I have posted links to this piece in the comments section before, but never on the front page. This seems like a good time to do so, given that the question of what markets want is beginning to exercise people (see for example here, or here). The essential point is that markets understand that governments face political constraints, and take this into account when assessing the credibility of their economic policies. (And, moreover, market participants tend not to believe in tooth fairies or negative fiscal multipliers.)

We’ve known all along that fiscal adjustment here would be contractionary, and that our economy thus needed substantial export growth if it was to avoid falling into the hands of the IMF. That in turn requires a buoyant European economy; hence my alarm regarding austerity measures in countries like the UK and Germany. One of the key insights of Barry Eichengreen’s work is that you have to analyse international monetary arrangements as systems: it makes little sense to analyse policies in one country at a time as if countries are isolated from each other. Ireland has no choice right now concerning what policies to pursue, but other countries do, and if those with fiscal space (as measured by the interest rates at which they can borrow) choose to embark on contractionary policies now, for what appear to be nothing more than ideological reasons, then that is profoundly irresponsible from the point of view of the fragile system that is the European economy.