To cut faster or not (leaving aside the banks)

paddy0090

The pace of austerity is a subject that keeps popping up in other threads as a result of Morgan Kellys article in the times. A similar argument was made by Joe Durkan of the ESRI. In todays IT an article today containing the opinions of 12 economists from across Ireland the merits of Kellys 2 ideas are discussed.

Some take issue with his figures and most reject on some level reducing the deficit in a year. Again there are questions over whether or not we could simply disengage from the ECB and hand over the banks. Bar the union economist none rule out increasing the pace of austerity. But I suppose this is to be expected given our undertakings in the Memorandum of Understanding.

There's also another argument here from Emmet Oliver in the Indo that it might halp shock the markets into seeing us in a different light. Though how much would be required to achieve such a shock I don't know.

While I'm not certain about 0 in a year, I think the economy could handle more austerity per year. Seeing as we've already agreed to meet targets in the MOU this may become the case anyway and I think it would be better to take the initiative.

FF might well have done the same, if (gravity had somehow failed) they were still in power. Having laid out an 'easier' route to recovery, they can now claim that any 'ruin' arising from deeper cuts is the current coalitions fault, irrespective of whether or not it was inevitable. Is the 4 yr program the least worst option or just the most politically viable one?

3 more years of media doom porn isn't going to do us any good either. Think about it, every other week some vested interest bring it's version of Revelations on show. However real it may be, I'm sick of it already. More than any single economist I think these stories do more to damage consumer and business confidence. I think people won't be as scared if we break the deficits back earlier. If the govt. is afraid to take decisive action for fear of the consequences like Hamlet, it will be reflected in the public.

BY cut I mean the deficit not specifically spending. And my suspicion is that any faster reduction of the deficit will be accounted for by greater tax increases and increased charges for middle income earners.

I'm not interested in the banks NAMA PS bashing or Welfare payments. Otherwise waht do you think?

Scofflaw

Good thread starter - in a sense this is the core of the debate, because if cutting the deficit immediately isn't feasible, default is effectively ruled out at once.

cordially,
Scofflaw

There is evidence to show that fiscal consolidations (cutting back) can generate growth if they follow the correct formula.
http://www.nber.org/chapters/c10973.pdf

For this to happen it must be done primarily through wage cuts and current spending cuts while maintaining capital expenditure (once projects are expected to generate revenue at a higher rate than the interest paid on the loans taken out to fund the projects).

Tax increases are to be kept to an absolute minimum when following this course of action as higher taxes will slow growth.

Of course we are talking about cutting huge numbers....but it must be remember that whatever we borrow is money that must be paid back with interest - this means less growth in the future as our resources are diverted into paying back the loans.

Fianna Fail focused on cutting capital expenditure instead of current spending while consolidating - the polar opposite of how to do an expansionary fiscal consolidation!!!

I must point out that if we followed the ESRIs advice and cut faster - by 2014 years we would still have taken a total of 6 years to get our house in order. This is simply outrageous when you take into account how bad the situation is and has been for years now.

How long do we want this to be drawn out? One of the 12 economists in the critique of Morgan Kellys article says that things arent all doom and gloom yet says things wont get going until after 2017.

http://www.irishtimes.com/newspaper/finance/2011/0513/1224296839491.html

TONY FOLEY

Senior lecturer in economics Dublin City University

I DO not agree that we are heading for economic ruin, although one could argue that large decline in GNP, 15 per cent unemployment and the likelihood that it will be 2017 or so before 2007 levels of economic activity will be resumed is already economic ruin.

Life is too short IMO.

sarumite

paddy0090 wrote: »

BY cut I mean the deficit not specifically spending. And my suspicion is that any faster reduction of the deficit will be accounted for by greater tax increases and increased charges for middle income earners.

I am curious why you think it would be greater taxation as opposed to greater cuts? From what I have read, spending cuts are preferable to taxation (suggested ration was I believe 3:1 spending cuts: taxation). I think it should come down to whether we have a spending problem, an income problem or both. My personal (and I am sure economically ignorant) opinion is that it is both, however spending is the major portion of the problem.

