerland, the UK and of course Iceland) those dangers are heightened. William Buiter has written some interesting articles on this topic, for example here and here.

2 If only. The failure by authorities around the world to force bank creditors to absorb their rightful share of losses, whether through haircuts or the conversion of some of the debt to equity, was in my view the single most critical error made during the crisis. It was a classic case of privatised profits and socialised losses and quite apart from the ongoing burden to taxpayers, the decision gravely undermined public confidence in the fairness of government decisions. The long-term cost may well, in some cases, prove critical.

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Martin
Martin
11 years ago

Ingolf,

I think you are misreading him to some extent, consider this quote from his blog

Consider this article in Reuters, which tells us that

A market backlash against countries seen to be dragging their feet on cutting debt and deficits has sparked budget cutbacks all over Europe as governments try to rein in spending.

This seems to imply that countries that haven’t dragged their feet have been rewarded, right? And this is often reported as something that has, in fact, happened — because it’s what’s supposed to happen.

But the rewards to austerity remain, well, invisible. Ireland’s risk spreads are worse than Spain’s, even though Ireland wasted no time on self-flagellation while Spain hesitated. Market confidence in Greece has declined since the government accepted the IMF austerity plan.

What I think Krugman is arguing against with the Ireland/Spain comparison is that people are arguing that austerity is bringing rewards and clearly the evidence at the moment is that this is not true, or at least far from proved. So I can’t see how this is ‘propaganda’. Krugman’s consistent argument from my reading has been that 1) countries like the USA and Germany are not like Iceland, Ireland and Greece, 2) so that even if austerity right away was the right choice for those countries (and the evidence doesn’t support that), that doesn’t necessarily translate to what countries like the USA and Germany should do

cheers

Martin

Butterfield, Bloomfiled & Bishop
Butterfield, Bloomfiled & Bishop
11 years ago

I second Martin

Ingolf
11 years ago

I don’t think I am, Martin.
 
Comparing the market’s risk perception about different entities (whether countries or corporations) without looking at their fundamentals renders the exercise largely meaningless. It tells us what but says nothing about why, nor about what might come next. Certainly, it provides no basis for judging the efficacy or otherwise of whatever actions they’ve taken.
 
Using the indicators in this fashion also means Krugman doesn’t take the past into account. There’s no context, if you like. As it happens, looking at these CDS spreads over the last few years paints quite a different picture to the one he suggests.
 
In early 2009, at the height of the crisis, Ireland’s risk spread hit 396 pts. At that time, Spain’s high point was 170. Last night, Spain closed at 241.85 and Ireland at 253.74. So, Ireland’s perceived risk (from around the time when they enacted their austerity campaign) has come down 140 pts while Spain’s, in the same period, has risen by about 70.
 
Let me hasten to add I’m not suggesting this is a QED for the “Austerians”. Without a whole lot more analysis of the fundamentals, no sensible conclusions can be drawn, and maybe not even then. What it definitely isn’t, though, is strong supporting evidence for Krugman’s argument.
 
And that’s pretty much the point I was trying to make; by using this data in such a superficial fashion, Krugman is devaluing his own commentary (and it’s often so good).

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
11 years ago

Yes Ingolf, thanks for those numbers which rest easier with my intuition. Sufficient austerity works for all its agony and inefficiency. In a way Keynes thought so too, but he feared for Britain if it was not up to the task. And he thought there was a better way. The thing that makes me suspicious of Krugman’s shtick on Ireland is that Hong Kong goes through one of these adjustments every now and again – with its peg to the $US and it is painful, but not infinitely so. At least without looking into it deeply it’s seemed to me that Ireland is in a similar economic position having built a strategy around gains from trade as a tiny country in a huge market.

Ingolf
11 years ago

Interesting comparing it to Hong Kong, Nicholas. You may well be right.

I haven’t read much about Ireland either but it does seem to have more than its fair share of idiosyncrasies. Mostly, as you suggest, probably tied up with its trading role.

Butterfield, Bloomfiled & Bishop
Butterfield, Bloomfiled & Bishop
11 years ago

Ingolf,

Ireland should not have had any increase in their CDS as they pursued a vigorous austerity policy which utterly failed.

