Is Paul Krugman assigning news articles at the New York Times these days? A few weeks ago, Krugman started vigorously arguing against “fiscal austerity” — the idea that countries facing down debt crises should start controlling their deficits. Exhibit A in his case against austerity was Ireland. Krugman wrote a blog post noting that Ireland had embraced austerity, especially compared to Spain, where there was little enthusiasm for fiscal cutbacks.
Krugman argued that an incorrect conventional wisdom was coalescing with regard to these two countries, with newspapers reporting that international bond buyers seemed “impressed” with Ireland’s commitment to austerity. “Well, I guess that’s right,” Krugman scoffed, “if by ‘markets impressed’ you mean a CDS spread of 226 basis points, compared with 206 points for Spain.”
Krugman referenced this post several times over the ensuing weeks. Then, on Tuesday, the Times ran a news article by Liz Alderman titled “In Ireland, a Picture of the High Cost of Austerity.” Alderman reported as matters of fact arguments that Krugman had been making on the op-ed page and on his blog: “Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession,” she wrote.
But Ireland’s economy — heavily reliant on financial services and exports — was hit harder by the global financial crisis than its European neighbors. Housing prices rose more rapidly in Ireland and fell more sharply when the bubble burst. As a member of the eurozone, Ireland could not attempt to boost exports by devaluing its currency. By contrast, the United Kingdom — with a more diversified economy, a smaller property bubble, its own currency, and a fiscal-stimulus package — still experienced a 4.8 percent drop in GDP.
“Despite its strenuous efforts,” Alderman reported, “Ireland has been thrust into the same ignominious category as Portugal, Italy, Greece, and Spain.” But Ireland’s debt problems were more severe than those of the four countries named, and its options more constrained: The country faced a longer road back and found it necessary to get a head start. As Alderman noted, Ireland’s budget deficit as a percentage of GDP stands at 14.3 percent, which is even worse than Greece’s.
But rather than attribute Ireland’s high borrowing costs to the size of its current deficit, Alderman attributes them to investors who “fear that the austerity program, by retarding growth and so far failing to reduce borrowing, will make it harder for Dublin to pay its bills rather than easier.” I’m sure some investors have that fear. But is that the primary reason that, to go back to Krugman’s comparison, Ireland’s CDS spreads are wider than Spain’s?
The evidence just doesn’t support this thesis. On Wednesday, the rating agency Moody’s announced that it would be reviewing Spain’s Aaa debt rating, following downgrades by other rating agencies earlier this year. After the announcement, Spain’s CDS spreads widened to 265 basis points, compared to 266 points for Ireland. Spain, it should be noted, has a smaller debt-to-GDP ratio than Ireland (65 percent to 77 percent) and a smaller deficit-to-GDP ratio (10.1 percent), but a weaker commitment to fiscal austerity. Krugman would never believe it, but maybe commitments to control deficits matter to investors after all.
— Stephen Spruiell is an NRO staff reporter.