Nody

sarumite wrote: »

I am curious why you think it would be greater taxation as opposed to greater cuts? From what I have read, spending cuts are preferable to taxation (suggested ration was I believe 3:1 spending cuts: taxation). I think it should come down to whether we have a spending problem, an income problem or both. My personal (and I am sure economically ignorant) opinion is that it is both, however spending is the major portion of the problem.

Because nuns/polices/<insert staff of choice> cut looks worse when vested interests get to run the "But think of the children campaign" then a 1% tax here, a stealth tax there (ala water charges, VAT, reduced deductions etc.) there looks in the newspapers. People will grumble about it but that is as far as it will go and hence no union revolts to deal with.

Amhran Nua

Nody wrote: »

Because nuns/polices/<insert staff of choice> cut looks worse when vested interests get to run the "But think of the children campaign" then a 1% tax here, a stealth tax there (ala water charges, VAT, reduced deductions etc.) there looks in the newspapers. People will grumble about it but that is as far as it will go and hence no union revolts to deal with.

It's going to happen anyway though. It's not mathematically possible to tax our way out of this, and with milquetoast jobs initiatives like the one recently released, we sure aren't growing our way out of this. I just don't see any way to avoid head on conflicts with the unions.

sarumite

Amhran Nua wrote: »

It's going to happen anyway though. It's not mathematically possible to tax our way out of this, and with milquetoast jobs initiatives like the one recently released, we sure aren't growing our way out of this. I just don't see any way to avoid head on conflicts with the unions.

'Milquetoast'....never heard that word before. Had to wiki it. Thanks :pac:

paddy0090

sarumite wrote: »

I am curious why you think it would be greater taxation as opposed to greater cuts? From what I have read, spending cuts are preferable to taxation (suggested ration was I believe 3:1 spending cuts: taxation). I think it should come down to whether we have a spending problem, an income problem or both. My personal (and I am sure economically ignorant) opinion is that it is both, however spending is the major portion of the problem.

Personally I agree with Blindjustice. It's been shown time again that trying to increase taxation in a recession doesn't deliver the desired results. So it makes more sense to cut spending than to chase your tail trying to collect taxes.

But as he said above we've gone about this a*se ways and apparently the current govt. seems to have no intention of changing course from the FF 4 yr plan. Even the jobs initiative was aimed at demand rather than supply.

I didn't just say taxation I said increased charges as well. So we come to the semantics of taxation and cuts. When does a cut in funding become a tax?

If the govt. cuts the funding to schools to educate one child then the school can replace this by charging(a stealth tax some might say) at the door. Alternatively it can become super duper efficient. Of course The govt. would never do so in poorer areas so the brunt of this cut/tax is felt by middle income earners. Well off earners yada yada yada.

This isn't as mad as you think. 50% of school in Catholic control (AFAIK I'm told the church can't come up with the cash) will be handed over to new patrons in six months. The patrons will require patronage!

In addition to this there is the scheme for mandatory health insurance to be impleneted within 6 years(before or after the next election). This will undoubtedly hit middle income earners hardest.

The pension levy wasn't progressive either, it hit everyone with a private pension with the same charge of .6%. Public or private sector the above will affect you the same(yes I know most public sector workers only have the govt. db pension but etc.)

This is all just speculation. Middle income earners represent the larger part of the labour force. They are also less troublesome. In that they are less mobile than the well off(able to exploit loopholes). And too proud to become criminals(in the very loosest sense of the word) as they have more to loose. An easier target all in all.

It's been argued elsewhere that bringing the deficit to zero overnight would involve cutting the income of every household by 10,000. While it's nice to think that it could be loaded on to the rich and I think 10,000 is overly pessimistic. On current form something like this figure is probably more likely.

