The correct framing of the Irish economic dilemma: guarantees vs. austerity

by on January 15, 2014 at 7:15 am in Current Affairs, Economics, Uncategorized | Permalink

The policy of No Bondholder Left Behind, on which the European Central Bank insisted, has been staggeringly expensive. To put it in perspective, the European Union has just agreed to create a fund of $75 billion to deal with all future banking crises in its member states. Tiny Ireland has spent $85 billion bailing out its own banks [TC: with more to come, and note the bailouts are more to the creditors than to the banks themselves].

That is from Fintan O’Toole, who wrote a good paragraph there.  Yet I do not agree with all of his framing, as he too often presents the Irish dilemma as a debate about austerity.

Let’s say that I, Tyler Cowen, accepted a debt obligation of $5 million, and in order to make some of the interest payments I cut back my spending on food, drink, and and my energy then so weakened that I could never write another book again.  That would be bad for my income, since even at the individual level there may be “multiplier effects.”  (Please note that by introducing this multiplier assumption I am restoring a kind of parity between the individual and collective cases, no need to snark on this point.)

One way to look at that episode would be to soft pedal the initial guarantee of the debt and focus on the consequences of my “austerity,” and attack the cuts in expenditure, while blaming the new commitments I took on only in passing.  I would say that is a misleading interpretation of what happened.

A better way to look at the episode is to focus on the wisdom or foolishness of the guarantee of the $5 million.  I would say such a guarantee would be foolish, either for me or for the much larger bank debt bailouts made by the Irish.

Another good and indeed scientific way to frame the question is to take the debt guarantee as given (albeit possibly mistaken), and ask whether my spending cuts should come quickly or be spread out more slowly over time.  That is a perfectly fair question to ask and we should not expect the correct answer to be obvious, although of course postponing spending cuts would have meant, for the Irish, borrowing at double digit rates and also risking a full scale “sudden stop.”  Furthermore, if we observe speedy rather than gradual spending cuts, the misery of the results does not in any way settle the question of which speed of adjustment would have been better.  Pointing out “this isn’t going so well” does not — at all — militate against the speedier path of cuts or for that matter militate against “austerity.”  At most it is an argument against the initial guarantee of debt (and even then we are not witnessing the counterfactual).

Nor does changing the topic by asserting “Germany should give Tyler the money” help us settle the right course of action in a world where Germany has no such intention.  The same can be said for “Germany should tolerate three percent inflation,” even if that claim is correct.

These points are not even Econ 101, rather they are Propaedeutic to Logic.

Overall, it is amazing how the single largest extension in the responsibilities and fiscal obligations of the Irish state — ever — has been turned into a PR defeat for the idea of fiscal conservatism.

If nothing else, that is testament to how powerful an incorrect message can be if it is repeated enough times and without the proper context.

Addendum: Here is further information on the recent Irish ritual chess murder — Bishop takes lung? — involving by the way an aggressive Sicilian.

leftistconservative January 15, 2014 at 7:47 am

you wrote:
“One way to look at that episode would be to soft pedal the initial guarantee of the debt and focus on the consequences of my “austerity,” and attack the cuts in expenditure, while blaming the new commitments I took on only in passing. I would say that is a misleading interpretation of what happened. ”

What you did not write was that the politicians were paid off by the corporations and were not acting with the consent of the people. Why should the people undergo austerity when the whole financial scheme was collusion between corporations and corrupt politicians?

DJ102010 January 15, 2014 at 8:15 am

Maybe this is satire, but if not… when, in a democracy, are politicians not acting with the consent of the people? When outcomes are bad? And how are they supposed to avoid undergoing austerity when their corrupt politicians spent all their money?

T. Shaw January 15, 2014 at 8:49 am


Iceland took the “democracy” road. They placed bondholders in line and to get their shares of the liquiidation proceeds from the resolutions of the failed banks.

Did the ECB force the Irish to guarantee the banks’ subordinated debt? Then, the Irish people had no say.

Who rules Ireland?

If Ireland were not under the euro regime, the government could have done as did Iceland or replaced banks’ bonds with Irish government debt instruments.

Or, an Irish central bank could have instituted a “QE” and “bought” the bank bonds from private bonddholders.