Every nation adopting austeity economics has failed in a poor economy. their deficit increases as does debt.

to reduce both you need to boost growth.

This is what Kruggers is saying which seems to have passed you by.

Ingolf
11 years ago

I doubt anyone could miss what “Kruggers” is saying, BB&B. The question is whether he’s right.

Ireland’s risk spread is down from its pre-austerity levels so I’m not sure what you mean with the comment about CDS rates. If you meant it “should” have been lower by now then I think you’re being a bit optimistic about how quickly policy works and also about our ability to be certain of Ireland’s political capacity to carry the policy through. Plus, of course, there’s the whole business of having guaranteed their outsized banking system. That’s a constant and dangerous wild card.

In any case, it’s far too early to even begin to judge whether its austerity policy has failed. It’ll be years before we know how any of the many different policy approaches will finally turn out.

Your use of “vigorous” did get me wondering about how Ireland’s austerity programme compares so I pulled out a few figures from Eurostat (it’s a brilliant site, by the way, with huge amounts of downloadable data). I’d intended to include the chart here but can’t see any way to add images to comments (if anybody does know how, would love to hear).

So, instead, a few figures. The latest data is from the December quarter last year. From the previous December quarter general government expenditure in Ireland was down 5% while Spain was up 4% and Greece up 8%. Compared to the Baltics, though, it’s pretty mild with Estonia down 17%, Latvia 15% and Lithuania 18%. Then again, they went even more berserk during the boom years.

On your last point, I don’t see that austerity leads to increased deficits and increased debt. Quite the contrary. It’s certainly true that some of the bottom-line gains from cutting spending and/or increasing taxes will be lost because of subsequent slowing of the economy (particularly in the early adjustment phase), but there’ll still be net gains.

Butterfield, Bloomfiled & Bishop
Butterfield, Bloomfiled & Bishop
11 years ago

the major point is they all implemented austerity policies which should have meant NO increase in their CDS’s.
This didn’t happen.
counties implementing Austerity economics in all cases gained negative growth, higher deficits and higher debt.
Great policy outcome.

higher deficit and debt always come from weak economies not from stimulus spending.

Stimulus spending actual boosts an economy and means a lower deficit and debt.

There isn’t any net gains at all.

They have massive unemployment, higher debt and a higher deficit. for what.

nothing.

Ingolf
11 years ago

I still can’t see the logic in your first point, BB&B. As it happens, the path of risk spreads since early 2009 if anything supports the case for austerity; Ireland’s was tracking lower until March this year when the recent Eurozone troubles broke out whereas Spain’s has been rising since August last year. Truth is, nobody knows what’s going to happen with any of these countries and prices reflect the constantly shifting perceptions.

No argument that growth (at least initially) slows as a consequence of austerity measures. That doesn’t mean, however, that the deficit increases. Certainly, government revenue will be less than it would otherwise have been, but it won’t be lower by as much as the spending reduction. For deficits to actually increase as a result of cutting spending, the multiplier effect would have to be greater than I think anybody even dreams it could be and tax rates would have to be exceptionally high on the affected economic activities.

The debate about whether stimulus is “good” or not is a separate one. One can argue that there are other benefits that more than make up for the increased deficits it brings about.

Butterfield, Bloomfiled & Bishop
Butterfield, Bloomfiled & Bishop
11 years ago

Ireland for example implemented an Austerity budget the market would drool over.
Why in heaven’s name did their CDS’s ever rise at all. They were doing the ‘right ‘thing.
Except those same poicies brought on a horrible recession. Spending was supposed to fall from 34 to 32% of GDP. It rose to 46% purely because of the weak economy.
the Deficit rose dramatically and so did debt.

See Lithuania, Lativia and Estonia for similar examples.

You and your solutioms make the situation worse.
The market’s solution made it worse.

If Ireland had have implemented a stimulus package , economic growth , the deficit and debt would all be better!

Patrick
Patrick
11 years ago

As an interested but ignorant observer I would like to ask two things:

1) Does the above apply equally to tax cut stimulus? Ie is Krugman (and apparently BB&B although I don’t really understand BB&B’s comments) arguing that you can fund tax cuts out of future growth?

Or is it to be assumed that the ‘multiplier’ really greater than 1 (this seems far from obvious to me)?