@scofflaw

I've never considered default to be an option, more a reality that could yet dawn on us if we don't get the accounts in order or even if we do. The credit system is banjaxed and the growth figures are on a downward trajectory. We are the only PIG making reving sounds on the runway. I do agree but I think if we don't change course soon it will become inevitable.

Sleepy

Given the levels of waste in public expenditure we see on a weekly basis, I'm convinced this is the correct path to follow and the only reasons we're not following this path is because it's political suicide for anyone with the balls to implement it.

With any combination of the following, we'd see the deficit contract rapidly:

• Consolidation of quangos, government departments, local authorities etc.
• Reduction of welfare in all it's forms: children's allowance, pensions (both non-contributory and PS), dole, rent allowance etc.
• Benchmarking of PS salaries with *genuine* private sector equivalents (both ways, pay the best staff what they're worth out of some of the savings made in reductions)
• The least popular of all: redundancies on a massive scale: If you're not up to scratch, you're gone, if your position can be considered a "nice to have" rather than an essential service, you're gone.
• Better focus of education spend: less funding for theology, 15th Century Irish Poetry, women's studies courses etc; re-allocate some of the savings into technology, science, bio-med, agri-business etc. (again, the "nice to have but not essential rule - we need more people putting their shoulder to the wheel and less pursuing personal interests)
• Inclusion of existing staff in the salary cuts for new PS workers
• The policy of salaries incrementing on an annual scale to be terminated permanently. Salary should rise with performance, responsibility and an index-linked inflation raise every couple of years *NOT* because you've kept a seat warm for another 12 months.
• Intelligent use of ICT technology to make public services more efficient: make more services available via the web, stop pissing money away on expensively designed brochure sites, provide staff with the tools they need to do their jobs properly.

Of course, doing any of this requires telling the unions to go f*ck themselves and backbone beyond anything I've ever seen in an Irish politician.

Scofflaw

So, for those who advocate immediately balancing the accounts, would you care to outline the negative impacts / downside risk of a sudden large reduction in government stimulus - or do you not believe there are any? And if not, why not.

Please - as they say - use facts and research to back up your contention?

cordially,
Scofflaw

paddy0090

Scofflaw wrote: »

So, for those who advocate immediately balancing the accounts, would you care to outline the negative impacts / downside risk of a sudden large reduction in government stimulus - or do you not believe there are any? And if not, why not.

Please - as they say - use facts and research to back up your contention?

cordially,
Scofflaw

So you're happy with the status quo?

Who exactly is being stimulated and is he/she worth it?

John Bruton is a former taoiseach and former EU ambassador to Washington. He is chairman of IFSC Ireland, a private sector body that seeks to promote Ireland’s international financial services sector

Nat jobs for de lads an dat, I swear!

Perhaps I'm losing my memory but I don't remember anyone saying that an overnight zero deficit was a great option. The negative impacts are understood(by most) in the general rather than the specific. Which are you asking for?

There are well documented and immediate limits to stimulus. Even without the stats, I'm quite certain it won't cover the required growth rate. Borrow to grow or stabilise can only last so long. We've been doing it for too long now.

To be, or not to be, that is the question:
Whether 'tis nobler in the mind to suffer
The slings and arrows of outrageous fortune,
Or to take arms against a sea of troubles,
And by opposing end them?

Hamlet by William Shakespeare

Sooner or later we all gotta get off the fence.

Sea Sharp

I do agree that cuts need to be made at a faster rate than was proposed by the previous government but cutting the deficit overnight is simply not practical. We need to find the middle ground.
The greater the drop in a person's income, the greater the shock that will be to the persons lifestyle. This can be partially overcome by spreading out the pain by making the inevitable budget cuts more frequent than once annually.
It's fair to say that a €30 euro drop in JSA in December 2011 would be a lot worse than a €15 drop in June and then another €15 drop in December. (it's worth noting that JSA will need to be dropped by €75 over the next few years assuming that cuts are evenly proportional throughout all spending areas.) people need time to cut their grocery bills, move to cheaper rent etc..