In the US, under bankruptcy laws and the new Dodd-Frank regime for resolving (stress tests, living wills, resolution plans, etc.), systemically important financial institutions’ (SIFI) bondholders would become shareholders in failed bank holding companies.

leftistconservative January 15, 2014 at 9:08 am

pretty much all the western nations are now pseudo-democracies, at least to varying degrees. The politicians are not held accountable because the common interests of the people are not well-defined. As the common, shared interests of the populace grow less well-defined, the populace is not able to hold the politicians accountable.

This is basic democracy.

That is why the elites created the EU–to dilute the common, shared interests of the populace, thereby creating a pseudo-democracy.

Thus the actions of the politicians are beyond the reach of the populace, and the populace is thus not ethically bound to account for the consequences of the acts of the politicians.

Same thing applies to america to a much greater degree.

Adam January 15, 2014 at 5:13 pm

You know, that and the “not blow each other to bits every few generations” thing.

Benny Lava January 15, 2014 at 7:55 am

False. A scientific way to examine the situation would be to focus on empirical evidence rather than reasoning by analogy. Enough with the feelingsnomics!

derek January 15, 2014 at 9:57 am

So what empirical evidence is there? The only one that cannot be disputed is that bad lending and bad borrowing has enormous consequences that lead to no good choices. What choice you take is between shades of bad.

If they hadn’t guaranteed the bonds they would have been forced to pay higher cost for existing debt and forced to stop borrowing to meet current obligations.

I’m not that old but I remember canadian provinces paying 16-18% on their bonds. They were forced to stop borrowing. It was amazing seeing openly socialist governments bragging that they balanced their budgets.

Austerity is the result of foolishness.

Benny Lava January 15, 2014 at 10:20 am

Well Tyler has long advocated for Irish austerity. Even linking to trolls like derugby who blatantly lie about austerity. And the results? Ireland is doing poorly. Much worse than the US or Iceland. Worse than Germany (who did major stimulus in 2009 rather than budget cuts). So Ireland’s course of action was suboptimal. But leave it to Tyler to defend it via an analogy and feelings. And he dares call economics a “science”.

JWatts January 15, 2014 at 10:37 am

“Much worse than the US or Iceland.”

Yes, but Iceland did austerity. It was selective and they also pushed as much of the pain onto foreigners as possible, but none-the-less there were significant cuts to their budget.

Benny Lava January 15, 2014 at 12:59 pm

What austerity? Iceland postponed cutting spending and inflated their debt away.

Or is Icelandic austerity just a feeling you have?

Norman Pfyster January 15, 2014 at 11:39 am

I think Tyler’s point was merely that excluding the debt guarantee from the calculation of government actions leads to a misleading debate. Ireland chose to spend a large portion of the expansion of fiscal funds on bank bailouts. Maybe that was suboptimal, but you would need to rely on a different model than the Keynesian “austerity” model.

Benny Lava January 15, 2014 at 11:57 am

What expansion? Ireland has cut spending every year since 2009?

Just because you feel that Ireland is increasing spending doesn’t make it true.

Adam January 15, 2014 at 5:22 pm

Ireland did not choose. The IMF, the EC and the ECB chose.

And I fail to see the significance to the Irish economy of debt service to foreign banks, which is what the “spending” associated with the guarantee is largely composed of, as far as I understand.

derek January 15, 2014 at 11:53 am

Comparing Ireland to Germany or the US is nonsense. They both were able to borrow money. Ireland could not. Iceland creditors took a haircut, and neither Ireland or Iceland are doing well. And the situations were different in both cases. Austerity means nothing except a dog whistle.

Ireland still was able to borrow after the shock happened. They figured they needed to borrow. Unfortunately if you need to borrow money you have to do things that encourages others to lend to you. If they were unable to do a massive stimulus it probably was because the folks who were to lend them money to do that were somewhat unwilling.

There is no easy way out of a financial crisis or a debt crisis. You either write them off or you pay them back. Both have serious consequences. And for a small nation to print money only works if they don’t owe anything in other currencies and don’t have to buy anything from elsewhere to manage.

I would suggest the opposite of austerity is magic thinking.

