Should governments cut spending rapidly this year and next if the economy is still on its knees?
This debate is raging, not just in Ireland, but around the world. Broadly speaking, the EU and the European Central Bank (ECB) want to cut back government spending quickly, while the Americans are more cautious, wishing to make sure that the economy is strong enough before they start cutting.
All this comes against a background of the world economy turning out to be more fragile than expected and a real worry in the US that there will be a double dip recession.
The data from the US is not reassuring right now – particularly from the housing market, which has been a good leading indicator of how strong any recovery is likely to be.
The latest in a long stream of increasingly powerful signs that the US housing market is plunging headlong into a double dip came in data published last Tuesday. It showed that housing starts in June fell to a seasonally adjusted annual rate of 549,000 units, including both single-family homes (the great majority) and multiunit buildings.
This was 5 per cent below the level for May, of 578,000 starts – which itself had originally been reported as 593,000, but was revised down with the publication of the June data.
The all-time record low in this series – which stretches all the way back to 1959 – was in April 2009,when 477,000 units were started. So, although there has been a recovery from the trough, it has been a very minor one when you consider that the peak, in January 2006,was 2.3million units.
After a ‘dead-cat bounce’ last spring and summer, the direction has been sideways for the last year.
Now, housing starts are clearly heading downwards again. This renewed slump led Ben Bernanke, chairman of the US Federal Reserve, to admit candidly this week that the outlook for the future was ‘‘unusually uncertain’’. That is banker-speak for ‘‘what we have done so far to solve the problem does not seem to be working’’.
It is refreshing to hear a man in power admit he is not sure which way things are going.
This honesty is not a weakness; it is a strength. It also informs the US position when they question whether it is prudent to cut back state spending right away.
Contrast this humility from the Americans with what was on display in Ireland this week.
Here, where practically every mainstream economist got this boom/ bust cycle totally wrong, many, completely unabashed, are still confidently doling out advice and long-range economic forecasts, despite the fact that the future is extremely uncertain.
In Ireland, the Economic and Social Research Institute (ESRI) has a pretty patchy forecasting record, particularly in recent years.
Yet last week, based on its long-range forecasts, the ESRI was telling the government to ‘‘front-load’’ expenditure cuts.
In a week when the Department of Finance took a hammering for its competence in economics, let’s look at the ESRI, another public sector institution.
In December 2005 (less than five years ago) it produced a long-range forecast similar to the one it produced this week – which was supposed to tell us where we would be now, in 2010.According to its ‘‘worst case scenario’’, Irish GDP would be â‚¬196,876 million; in fact, it is â‚¬166,345 million.
At worst, our debt-to-GDP ratio would be 16 per cent; it is now66 per cent.
It forecast that the 2010 budget deficit would be, at worst, 0.3 per cent GDP; it is, in fact,14.3 per cent of GDP.
So, to use the vernacular, the ESRI, writing in December 2005 hadn’t a rashers what they were taking about.
Remember, I’ve used their worst case scenario here.
The ‘‘high growth scenario’’ in 2005 said that GDP would be at â‚¬208,718 million, the debt/GDP ratio would be 15 per cent and unemployment in 2010 would be 123,000.
The point here is not to have a go at the ESRI – we all make mistakes – but to show that trusting an institution like that, which hasn’t exactly covered itself in glory, might not be the cleverest thing to do.
So when the policy advice from the ESRI is to ‘‘front-load’’ expenditure cuts in December in order to impress the financial market, I am a bit sceptical – particularly as the ESRI itself said the reason its forecasts were so wrong was it that it didn’t have any expertise in credit, banking and financial markets. If it has no expertise, how can it make pronouncements on the likely reaction of the financial markets to anything?
It would seem more logical to adopt the US approach: throw our hands up and say we don’t really know what is going to happen next.
What we do know is that if the government can invest now in productive assets such as people or infrastructure, which will generate a return on investment greater than the rate of interest, this is likely to put us in a stronger position to emerge from even a double-dip slump.
As a response to the Irish people deciding to save more (which is what is happening), privatising the state assets that make most money and cutting back on social services seem a little odd.
It is made all the odder by the fact that we are a tiny part of a monetary union, and the only real benefit of our membership is that we can borrow to invest in productive assets. (By all means, sell state assets, but do so towards the top of the cycle when the state can get a good price for them, rather than now when it will definitely be a fire sale benefiting buyers, not sellers.)
The downside of the monetary union is that it makes the recovery much harder, because you can’t devalue to regain competitiveness. In political terms, it also biases economic policy towards evolutionary progress, when something revolutionary might be necessary.
The upside is that it allows you more time to transform the place.
This is what the Americans are doing: playing for time.