Then of course there's the nightmare of how they're going to get passed the unions. I think FG should, in the run-up to the next budget, clearly state that €XX billion needs to be cut and we're going to do this mostly by targeting public sector wages. This should (as always) be said in a vague enough way to get the unions assuming the worst and have them preparing for and threatening strikes that will bring the country to a halt.
Inevitably this will get a lot of publicity and the unions will making stern threats will be all over the news.
Then when the budget comes FG will announce that the absolutely necessary €XX cuts had to come from the social protection budget and not the public service bill as previously stated.
Everyone will, albeit incorrectly, read between the lines and assume the government caved into the unions and if the unions made a big enough fuss in the run up to the budget they will now be absolutely demonized and made to be public enemy number one. The resentment throughout the country will be enough to lose support for, and ultimetely take the unions down. Then in the next budget €XXbillion can be taken from the public sector bill without a hitch as everyone is familiar with where the alternatives lie.
This would allow the government to get a good chunk off the deficit and use someone else as a scapegoat therefore not looking like the bad guys

sarumite

paddy0090 wrote: »

I didn't just say taxation I said increased charges as well. So we come to the semantics of taxation and cuts. When does a cut in funding become a tax?

If the govt. cuts the funding to schools to educate one child then the school can replace this by charging(a stealth tax some might say) at the door. Alternatively it can become super duper efficient. Of course The govt. would never do so in poorer areas so the brunt of this cut/tax is felt by middle income earners. Well off earners yada yada yada.

Ok, I think I see what you mean. While its probably true as well to be honest, I really hope the government try and do it differently.

ei.sdraob

I think Scofflaw should be the one to provide evidence that this "stimulus" is not just leaving our open economy like water out of sive.


From his own graph


Its obvious that Irish are not putting money into Irish banks despite reports of increased savings by people. This money is either leaving the country and/or being used to payback debt which in turn ends up leaving the country.
3 years of "stimulating" on high interest borrowed billions and waiting for EU to get act together is not working out to well now is it? :rolleyes:
And before you point at exports let me point out that most of that is from MNC who in turn funnel the money onto offshore locations.

Sand

Id agree - given that the spend now/cut later path has been chosen, surely the advocates of such an approach have a greater responsibility to demonstrate it is the correct option, with the least costs and greatest benefits. Afterall, if theyre wrong in their contention....we're screwed. And theyve been wrong in their assurances before. And already the growth rates projections on which their plan hinges have been cut, and debt ratios are being recalculated upwards...

Scofflaw

If you can't make a case, just say so. The stimulus effects of government spending are pretty well covered in the literature.

cordially,
Scofflaw

Permabear

This post has been deleted.

Sea Sharp

Sea Sharp wrote: »

spreading out the pain by making the inevitable budget cuts more frequent than once annually.
It's fair to say that a €30 euro drop in JSA in December 2011 would be a lot worse than a €15 drop in June and then another €15 drop in December.

The 30 euro drop in one go is better because of expectations
http://www.econlib.org/library/Enc/RationalExpectations.html

When people know cutbacks are due in the future they save money in the knowledge that the economy is going to retract - they fear they might lose their job of get further paycuts. They save for the rainy day knowing its coming. Economic activity is further contracted during this time. Businesses do the very same to try and insulate themselves.

Also borrowing that extra money means it must be paid back with interest. So we lose not just the growth equivalent of that money but we lose it with interest.

I will add that an attempt at an expansionary fiscal consolidation will fail to do anything but turn us into a zombie like our current course will unless we resolve the banking issue.

Its important to note that if we are overpaying ourselves and diverting money to quangos that are unproductive - FAS for example then cut backs will clearly generate growth. This is because the money wasted has an opportunity cost. It is money taken from taxpayers and businesses who would allocate it more efficiently and thus increase GDP.

Some basics for those interested:
http://en.wikipedia.org/wiki/Opportunity_cost
http://en.wikipedia.org/wiki/Production_possibilities_frontier

Scofflaw

Permabear wrote: »

This post had been deleted.

