The Cowen experiment

Not every country is opting for fiscal stimulus:

Ireland's prime minister announced €2 billion ($2.57 billion) in
public-spending cuts on Tuesday, saying the country desperately needs
to shore up its battered public finances. Also Tuesday, the Polish
government approved a contingency plan to trim public spending by 19.7
billion zlotys ($5.65 billion). The budget cuts come even as other
countries are boosting spending to juice their economies.

Speaking to the Irish parliament, Prime Minister Brian Cowen said
the bulk of this year's cuts — some €1.4 billion — would come in the
form of increased pension levies on public-sector employees. That is
effectively a pay cut for those workers. Mr. Cowen also pressed forward
with tax increases for higher-income workers and second-home owners.

I'll let you know how it goes.  A few things are worth noting.  First, a small open economy has a harder time making fiscal stimulus work.  Second, a small open economy often has to worry more about its credit rating.  Third, a small open economy offers a tougher testing ground for macroeconomic "field experiments" because there are more confounding external factors.

Comments

not really an experiment. their economies will benefit plenty from stimulus in neighboring countries.

Babar is right. Just as it is rational for an individual to increase saving in a recession and hope that other people keep spending, it may be rational for the government of a small economy to cut public spending and hope that other countries increase theirs.

In my view, Ireland is probably a bit too big for this to be the right decision - but it's close to the threshold. But someone more skeptical about fiscal stimulus may well think the threshold is higher.

I think Babar hit it. Free-riding? I'm surprised you didn't mention that in your post, Prof. Cowen. I'm sure you thought of it too.

As for "small economy" -isn't that relative? I imagine Ireland's economy is probably larger than the global economy was, in absolute terms, in the not too different past.

But I'm interested in hearing how my thinking may be in error.

This isn't free riding, it's strategic long-term planning. Ireland and Poland are signaling that their long-term taxes will remain low. "Stimulus" countries will be forced into higher rates or higher borrowing costs. If I'm investing long-term, I want to invest in the countries cutting their public sector to match their revenues, not expanding it as their revenues plunge. In addition to being bad policy, it shows that the government is irresponsible under pressure.

Good article, thanks

I think we need to be following the Irish lead here in the US. There is a documented inverse correlation between government spending and economic growth in developed countries.

The limit of fiscal stimulus is where you endanger your sovreign credit worthiness. Small countries get there first.

There is probably more room for manoeuvre (and arguably more hope for beneficial effect) from monetary stimulus (in the current context that means going beyond interest rate policy). For slightly different reasons both Ireland and Poland find that barred.

Big countries can find their way to sovreign credit worthiness limits; especially big countries with large payments deficits, However, stimulus (of either kind so long as it raises demand) in payments surplus countries can stretch the limits for other countries. That stretch might be considerable: the underlying proposition is that sovreign credit worthiness is necessarily relative. The people who have the money to buy sovreign debt cannot take it to a safer haven than exists on this planet. But to rely on that proposition without some proper analysis and search for evidence looks very risky (as do the other options).

"Third, a small open economy offers a tougher testing ground for macroeconomic..."

If I'm thinking about this right, "macro" works best when you are the entire world, and "micro" when you're swimming in a contimuum of competitors. In which case a small enough country won't be macro at all, and is playing a different game to what the US (or the EU) play.

You could look it as public wages adjusting downward to maintain employment. A classical economist would talk about wages and prices adjusting during a recession, perhaps if wages can fully adjust they can avoid some of the downturn. We will see.

Ireland currently has so many foreign workers, especially in the trades, that downward pressure on wages will lead to how Ireland has traditionally dealt with economic downturns, the export of people.

Ireland has already taken steps protect the financial backbone so the transfer of assets to new sectors of the economy could go smoothly. again time will tell

I don't understand the commenters that claim this isn't a natural experiment or that it won't be valid because Ireland will free-ride on neighbors' stimulus.

There are also other small economies nearby that will try stimulus or take different actions - if Ireland and Poland have significantly different results from other economies of similar makeup it isn't difficult to draw some conclusion from that fact.

It sounds to me that you are claiming it doesn't mean anything just in case that it is successful so that your priors are confirmed.

Good post

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