Knowing and Making

Rising German bond yields over the week since the Irish bailout have been interpreted ( here  and here ) as an increase in default risk to the German government. But surely there is another "risk" much more likely to explain this increase. And that is the simple risk of inflation. The Irish bailout must make inflation more likely - through one of two routes. One : ECB liquidity support, i.e. lending to Irish and other banks, might not be repaid - which will result in an effective increase in money supply unless the ECB then tightens monetary policy to reduce it, which would be politically quite difficult. The ECB lending is secured on bank assets, but we know that those assets might not be worth 100% of their nominal value. So in the case of a bank default, the ECB has printed a billion euros to buy an asset which repays less than a billion euros of principal. Two : monetary policy may be deliberately loosened, either to help reduce the pressure on sovereign borrower...

Great interview of Jürgen Stark (chief economist of the ECB) by Spiegel Online. He's a very funny guy for a central banker (maybe I'm revealing too much about my sense of humour). SPIEGEL : You are maneuvering yourself around an answer to the main question: What happens if Greece doesn't make it? Stark : I do not think that is the most important question, but I will answer it with a clear statement: The country must and will make it. More importantly, he is very clear that Federal Reserve-style monetary expansion is not on the cards for the ECB, and that he thinks eurozone governments should be cutting deficits faster. Also: Stark : ...I would like to point to one aspect in this context: Great Britain has a budget deficit of the same magnitude as Greece's. The US budget deficit is also more than 10 percent of GDP. All advanced economies are currently having problems. In fact, it is astonishing to see where most of the criticism of the euro is coming from at the momen...

Ireland has a problem. It is at risk of getting into some terrible debt. Its fiscal deficit has soared this year to about 14% of GDP, more than almost any other country, and on current path its debt is forecast to reach 126% of GDP by 2016. This is mainly due to a collapse of over a tenth in Irish GDP during the recession - which, under the informal definition, qualifies as a full depression in Ireland. What is to be done? The government is willing to take fairly drastic steps to cut its deficit, even though the economic recovery is still tentative (as a very export-oriented economy, Ireland can afford countercyclical fiscal policy better than most nations). But can the government carry its citizens with it? An Economist article last week offers a clue. Take a look at the chart at the top of the article. Ireland's figures look bad, but it has an advantage: it starts from a reasonable public debt position. On this projection, in 2011 Irish public debt will be 96% of GDP w...