The downsides of the current approach have been debated ad nauseam - indeed, it's those very downsides that make the notion of default/instant deficit balancing attractive.

What I'm asking is simple - what are the downside risks of immediate balancing of the state budget, according to those who favour it? Are there simply none? Is it the belief of those supporting it that the entire budget savings can be made out of removing waste and inefficiency?

cordially,
Scofflaw

ei.sdraob

Scofflaw wrote: »

If you can't make a case, just say so. The stimulus effects of government spending are pretty well covered in the literature.

cordially,
Scofflaw

Linkie to literature of "stimulus" effects in the worlds most open economy?

Scofflaw wrote: »

What I'm asking is simple - what are the downside risks of immediate balancing of the state budget, according to those who favour it? Are there simply none? Is it the belief of those supporting it that the entire budget savings can be made out of removing waste and inefficiency?

What is the downside of someone who owns a high interest subprime mortgage of borrowing from a loan shark at kneecaping rates in order to sustain a drug habit (public expenditure) and a husband with gambling problem (banks).
The inability to service debt if projected growth does not materialise is "well documented".

View

Permabear wrote: »

This post had been deleted.

Do you have a link for the 204 Billion figure?

NTMA puts the debt at 101 Billion as of March 31st and that includes the parts of the "Bailout" loan monies that we have already received. Even adding in the rest of it, the figure should be somewhere around the 160-170 Billion range at a guess.

Permabear

This post has been deleted.

Scofflaw

Scofflaw wrote: »

If you can't make a case, just say so. The stimulus effects of government spending are pretty well covered in the literature.

cordially,
Scofflaw

Stimulus is ineffectual when the economy is running inefficiently.
For example Ireland was being stimulated by low interest rates during the boom and the money went into property. Stimulus, if timed correctly, could give a good boost to an economy. The timing needs to be after inefficiencies have been taken out of the economy a recession will do that and a cut all in one go will do that ruthlessly.

Right now we are flogging a dead horse. No point in stimulating when the money is wasted on artificially high rents, property prices, insurance, electricity and wages.

Permabear

This post has been deleted.

ei.sdraob

View wrote: »

Do you have a link for the 204 Billion figure?

Scofflaw does

Scofflaw wrote: »

Source: http://economic-incentives.blogspot.com/2011/05/public-debt-and-bank-losses-how-much.html

View

ei.sdraob wrote: »

What is the downside of someone who owns a high interest subprime mortgage of borrowing from a loan shark at kneecaping rates

A rate of circa 6% is hardly high interest by anyone's standards particularly given that is considerably lower than what the markets want to charge us at the time (circa 10%). Whether you like it or not the government preferred to borrow at the lower of the interest rates on offer at the time. Should the markets decide to offer us an even lower rate, than we are currently borrowing at, in future we are free to borrow from the markets instead.

View

Hmm, there appears to be difference in the debt figures.

The NTMA link I used was this, showing the debt at 101 Billion as of March 31 (which included some of the "Bailout" loan monies).

ei.sdraob

View wrote: »

A rate of circa 6% is hardly high interest by anyone's standards particularly given that is considerably lower than what the markets want to charge us at the time (circa 10%). Whether you like it or not the government preferred to borrow at the lower of the interest rates on offer at the time. Should the markets decide to offer us an even lower rate, than we are currently borrowing at, in future we are free to borrow from the markets instead.

Well putting aside for a minute that you are comparing apples and oranges.

The IMF/EU loan is given with 2 assumptions in mind:
* that the large deficit is cut in few years (theres no choice the cuts are inevitable)
* and that certain growth rates are met, no growth > inability to service debts

In the meantime growth forecasts have been revised down, and no sign of promised reform is to be seen.

Scofflaw

Deleted User wrote: »

Stimulus is ineffectual when the economy is running inefficiently.
For example Ireland was being stimulated by low interest rates during the boom and the money went into property. Stimulus, if timed correctly, could give a good boost to an economy. The timing needs to be after inefficiencies have been taken out of the economy a recession will do that and a cut all in one go will do that ruthlessly.

