The Irish Economy

I return to the case for a new fiscal framework in today’s Irish Times: you can read the column here.

The Central Bank’s new Head of Financial Regulation, Matthew Elderfield, delivered his first public speech today at the Leinster Society of Chartered Accountants (text here.). The speech is an impressive statement of intent and forms a very clear break from the past. I was particularly pleased to read this passage:

High impact firms and those with a poor track record should not expect to receive the benefit of the doubt from me or my staff when the best approach to addressing a risk is a point of contention between us. We will have an open and engaged dialogue with a firm’s senior management. But if we remain unconvinced by management’s plans we will be prepared to substitute our prudential judgement for their commercial one and say: Just do it.

This Nike approach to financial regulation could come as something of a shock to our banks.

The Taoiseach has launched the report of the report of the Taskforce on Innovation (here’s a link to a page featuring the report, a summary and a video featuring lots of people telling us how cool innovation is).

I was critical of the composition of the taskforce when it was appointed but, rather than fire off knee-jerk criticisms, I’d like to take some time to read it before commenting further. However, as always, cogent opinions from our commenters are very welcome.

Ronan has updated his analysis on property yields and its implications for NAMA and long-term economic value. It doesn’t make for comfortable reading. I wonder does Ronan understand the mystery of the standard discount rate …

In the past couple of weeks, the Oireachtas Committe on Finance and the Public Sector met with the authors of the two forthcoming preliminary banking inquiry reports, Klaus Regling and Governor Honohan (Regling was accompanied by his assistant Max Watson). The transcripts of these meetings are now available online here and here.

Last week, the IDA launched its new strategy document “Horizon 2020.”  Michael Hennigan has a critical article on the strategy in today’s Irish Times.

The Department of Foreign Affairs recently released a report on the progress toward meeting some of the goals set out in last year’s Farmleigh summit. I have to confess to a degree of unease about a process that doesn’t permit people to debate and scrutinise ideas in full open view. I am pretty sure that the vast majority of the people who attended and spoke are big enough and bold enough to have withstood an IrishEconomy type treatment for their ideas and I don’t see why it wasn’t simply podcast. As it was, the event was mostly held in private for a group of selected invitees. The progress report for what was discussed is linked below. Some of the ideas include a National Diaspora bond and an overseas graduate programme. Other paragraphs suggest that Farmleigh may have been influential in shaping budgetary policy, which is something that doesn’t sound very plausible. In general, I can’t disguise a degree of scepticism about such approaches but, having said that, some very influential and succesful people attended and gave their views so debating this document seems a good use of a thread.

link here

Bundesbank president Axel Weber gave a speech on “The Reform of Financial Supervision and Regulation in Europe” today at the Institute for International and European Affairs. The Institute has provided the text of Weber’s speech and an audio podcast here.

Update: Thanks to Michael Hennigan for noting that the impressive Mr. Weber also gave a completely different speech to Financial Services Ireland on the same day, titled “Making the Financial System more Resilient – The Role of Capital Requirements.”  Link here.

Here’s a link to the latest set of briefing papers for the European Parliament’s Economic and Monetary Affairs Committee. One set of papers (including one by me) focuses on global imbalances and the role they played in the financial crisis. The other set of papers focuses on European fiscal issues. These papers include a summary by Daniel Gros (CEPS) of his proposal with Thomas Mayer (Chief Economist of Deutsche Bank) for a European Monetary Fund.

These briefing papers are provided to MEPs on the committee prior to a meeting they will have with ECB President Trichet on March 22nd at which these and other issues will be discussed.

Daniel Kanda has written a new IMF working paper on this topic: you can download it here.

Summary: Asset booms and sectoral changes can distort traditional estimates of structural fiscal revenue, and could lead to serious fiscal policy errors. This paper extends the estimation of structural revenues to take account of asset prices and sectoral changes, and applies this to the case of Ireland, where a property bust has revealed a large hole in the public finances. It is shown that excluding these factors led to a substantial bias in the estimation of structural revenues, and the structural balance prior to the crisis was much larger than earlier estimated.

Following the approval of NAMA by the European Commission, the Department of Finance has published revised guidelines in relation to NAMA’s pricing of assets. This is a revised version of these regulations released before Christmas. Based on a quick read, there are appear to be a couple of changes, both of which show that the Commission is pushing the government towards paying lower prices.

The first relates to the discount rate used to value cash flows when coming up with long-term economic value.  These had provided for an adjustment of 0.8 percent above the relevant government bond rate. This adjustment is now 1.7 percent.  This change will lower the value of the assets.

Government bond rates are, of course, lower now than they were last September. This is probably what the Minister was referring to when he said “There will, however, be a reduction in the interest rates used for loan discounting purposes” a comment widely (and now it seems incorrectly) reported as being related to the Commission’s recommendations. We see now that the Commission’s recommendations, taken on their own, will imply lower prices paid.

The other change I can spot relates to the (to me) mysterious “Standard Discount Rate”. The regulations for this used to be as follows.

The standard discount rate that NAMA shall apply in the calculation of the long-term economic value of all bank assets shall be 2.75 per cent to provide for enforcement costs, and 0.25 per cent to provide for due diligence costs.