Benny Lava January 15, 2014 at 11:59 am

Austerity means nothing but a dog whistle to you because to think otherwise would contradict your priors, and that would hurt your feelings.

Adam January 15, 2014 at 5:25 pm

I would suggest that you’re talking in the abstract. Ireland could borrow. Ireland did borrow.

But the money it borrowed went to repay sums owed by its banking sector, largely to foreign banks.

Adam January 15, 2014 at 5:19 pm

The tragedy of Ireland is that it had no choices, and the the decisions were not made with the best interest of Ireland, the Irish economy or the Irish people in mind.

Ireland’s banks couldn’t fail because if they failed, they’d have threatened Germany’s banks and/or France’s banks which would in turn threaten the rest of the European banking system. That’s a really great reason to prop up Ireland’s banks, for Germany and France and the rest of the Europe. It doesn’t achieve much for the Irish, though. And yet they are the only one’s paying for it.

I’m not sure why you think letting it’s banks fail would have forced the Irish state to pay higher borrowing costs or stop borrowing. And if that’s your concern, the guarantee certainly did not help. They had a banking crisis, not a fiscal crisis. At least until the state took on the obligations of the banks.

Rich Berger January 15, 2014 at 7:56 am

I read O’Toole’s piece and I have no idea what is really going on. One in four children in households where no one is in paid employment? What are they living on: austerity? Sovereign debt has almost doubled? How did Ireland get the $85 billion to bail out the banks? Was it a gift or did they borrow it?

Z January 15, 2014 at 8:53 am

I tried to find some budget figures for Ireland to see if they actually cut spending. I was unsuccessful, but I found some related data that suggests “austerity” means slowing the growth of government spending. Public debt appears to be increasing at an increasing rate, which is the opposite of what “austerity” is supposed to address.

I think “austerity” is another word the Left has rendered meaningless.

Benny Lava January 15, 2014 at 12:02 pm

You didn’t find it because you did not want to find it. Ireland cut total spending and raised taxes:

Feeling bad conservatives have tried to redefine “austerity” because otherwise they would feel too bad. Boo hoo hoo!

Adam January 15, 2014 at 5:32 pm

If only you could search the internet for “Irish government spending”:

enoriverbend January 15, 2014 at 10:24 am

Some figures from 2013 for Ireland: Total population 4.5M, number of people getting weekly welfare checks 1.4M (but on behalf of 2.2M beneficiaries); 600K getting monthly child payments. This does not include other significant social expenditures like health care support. Welfare spending alone accounts for 1/3 of Ireland’s government revenues.

If the Krugman et al analysis of government checks being great for the economy is correct, Ireland has a rich and rosy future.

Andre January 15, 2014 at 12:39 pm

What a weak try on a Krugman hit, there is so much good material and you try this?

His position was that cutting the budget to bail out the banks in the face of a wrecked economy would make all of these problem worse. which it has. And of course if they weren’t getting these checks it would be worse still. which it would.

Don’t forget to count the 400k people who up and left as well.

prior_approval January 16, 2014 at 12:22 am

’600K getting monthly child payments’

In Germany, all parents receive monthly child payments – it is a fairly normal part of the European idea of ‘welfare.’

It is not means tested – rich parents get their money just like poor ones. Much like how children are covered for free by the Krankenkassen (health insurers).

Neal January 15, 2014 at 8:12 am

Never go up against a Sicilian when death is on the line!

T. Shaw January 15, 2014 at 8:50 am


dearieme January 15, 2014 at 8:18 am

The action the Irish government took seems idiotic: presumably Germany was squeezing them by the balls?

TMC January 15, 2014 at 9:49 am

Agreed. ” I have an offer you can’t refuse”

Mason January 15, 2014 at 8:34 am

@ Tyler Cowen: But what if you gave the debt obligation to a person or an institution that you’re depending on economically? Or, at least, you perceive to depend on it economically? To stay in you example, let’s say you have to make your living by writing books. Now the guy who publishes your books calls you and asks you for the debt obligation. If you don’t accept, he will be broke and he won’t be able to publish your books anymore so you will lose your income. But if you accept the obligation, he might be able to keep on publishing your books, and he might be able to get his debt problem in order. What do you do? Ireland, with its depedence on the banks, might have been in a very similar situation.