2) This letter from Ken Rogoff to Joe Stiglitz seems to me fairly sensible, and I say that as a skeptic of the World Bank in general. In particular this seems on-point:

You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF — no, make that we on the Planet Earth — have considerable experience suggesting otherwise.

How are Krugman’s arguments different to the argument that Rogoff is deriding here, and/or is Rogoff completely wrong?

Finally, as an interestingly divergent point of view, this from the Irish Times may be biased/wrong/what have you, but it appears to support Ingolf’s point that no-one really knows yet:

THE ECONOMIC tide is slowly turning. For the first time in three years, there are now more reasons for hope than for despair.

This week a raft of indicators, when taken together, give grounds to believe that the foundations of a jobs-generating recovery are falling into place. By economists’ standard definition, the recession ended in the first three months of the year according to the CSO’s latest GDP data. There are tentative signs that consumers are spending again. Every measure of retail sales in April was up, albeit marginally, on the low points registered at the turn of the year. All the latest exports numbers – also available to April – show strong growth, and a weaker euro since then should provide some additional boost.

Ingolf
11 years ago

Patrick,
 
1) In all of Krugman’s comments I’ve read recently, he’s focused on stimulus spending rather than tax cuts. FWIW, I’d guess he’d look less favourably on tax cuts, particularly if they weren’t highly progressive.
 
As to how he sees the longer term numbers playing out, I haven’t seen him getting into the detail at all, just noting that it’s something that will have to be dealt with once the economy is back on its feet.
 
And the “multiplier”? As you suggest, it seems hotly contested. There’s some agreement that it’s highly dependent on conditions and an economy’s structure, but beyond that the estimates vary from downright sceptics who put it at close to “0” to enthusiasts who in particular circumstances believe it could reach 3 to 4. To the extent that there is a consensus, it looks to be in the 0.5 to 1.5 range.
 
2) Very amusing letter. Good find. I think in fairness Krugman’s reasonably nuanced about government debt marketability. He accepts the difficulties of countries like Greece but doesn’t think the US, for example, is anywhere near that stage.
 
It would be great if Ireland (and everywhere else for that matter) was turning the corner, but I’d be amazed if it turned out to be so. As far as I can see, the imbalances will take many years to sort out. Still, that’s obviously just my guess.
 
BB&B,
 
Not sure where your spending figures came from; in 2008 (per Eurostat) general government expenditure in Ireland was already 42% of GDP and rose to 48.4% in 2009. As for the Baltics, see #7.
 
Anyway, we seem for the most part to the talking past each other so I’m going to let it go.

Butterfield, Bloomfiled & Bishop
Butterfield, Bloomfiled & Bishop
11 years ago

from the Irish budget papers actually.

Very easy to read.

.
.
11 years ago

Homer,

You’ve trotted out this Lysenkoism on catallaxy numerous times. It is easy to debunk. See the Irish GDP figures.

Leave these poor people alone.

derrida derider
derrida derider
11 years ago

You seem to believe that when investors are no longer willing to hold a government’s debt, all that needs to be done is to increase the supply and it will sell like hot cakes

But Krugman’s crucial point – which I think Ingolf has not responded to at all in spite of it being pointed out by Martin in the very first comment on this post – is that US and German government debt is indeed selling like hot cakes, partly because no-one will buy other public or private debt. So long as this is so a stimulus is all upside for the US and Germany and that’s what these governments should do.

Whatever the best course from here for Ireland and Greece, their cases are utterly different from those of the US and Germany. Germany can best help Greece by itself avoiding a deflationary malaise .

Ingolf
11 years ago

You’re right. I didn’t respond to that part of Martin’s comment (early dementia, perhaps).

The only glancing mention was in a comment on the quote from Rogoff; “I think in fairness Krugman’s reasonably nuanced about government debt marketability. He accepts the difficulties of countries like Greece but doesn’t think the US, for example, is anywhere near that stage.”

Clearly, he (and you) are right. Treasury yields have been drifting lower for some time and there are no signs of indigestion. Ditto for Germany. Who knows how long it will last, but in the meantime they’re certainly free to hit the stimulus pattern button hard if that’s what they want to do.