Right now we are flogging a dead horse. No point in stimulating when the money is wasted on artificially high rents, property prices, insurance, electricity and wages.

Hmm - no, sorry, the word 'stimulus' has caused some confusion. All spending stimulates the economy - that is, creates economic effort, which can be seen at a very basic logical level. If a business ("Acme") spends €1m a year on printing in the local economy, that money goes somewhere - if there is no local printer to start off with, there soon will be. That local print shop will also service other local business which might or might not on its own allow someone to run a local print shop profitably. The print shop will adjust to the level of spending on printing in its catchment area.

Likewise, if Acme reduces its need for printing, the local print shop will have to adjust to the reduced spending. If it is still possible to run the print shop profitably, then, given enough time to adjust, there will still be a print shop, even though it will be smaller, and employ fewer people.

If, however, Acme just stops the whole €1m overnight, the chances are that the local print shop will find itself overstaffed and over budget. Not having time to adjust its costs downwards to meet the reduced demand, there is a risk that the print shop will go out of business before it can adjust.

Is that realistic? Sure - it happened to the first business I was involved in, during the dotcom crash. It wasn't that there was no business - it was that we'd just expanded, had committed to new staff costs, and then business fell to less than half its previous level. The result was that the business closed, because it could not adjust in time to avoid plunging into debt, and there was little likelihood of being able to pay off such debt on the reduced demand.

cordially,
Scofflaw

later12

Scofflaw wrote: »

if cutting the deficit immediately isn't feasible, default is effectively ruled out at once.

That isn't necessarily the case. It is quite likely at this stage that Ireland will not cut its deficit rapidly, and that it will agree a restructuring on its official debt, which is a form of voluntary default. I appreciate that you are most likely talking about a unilateral default which allows CDS contracts to be called upon, i.e. an 'event of default' as it is written, but one shouldn't give the impression that it's a black and white decision between discharging obligations and cutting the deficit overnight.

ei.sdraob

Scofflaw wrote: »

Hmm - no, sorry, the word 'stimulus' has caused some confusion. All spending stimulates the economy - that is, creates economic effort, which can be seen at a very basic logical level. If a business ("Acme") spends €1m a year on printing in the local economy, that money goes somewhere - if there is no local printer to start off with, there soon will be. That local print shop will also service other local business which might or might not on its own allow someone to run a local print shop profitably. The print shop will adjust to the level of spending on printing in its catchment area.

Likewise, if Acme reduces its need for printing, the local print shop will have to adjust to the reduced spending. If it is still possible to run the print shop profitably, then, given enough time to adjust, there will still be a print shop, even though it will be smaller, and employ fewer people.

If, however, Acme just stops the whole €1m overnight, the chances are that the local print shop will find itself overstaffed and over budget. Not having time to adjust its costs downwards to meet the reduced demand, there is a risk that the print shop will go out of business before it can adjust.

Is that realistic? Sure - it happened to the first business I was involved in, during the dotcom crash. It wasn't that there was no business - it was that we'd just expanded, had committed to new staff costs, and then business fell to less than half its previous level. The result was that the business closed, because it could not adjust in time to avoid plunging into debt, and there was little likelihood of being able to pay off such debt on the reduced demand.

cordially,
Scofflaw

From your own story, the businesses failed and the world moved on. The dot com bubble was spectacular yet now a decade later the internet is full of business with companies (including my own) making money. The bubble if anything was a good lesson, but the world and in the internet survived and moved on.
Unfortunately nowadays we have this paradigm of "failure is not an option", be it a bank with no atm's or an insurance company not following its obligations.
As I pointed out above, if the growth does not materialise (and projections are being revised down) then there might be no choice but to cut faster, just as is there is no choice now as to whether to cut or not.

Anyways MK style default on the ECB might not be an option either now, considering that the NTMA lodged the remaining cash reserves into the banks.
The country is now being firmly held by its balls. How much squeezing will it take before something gives...