I know I shouldn't argue economics with a Nobel Laureate but....


A couple of weeks back I said that I thought that Iceland might well come out of all of this in rather better shape than Ireland. They've admitted their bankruptcy, defaulted, devalued and now seem to be growing again. Paul Krugman agrees:

What’s going on here? In a nutshell, Ireland has been orthodox and responsible — guaranteeing all debts, engaging in savage austerity to try to pay for the cost of those guarantees, and, of course, staying on the euro. Iceland has been heterodox: capital controls, large devaluation, and a lot of debt restructuring — notice that wonderful line from the IMF, above, about how “private sector bankruptcies have led to a marked decline in external debt”. Bankrupting yourself to recovery! Seriously.

But where I argue with his statement is that he's saying Iceland is heterodox, Ireland orthodox. Countries of course aren't companies or people but the orthodox response to bankruptcy is to admit it and restructure. Devaluation is a time tested tactic as well: as the UK's experiences in 1931 and 1992 (coming off the gold standard and the EMS respectively) show. As Argentina more recently and any number of other times and places show.

What Ireland (and Greece etc) are trying to do now is the heterodox path: given that they can't have an external devaluation they must have an internal one and that the political demands of the European Project seem to rule out default (at least at present), they're not able to do what the orthodoxy prescribes for them.

If you can't pay your debts you've got to default (or the nicer sounding euphemisms of restructure, impose haircuts,) and if your cost base is too high then you should devalue. This isn't, pace the Professor's description, odd, unusual or even slightly different. It's the straight textbook reaction to being in this place where everyone would really prefer they weren't.