Ireland and Austerity : Is Paul Krugman wrong?

In a recent article in the New York Times Paul Krugman took the US deficit hawks to task, he argues that Ireland’s approach to austerity has not been rewarded by the markets.

Consider, if you will, the comparative cases of Ireland and Spain.

Both countries appeared, on the surface, to be fiscally responsible until the crisis hit, with balanced budgets and relatively low debt. Both discovered that this was an illusion: revenues were buoyed by immense real estate bubbles, and when the bubbles burst they plunged into deficit — and found themselves potentially on the hook for large bank losses.

The countries responded differently, however. Ireland quickly embraced harsh austerity; Spain has had to be dragged into austerity, and still faces major political unrest.

Krugman then points to two data points for each country that show the price of a Credit Default Swap (which correlates to the risk that a country will default on it’s debt) is higher for Ireland than for Spain and another set of data points that show the yields on Irish bonds are higher than Spainish bonds.

The article is discussed over on Irish Economy and on Progressive Economy. Michael Burke highlighted a time series showing worsening of Irish bond yields vis-a-vis German and Belgian yields, and on his article on Progressive Economy provides a graph showing no significant long-term improvement in Irish bond yields vis-a-vis Spanish bond yields (however, the graph does show a significant disimprovement as the banking crisis struck in 2008 thereafter followed by some improvement in Irish bond yields relative to Spanish yeilds – the yield on Irish bonds fell by aprox 17% peak-to-trough, while Spanish bonds held steady. Graph available here).

However, a commenter on the Irish Economy thread (Mark Hutchinson ) linked to this interesting graph – which makes the relative performance of various European countries CDS ratings apparent. While the price of a Credit Default Swap is higher for Ireland, the Spanish price (and the price of some other European CDSs) have risen more over the past year and a half.

So who is right? I recommend taking Paul Krugman’s approach of trusting your own lying eyes. But remember at the very least we have to be careful with the statistics we use and given the complexity of the events that occured very careful in how we interpret them – or more accurately spin them. When attempting to interpret them this explanation of the narrative fallacy, described by Nassim Nicholas Taleb in the Black Swan, might help.

PS – FWIW – I’m generally in favour of using an increase in capital spending to offset the contractionary effects of rebalancing Ireland’s fiscal position providing the multiplier from such investments is significantly greater than 1, and the investments themselves are made in productively (i.e. no pork / bridges to nowhere).