Sherparick January 15, 2014 at 8:53 am

Mason, I think you captured the Irish dilemma in the autumn of 2008. Within the EU they felt beholden to the ECB, Germany, and the Netherlands. I think Trichet made it plain to the Irish Government that they could not allow their banks default on the bonds held by German and Dutch Banks (the ECB was probably very concerned about the stability to those banks in 2008). The guarantee was great part the result of this quasi-coercion.

Frances Coppola January 15, 2014 at 9:06 am

So if I understand you correctly, Tyler, you are basically saying that Ireland should not have bailed out its banks and should not do so in the future either. I think lots of people would agree with that in Ireland – but possibly not in Germany or the UK, which would be hit hard by such a default on banking system obligations. Not that I think that refusing to bail out banks is a bad thing. FWIW I think Ireland should never have bailed out its banks – it was a terrible decision. It should have done an Iceland and damn the EU harpies saying “you can’t do that, what about our banks”? But we should be aware of the consequences of such a decision, that’s all.

leftistconservative January 15, 2014 at 9:11 am

the meaning of his words are obfuscated via overwriting, but i THINK he is saying that the perspective to adopt is that irish should have to pay for their actions via austerity. What a shocker!

Tyler Cowen January 15, 2014 at 9:49 am

Clear as day: “I would say such a guarantee would be foolish, either for me or for the much larger bank debt bailouts made by the Irish.” I do of course recognize they may not have had a choice.

Adam January 15, 2014 at 5:35 pm

If the banks were going to be bailed out, they needed to be bailed out by the entire Euro Zone.

Yet another example of the perils of currency union without fiscal union.

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prior_approval January 16, 2014 at 12:23 am

This is the best piece of spam ever.

lxm January 15, 2014 at 4:05 pm

Overall, it is amazing how the single largest extension in the responsibilities and fiscal obligations of the Irish state — ever — has been turned into a PR defeat for the idea of fiscal conservatism.

You are, of course, completely correct.

This is not a story about austerity, though that appears to be outcome.

Rather it is about bank thievery. I remember at that time reading lots of material about how the banks to get their guarantees. Here’s one:

There are plenty more.

So framing it as a story of austerity is incorrect. How about framing it as a story about thievery.How helping (or being taken to the cleaners by) the banks has punished the Irish people.

Adam January 15, 2014 at 5:11 pm

This is as strange post. There was a ton of criticism of the Irish bank guarantee. But Ireland wasn’t really given a choice. The international institutions insisted on it.

Hmm. Why might that be?

It’s not just that Germany won’t “give” Tyler the money. It’s that Germany lent Tyler a huge stack of money speculatively betting that the value of Tyler’s house would keep rising and insisted on getting repaid even after Tyler went bankrupt and the house was sold at the foreclosure auction for pennies on the dollar. Germany’s doesn’t need to “give” Ireland any money, it just needs to let it’s banks take the hair cut they should have taken for speculating in the Irish economy.

Also, it’s a little hard to see why Ireland spending massive new sums aboard – which is what the bank guarantee effectively amounts to – would say anything at all about the impact of domestic fiscal policy on the domestic economy.

prior_approval January 16, 2014 at 12:29 am

Well, not that this blog likes to talk about it, but Hypo Real did take a hair cut – if being nationalized and having the shareholders take the loss is what one considers a ‘haircut’ -

‘With the German state (via SoFFin) already owning 90% of HRE, an extraordinary general meeting on 5 October 2009 approved a €1.30 per share squeeze out of the remaining private shareholders,[12] including J.C. Flowers (which a year earlier had taken a 25% stake at €22.50 per share).[13] The decision resulted in the complete nationalisation of the firm[12] within a year of it having been a DAX constituent.’

Generally, no one likes to talk about the fact that Germany is the country that replaced a supported bank’s management (Commerzbank), or the country that forced a bank’s shareholders to take a loss.

Mainly because then it would appear that Germany actually does what it wants others to do, too.

SPX January 16, 2014 at 8:11 am

“The international institutions insisted on it”


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Tom January 21, 2014 at 4:41 pm

Very well done. Alas your target audience will certainly not listen.

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