This is what Paul Krugman, a Nobel prize winner for economics, was getting at when he took the ESRI to task this week, writing that the institute was doling out policy advice based on assertion, rather than persuasive analysis. It seems that in Ireland, some of the strongest supporters of the euro are advocating policies more appropriate for a country with an independent currency.
Small countries with independent currencies always run the risk that the markets will close down on them, so they must react quickly. In the EMU, the opposite applies because the small country is simply the weakest link in a chain.
It looks like the ERSI – because it doesn’t have (as it admits itself) the expertise in financial markets – doesn’t understand that the euro gives us time.
This is the real lesson from Greece’s bailout.
There are many good reasons to reform the public sector; an immediate threat from the bond market isn’t one of them.
The front-loaded cuts idea seems based on a strange ideology, whereby one very well-paid public sector institute contends that we must close down other public sector institutes. Pots and kettles come to mind.
Seems we are doomed to repeat Hoover’s mistakes, austerity will do what this government does best, make a bad situation worse. ESRI and similar public organisations should be required to show a performance graph on their websites showing their predictions over time against actual economic data that transpired http://bit.ly/a8dyJ5 As other posters noted we are going the way of African/Latin American debtor currencies, current suicides at 3/day being the Frontline of the dying middle class, their children forced to emigrate, a society of the super rich and the poor buggers who hadn’t the wit or means to emigrate or the… Read more »
So what do you make of the governments’ announcement to spend â‚¬39 billion over the next 6 years. Too little, too late? Or will it suffice to keep us ticking over until the uncertainty has passed?
Hi David, I thought it was just me; I thought I was missing something. I just couldn’t understand how people whose ability to foretell the future had been so manifestly wrong in the past could get back on their soapboxes and start spoofing and waffling again. Even worse, our woeful government continues to treat this spoofing – when it suits them – as something we should all bow down to. The snake oil salesmen at least moved from town to town and had the advantage of fooling people once before disappearing to hoodwink the next group of suckers. The modern… Read more »
@ David McWilliams – a much needed article but I would have gone harder on the ESRI (its make-up, who’s who etc) and harder on the shameless well paid economists, working both sides of the deal, who Professor Noam Chomsky said generally, were a class who played a major role (like the high priests of the Mayan civilisation) in bringing this economic storm on our heads. A look back at ESRI forecasting, Dept. of Finance forecasting, the role of the regulator, the Dail (TD’s with property and banking shares portfolios), economists who predicted ‘modest growth’, to ‘soft landings’ and here… Read more »
Helicopter Ben and the FED have ran out of bullets on with the printing press again,they may have deflation now ,but just wait until the mula filters and inflation takes hold ,the same goes for that bunch in the ECB. As for for that lula Krugman ,anything that big government,big spending ,print money Keynesian socialist advocates I would run a mile. We in this country have to get back to basics and start producing real stuff with real value and be competitive.The welfare state is killing us ,as it will all other socialist welfare states in Europe. Just read the… Read more »
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Can we dismantle the ESRI ? Just disband as a useless quango. The further you go from Merrion Square the less seriously it’s opinions are taken. Increasingly people regard it as expensive entertainment. It is a bit like Pravda/RTE – a mouth piece for government policy/agendas.
I am looking forward to the ESRI telling us that the PAYE sector is saving too much. Well, it looks like as is the ‘manufacturing of consent’ is not working like it used to in the past.
Sell the ESRI. Let them exist on the private sector. As a taxpayer I am fed up paying for outlandish salaries for a bunch of clowns, many of whom are related the politicians, to tell me bullshit that is so of the mark that I am tempted to laugh in derision. Basically, the ESRI has failed in it’s ‘responsibility’. The reports are so biased in favour of IBEC, that you may as well have IBEC commission a bunch of private sector cronies to produce a ‘yes-man report’. Privatize the ESRI. It is owned by the private sector via IBEC anyway.… Read more »
David, I managed to get hold of Hudson’s “Super Imperialism” and have read the preface and most of the intro (!) – it’s dense but excellent and needs to be taken slowly if at all. It was revised in 2003 but is essentially the same book he published in 1971. The big insights (for me), as identified by him nearly 40 years ago, are the extent to which the US’s own economic interests predominate and that all foreign policy, aid and diplomatic activity is subservient to this end. And, secondly, the reason why the US has become the first country… Read more »
Thought this was interesting. In the comments section of Paul Krugman’s article – that David refers to – was a posting by someone registered as Ray MacSharry, Galway – 5th post down. “Paul, With no ability to control currency, with a rising debt to gdp ratio..with a very high unit labour cost, and with the crystalisation of proportionally massive banking losses and a crashed property market, the policy levers open to Ireland are few and far between. There is little this country can do other then to trim spending,try and engineer an economy wide deflationary effect on wages and costs…and… Read more »
Ireland’s still more or less the world’s most open economy, rendering stimulus/austerity arguments here moot. Substituting Ireland for (America) in the ongoing debate about stimulus makes little sense.
