Politics & Policy

Krugman on Ireland and Spain

Fiscal austerity is a bad idea for overindebted European governments? Hardly.

In his farewell column, New York Times ombudsman Daniel Okrent wrote that Paul Krugman “has the disturbing habit of shaping, slicing and selectively citing numbers in a fashion that pleases his acolytes but leaves him open to substantive assaults.” That was in 2005, and Krugman has only gotten worse. A recent example is illustrative.

Lately Krugman has been wringing his hands with despair at what he perceives as madness all around him. Krugman thinks the idea that overindebted governments ought to cut back on their spending is “terrifying,” “crazy,” and “deeply depressing.” He argues that such cutbacks — “fiscal austerity” — will only worsen the global recession. Instead, he thinks governments need to maintain or increase deficit spending until the global economy starts to recover. This is his favored solution to the problem of persistently high unemployment. In fact, Krugman thinks that unemployment remains persistently high because the stimulus wasn’t big enough.

To bolster his argument, Krugman has introduced evidence purporting to show that markets do not appear to have been moved by austerity measures adopted abroad. Over the weekend, he wrote a blog post titled, “Does Fiscal Austerity Reassure Markets?” To answer the question, Krugman decided to compare two countries in debt-crisis-stricken Europe: Ireland and Spain.

These countries responded to the debt crisis differently, Krugman wrote. “Ireland quickly embraced harsh austerity; Spain has had to be dragged into austerity, and still faces major political unrest.” According to Krugman, this should lead one to believe that credit default swap (CDS) spreads — which are, roughly speaking, an indicator of investor confidence in a country’s ability to pay its debts — should be higher for Spain than for Ireland. Instead, it’s the other way around.

The question that immediately springs to mind is whether there are any other differences between Spain and Ireland that might account for the difference in their CDS spreads. And, of course, there is a rather large one: Ireland’s debt is 77 percent of its GDP, while Spain’s is only 65 percent. Simply put, Ireland is more indebted than Spain. So, let’s enhance the comparison. Portugal, like Spain, has an iffy austerity plan, but it also has a larger debt load (86 percent) than Ireland or Spain. Portugal’s CDS spread stands at 289 basis points to Ireland’s 226 and Spain’s 206.  

Investors take a lot of information into account when they buy and sell CDS. It is foolish to claim, as Krugman does, that the difference between Ireland and Spain’s CDS spreads is evidence that investors do not price in austerity measures. In fact, it’s likely that Ireland’s CDS spread would be much higher if it hadn’t moved aggressively to rein in spending — its budget deficit, at 14.7 percent of GDP, is even worse than Greece’s. Instead, the chart below illustrates that Ireland’s CDS spreads are lower than we would expect them to be given Ireland’s indebtedness, compared to where Portugal’s and Spain’s are:


Now, the dip represented in this chart is not necessarily due to investors being impressed with Irish austerity — Ireland’s economy is expected to grow more rapidly than Spain’s or Portugal’s, and that’s probably a contributing factor. But it does illustrate how Krugman shapes and slices numbers to fit whatever argument he is trying to advance. In context, Ireland’s CDS spreads look better than Spain’s, not worse.

Stephen Spruiell is an NRO staff reporter.


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