On Fiscal Policy Eurozone Periphery Is, In Fact, Damned If They Do And Damned If They Don’t

Niamh Hardiman spies malfeasance amongst the ratings agencies in their evaluation of European public policy:

Evidence from Ireland bears this out – there seems to be no consistency in the way the ratings agencies evaluate the decisions of governments in the Eurozone periphery. Governments are put under pressure to engage in ‘orthodox’ fiscal retrenchment, in line with the EU’s excessive deficit procedures, and as required of Greece, Ireland and Portugal in line with their IMF-EU loan programmes. But as soon as they take relevant action, they find their ratings downgraded on the ‘heterodox’ grounds that taking money out of the economy will damage growth potential. Two bodies of economic theory seem to be at work here: ‘expansionary fiscal contraction’ when the aim is to enforce cuts, Keynesian counter-cyclical policy when the objective is to punish excessive contraction. Damned if you do and damned if you don’t.

The red lines there indicate episodes of fiscal contraction. I don’t, however, think this actually reflects funny business on the part of the raters. Rather, it reflects the fact that Ireland is screwed. Imagine if there were no Euro and Ireland still used the Irish Pound. Now imagine that the Central Bank of Ireland had a policy of completely ignoring economic data about Ireland when making decisions about Irish monetary policy. Instead, it focused primarily on German data, relying to an extent on French, Dutch, Belgian, and Austrian information. Well, nobody would be surprised if this turned out poorly for Ireland. But by the same token, nobody would be that crazy.

And yet here’s Ireland on the Euro with its monetary policy set in Frankfurt by a European Central Bank that evidently doesn’t care about Irish conditions. So Ireland can’t tighten fiscal policy and hope for monetary expansion to offset it. But Ireland also can’t avoid fiscal tightening. They’re damned if they do, damned if they don’t, and that reflects the reality of the situation, not the prejudice of the ratings agencies.