Folks, here is an interesting collection of quotes, from various sources, about why the EU stress-tests on banks have not fooled anyone:
And the good news is…Cowen has just signed the dotted line for another 39 Billion Euro of your money to be spent on infrastructure. I love the way they give the billas the good bit. We don’t have the money. And Cowen has already made promises. The Dublin Chamber of Commerce ( IBEC Junior) have given a guarded welcome. (Obviously they held out hopes for more). We have two large banks which were in the grey category in last weeks reports. We are borrowing 19-20 Billion per annum to meet the Irish lifestyle. Plus Anglo. Plus NAMA. Plus half a… Read more »
Some of ye might remember me mentioning this thing called the “echo bubble” last October if memory serves me right. Now it happens for various reasons after an original bubble has burst, the idea being to re-inflate the original bubble by as much as possible, which it is hoped, at least by the “inflaters”, to reduce their exposure and by extension their losses. That’s the theory anyway. Now at this point let me stress that all bubbles are not massive Economic “Armageddons” as we have in Irelands property case, but can be very insignificant events and go unnoticed by the… Read more »
Came across while doing some research on the origins of the name “Wall Street”, thought it may be of interest, the bones of the Celtic Tiger economy are about to be built on by construction stimulus II………… “The Dutch intially ‘settled’ what is now Manhattan, they called it New Netherland, later New Amsterdam of course the Indians were chased off it, usual slaughter etc. The Dutch built a wall (timber/earth) from one side of the island of ‘Manhattan’ to the other to reinforce their settlement, some time later the British conquered the region and the settlement and christened it New… Read more »
David McW says: “The downside of the monetary union is that it makes the recovery much harder, because you can’t devalue to regain competitiveness.” Remember that Ireland’s subscription to the ECB capital (presumably based on the reserves we contributed when we went into the Eurozone) was about 1% of its total capital. David understands bank balance sheets much better than any of us so I’d like to have his comments about the ECB balance sheet at http://www.ecb.europa.eu/stats/keyind/html/sdds.en.html It seems to me that ECB official reserve assets are â‚¬569.7 billions and its gross external debt is â‚¬10.78 trillions, a leverage ratio… Read more »
Coulda Woulda Shoulda http://nyti.ms/ctjkus
The problem with the airy assertion that government spending on infrastructure and productive assets is the way forward, is that all the evidence points towards the government being completely incapable of any such thing. For 40 years we’ve had these announcements by the US, UK and Irish governments (and others no doubt). They’re going to “put the country at the forefront of the white hot technologies of tomorrow”, or some such nonsense. All that’s happened over that time is that total debt has mounted. Every ‘boom’ has been based on a massive net loss being covered up by a huge… Read more »
Capital Budget Declaration to The Nation : Yesterday was a Full Moon and was chosen as that special moment to make maximum impact to the Government flagging morale.
The DOF has been accused of lack of economist on their staff but they certainly know their astrology.
There was â‚¬76.2bn capital spending promised in the National Development Plan (NDP) for 2007 to 2013. The revised spending plan promises to invest â‚¬39 bn in infrastructure between now and 2016, a drop of 37.2 bn or roughly the cost of bailing out Anglo. At least we can see the damage now. More school prefabs, no roads outside Dublin and private pensions lose tax allowances to suppliment tax free senior public service golden parachutes. There will, however, be tax allowances for buying rowing boats in areas subject to flooding and for those who fly abroad for urgent medical treatment. Geobbels… Read more »
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Tolls on National Roads coming…we are saved!
Hello everyone, The following link will explain much better than I can what I have been saying about various interests controlling us by controlling the money supply. I would think David that these various interests know you are telling the truth but have discounted you because the also know that the ordinary man on the street is too lazy, disinterested or busy watching dead enders or fair shitty (latter day Roman citizens fixated by bread and circuses)to do anything about it even when he himself is the human being stopping enemy bullets with his chest fired by other human beings… Read more »
Fractional Banking and all those other complex linguistics invented to confuse people like me still can’t explain away simple crookery. http://bit.ly/aSnLUG There isn’t a Dicky Bird about this from the mainstream media. Given that the Nepotistic And Moribund Association was set up to wear external underpants in its quest to save Hay-Run(or Oir-Land as our Neo-Brits would have it), this craic is beyond a joke. These people are so myopic in the panic to save themselves, they’re the only ones that don’t get the reality of the situation. Is it a Ship of Fools or as TotalMayhem subtly states above… Read more »
Dav0 is right trying to turn your attention towards other contents of Chris Masterjohn’s blog:
It will point you to a different kind of conspiracy, a knowledge of which may be of more direct benefit to you than studying the shenanigans of your new Irish Landlords. Regards,
Stan Bleszynski ( http://stan-heretic.blogspot.com )