About P O Neill

is Irish and lives in America.

Chasing the numbers

IMF statement on Ukraine, yesterday –

Despite these positive developments, in view of the larger than expected economic decline in the first half of the year, the mission revised down growth projections for 2015 to -11 percent.

IMF previously published growth projection for 2015 — in August:

The 2015 baseline growth projection has been marked down to -9 percent (relative to -5½ percent at the EFF approval), driven by a delayed pick up in industrial production, construction, and retail trade, and expectations of a weaker agricultural season.

So in 2 months, from a projection already set over half way into the year, another 2 percentage points has been knocked off the growth rate, which itself is now nearly 6 percentage points off its original assumption. And that’s in a context where the eastern conflict situation has been stable compared to the earlier part of the year.

With the business news industry about to fixate on every number that is uttered in Lima at the IMF-World Bank meetings, it’s worth considering the shelf life of these projections.

It’s not just the currency

Paul Krugman writing in June 2012 on the UK-Spain interest differential, attributing it to the constraints of currency union -

Then there’s the lender of last resort issue, which turns out to be broader than even those who knew their Bagehot realized. Credit for focusing on this issue goes to Paul DeGrauwe, who pointed out that national central banks are potentially crucial lenders of last resort to governments as well as private financial institutions. The British government basically can’t face a “rollover” crisis in which bond buyers refuse to purchase its debt, because the Bank of England can always step in as financier of last resort. The government of Spain, however, can face such a crisis – and there is always the risk that fears of such a crisis, leading to default, could become a self-fulfilling prophecy. As DeGrauwe has pointed out, Britain’s fiscal outlook does not look notably better than Spain’s. Yet the interest rate on British 10-year bonds was 1.7% at the time of writing, whereas the rate on Spanish 10-years was 6.6%; presumably this liquidity risk was playing an important role in the difference.

At the Jackson Hole Federal Reserve Bank of Kansas City central bankers symposium yesterday, one of the more interesting papers, by Faust and Leeper –

Why, if Spanish debt was in safe territory, did its 10-year bond yields begin to rise in 2011? Figure 14 suggests that more than bond-market vigilantism was in play. During the decade of good fiscal housekeeping, Spanish inflation was chronically above union-wide inflation, at times by more than a percentage point. Thoughtful observers would note that in a monetary union, Spain’s persistently higher-than-union-wide inflation rates could damage the country’s competitiveness and future growth prospects. With weak future economic growth come lower tax revenues and higher social safety-net expenditures that reduce the expected flow of Spanish primary surpluses and shift the country’s fiscal limit in toward prevailing and growing debt levels. Whether from lack of competitiveness or some other source, Spain did experience a second dip in economic growth from 2011 through the middle of 2013. Unemployment continued the upward march that it began during the recession, rising well above 20 percent before peaking at 27 percent in February 2013. These developments raised concerns about Spain’s ability to finance government debt that rose from 69 to 92 percent of GDP between 2011 and 2013. Movement of debt toward Spain’s fiscal limit coincided with an inward shift in the country’s limit distribution, a combination that Bi’s (2012) fiscal limit analysis predicts would raise risk premia.
Fiscal limits tell us that debt-GDP ratios are an incomplete—and potentially misleading— summary of a country’s fiscal health. What matters is the distance between current debt and the fiscal limit distribution. The position and shape of that distribution, in turn, depend on the great many factors that determine the discounted value of future primary surpluses. As the Spanish and U.S. fiscal stress examples illustrate, interactions between cyclical outcomes (inflation and unemployment) and longer-run developments (fiscal financing and sustainability) run in both directions to compound the confounding dynamics.

Bottom line: the interest differential that seemingly favoured the UK over Spain is about more than the Bank of England’s ability to finance the government in a crisis. It’s also about the other factors which determine the likelihood of such a crisis in the first place.

Ireland and Greece, again

Hans-Werner Sinn has an op-ed in Saturday’s New York Times calling (again) for a Greek exit from the Euro, a recommendation on which he agrees, as he notes, with Paul Krugman and Joseph Stiglitz. Part of his argument is that is that an official lending “bailout” program within the Euro won’t work because it will impede the necessary decline in local prices to make Greece competitive again within the single currency. His evidence that not getting a bailout improves competitiveness is … Ireland:

Take the case of Ireland. Like Greece, Ireland became too expensive, as interest rates fell sharply during the introduction of the euro. When the bubble burst, in late 2006, no fiscal rescue was available. The Irish tightened their belts and underwent a drastic internal devaluation by cutting wages, which in turn led to lower prices for Irish goods both in absolute and relative terms. This made the Irish economy competitive again.

But, you might object, I have a clear memory of Ireland getting a Troika bailout? Indeed –

Granted, Ireland also received fiscal aid. But that came much later, toward the end of 2010, and when it came, the internal devaluation stopped almost immediately. Twelve of the 13 percentage points of the Irish decline in relative product prices came before that date.

This interpretation of Ireland plays an important role in Sinn’s recommendation for Greece: it showed that it’s possible to manage a real devaluation without a bailout, but Greece began too late and had too far to go for this route to be feasible, hence it should leave the Euro.

But is this valid?

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IMF: Eastern Mediterranean country with unfair debt service requirement

From new IMF report on a certain country –

The case for fiscal adjustment is also grounded in fairness. Without it and with ever more debt, interest payments will soar to some 12 percent of GDP, or about 40 percent of total spending, crowding out essential social programs and infrastructure projects and largely benefitting public debt holders at the expense of the less-privileged. Thus lack of fiscal adjustment is also costly and inequitable.

That country where debt service will ever more crowd out social spending and be increasingly unfair: Lebanon.

Water under the bridge

From that Eurogroup Greece prior actions draft still under discussion in the middle of the night in Brussels –

There are serious concerns regarding the sustainability of Greek debt. This is due to the easing of policies during the last twelve months, which resulted in the recent deterioration in the domestic macroeconomic and financial environment.

It’s a truly remarkable statement that concerns about the sustainability of Greek debt only arose in the last year, since the 2010 IMF bailout — an event that everyone, including the IMF, seems to have forgotten — was only rammed through by ignoring the normal IMF debt sustainability criterion.

UPDATE: The identical statement is in the final draft.


Two year escape hatch

IMF Chief Economist Olivier Blanchard in a new blog post defending the 2010 Greece program against various criticisms, including the absence of debt restructuring –

Moreover, private creditors were not off the hook, and, in 2012, debt was substantially reduced: The 2012 private sector involvement (PSI) operation led to a haircut of more than 50% on about €200 billion of privately held debt, so leading to a decrease in debt of over €100 billion (to be concrete, a reduction of debt of 10,000 euros per Greek citizen). And the shift from private to official creditors came with much better terms, namely below market rates and long maturities.

Below the fold, a few relevant sentences from the IMF’s own ex-post evaluation of the 2010 Greece program, issued in 2013. Bottom line: what could be achieved in 2012 was severely constrained by what was (not) done in 2010, and the 2012 restructuring destroyed a core assumption of the 2010 program. In particular, when debt restructuring [private sector involvement (PSI)] was done, the hit on the remaining private sector creditors, including Greek banks, had to be larger because other private creditors were gone and official creditors that had taken on their debt, including the ECB, were off the table in the restructuring. It was then much harder for Greece to return to the market as the 2010 program had assumed, and the banks needed a lot more money to recapitalize.

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When extreme circumstances warrant setting up a lender of last resort within a larger currency union

From address by Professor Cormac O’Gráda, School of Economics, University College Dublin, to the Central Bank of Ireland Whitaker Lecture, 29 June 2011. The context is the Irish Free State’s 1 for 1 currency peg with the pound sterling, a continuation of the pre-1922 UK pound for Ireland –

The Emergency (World War II) also produced a defining moment in Irish banking history. Until then, Ireland’s lack of a central bank had not worried its joint-stock banks; on the contrary, they did not relish the idea. For over a century the Bank of Ireland had played the role of quasi-central bank, while looking on the Bank of England as its friend in need. Just a few days before the outbreak of war a delegation from College Green (Bank of Ireland HQ) traveled to London for reassurance about the availability of foreign exchange and the free repatriation of Irish bank assets held in London. In what must have been a difficult moment for the Irish bankers, the Governor of the Bank of England Montague Norman told them that:

notwithstanding the long and intimate relations between the two institutions he was not prepared to commit the Bank of England by promising to come to the assistance of the Bank of Ireland in an emergency of the nature under discussion. As an ordinary banking transaction there would be no question whatever about making an advance to the Bank, but in an emergency situation there was an important principal (sic) involved. The Bank of England looked upon Eire as a Dominion… Mr. Norman stressed the view that the Bank ‘whose centre of gravity was in Eire’ should look to their own Treasury or the Currency Commission to help them over difficult periods. Sir John [Keane, Deputy Governor of the Bank of Ireland] pointed out that the position in Eire did not admit of a solution in that way, as the [Irish] Treasury came to the Bank when it was short of funds, and the [Irish] Currency Commission was not a lender of the last resort. Mr. Norman then urged that as Eire was a separate political entity it should have a Central Bank of its own.

And so it took the Emergency and Montagu Norman to persuade the Bank of Ireland to switch its loyalty fully to the new state, and for the other joint stock banks to appreciate the need for an Irish central bank. The Central Bank Act followed in 1942.

The sterling currency union nonetheless survived up until Ireland joining the Exchange Rate Mechanism of the European Monetary System in 1979.

Low payoff from structural reforms in Greece?

The IMF has released a preliminary debt sustainability analysis for Greece — undertaken before this week’s cash crisis but after its adjustments to the numbers to take account of the deterioration in the relationship between Greece and its creditors since January. The document can be read cynically as the IMF using Syriza as an excuse to dump all the unrealistic assumptions in their earlier calculations, but it’s still helpful in spelling out those assumptions — which were there for everyone to see. Arguably the most incredible scenario was for growth (see Box 2):

What would real GDP growth look like if  total factor productivity (TFP) growth were to remain at the historical average rates since Greece joined the EU? Given the shrinking working-age population (as projected by Eurostat) and maintaining investment at its projected ratio of 19 percent of GDP from 2019 onwards (up from 11 percent currently), real GDP growth would be expected to average –0.6 percent per year in steady state. If labor force participation increased to the highest in the euro area, unemployment fell to German levels, and TFP growth reached the average in the euro area since 1980, real GDP growth would average 0.8 percent of GDP. Only if TFP growth were to reach Irish levels, that is, the best performer in the euro area, would real GDP growth average about 2 percent in steady state. 

That last assumption — 2 percent long-term growth — was the one that was actually in the program until now! These are of course results from an economic model that could be right or wrong. But that’s part of the political challenge of these lending programs: undertake massive effort on “reforms” and you might, if everything else goes well, get a not-especially-exciting growth rate. And the voters on Sunday don’t even know which set of “reforms” they are voting on, let alone their long-term consequences.

UPDATE: Note that the debt sustainability analysis is on the ballot on Sunday!