The 2.75 percent is now 5.25 percent. From previous discussions, the prize for best answer as to what the standard discount rate was went to Frank Galton: NAMA LTEV = LTEV*(1-Standard Discount Rate). Assuming that’s correct, then this latest change would also imply lower prices. Anyone who understands the standard discount rate (or can see any other interesting changes) feel free to explain it to us.

There are lots of stories in today’s press about the German-backed proposal to introduce a new European Monetary Fund to help out EU states in difficulty. Setting up the fund would require a new treaty, which would take a long time. So, on the face of it, this isn’t about helping out Greece, though it could turn out that Greece becomes the “test case” for how an EMF would operate.

One aspect of this story that I’m having some trouble understanding is why the IMF cannot be used to assist an EU member. The Irish Times Cantillon column explains the argument as follows. Current circumstances imply that:

The only possible lender of last resort is thus the International Monetary Fund, but an IMF intervention in a euro-zone economy would be a mortal blow to the credibility of the euro.

Ok, here’s a question. What does “mortal blow to the credibility of the euro” actually mean? And if it means something concrete (and bad) why does an IMF intervention produce this bad outcome while an EMF intervention does not? Answers on an electronic postcard …

Barry and I have updated our graphs here.

To recall: the red lines show what happen when governments respond to a worldwide economic crisis with monetary and fiscal stimulus. The blue lines show what happens when governments stick to monetary and fiscal orthodoxy. All very purgative and morally satisying no doubt, except that it led directly to the election of Adolf Hitler (something that I have been meaning to blog about for a while, but now I have to prepare for class..)

The first graph in this post is really quite alarming. (It would of course have been nice if there had been Irish data!)

For an individual country, ‘internal devaluation’ is the optimal strategy in our situation. (Optimal given our constraints that is — it is an incredibly lousy option relative to nominal devaluation, or being able to run a counter-cyclical fiscal policy.) But if everyone is doing the same thing, then it becomes collectively self-defeating.

This is a European problem, and requires European solutions designed to support demand and prevent continent-wide deflation.

Paul Krugman is alarmed here.

Paul Krugman’s NYT column focuses on the new Irish Economy Note by Greg Connor, Tom Flavin and Brian O’Kelly.

Today’s Irish Times publishes an open letter by 28 social scientists [co-ordinated by Tasc] that criticises the current set of economic policies and proposes an alternative vision: you can read the letter here.

It is hard for anyone to disagree with many of the policy recommendations in the letter. An important point is  that many of these policies could be pursued simultaneously with the current strategy of stabilising the fiscal situation and  contributing to the process of real devaluation as a mechanism to improve competitiveness. As has been repeatedly pointed out on this blog, labour demand can be boosted both through outward shifts in the labour demand curve (through productivity improvements) and through reductions in wage costs (movement along the labour demand curve) and there is no direct conflict between these two strategies.

The letter assigns at least part of the responsibility for the depth and severity of the recession to current government policies.  Policy failures during the pre-crisis period (inadequate financial regulation and pro-cyclical fiscal policies) have certainly contributed to the severe contraction and it would have been much better if Ireland had accumulated sufficiently large surpluses during the boom years to provide the fiscal space required to engage in counter-cyclical fiscal interventions.  In addition, it is possible to debate the appropriate mix between current and capital spending within the current aggregate envelope and the optimal sequence for the required increases in the overall tax burden.

However, given the massive shock to the economy and the public finances, the over-riding imperative in setting fiscal policy has been to demonstrate a commitment to fiscal sustainability. If the government had not undertaken a sizeable fiscal adjustment, the spread on sovereign debt would surely be much higher than the current elevated level and the upward movement in interest rates (influencing the funding costs for the banking system as well as for the government) would have had an even more contractionary impact on the economy.

Conditional on the environment facing the country, the path of fiscal adjustment is more certain of returning growth to the economy than an aspirational alternative that seems to rely on investment-led growth to jointly solve the fiscal crisis and the economic crisis without having to resort to cuts in the level of public expenditure (beyond any savings from efficiency gains).  The international economic consensus highlights that  the optimal fiscal response to the crisis varies substantially across countries, with fiscal adjustment required for those countries that face a difficult funding situation. As such, it is perfectly consistent to advocate more expansionary fiscal policies for some countries while also supporting fiscal adjustment in Ireland.

Finally, the letter makes a number of recommendations for re-shaping longer-term economic policies. The debate about post-crisis policies is important and the coherent vision provided by this letter is a valuable contribution - but the first order of business is to safely emerge from the current crisis.

Colm McCarthy makes a strong case for a bank resolution regime in today’s Sunday Business Post (article here).   If I understand intent of the argument correctly, however, Colm is proposing the regime as a critical element of a new regulatory system for the long term.  He is not proposing it as a means of imposing loss sharing on existing creditors.    Looking to the longer term, he argues that a resolution regime will make it possible to withdraw the guarantee.  

The wide-ranging guarantee of bank liabilities announced at the end of September 2008 runs out in little more than six months. Assuming that the banks have been recapitalised by then, the government can minimise subsequent risk of exchequer cost through getting out of the guarantee business as quickly as possible.

Bank resolution legislation – clarifying the power of the authorities to ensure that all providers of risk capital share quickly and appropriately the losses incurred by failed banks – is an important component in the state’s exit strategy from the banking collapse.

I believe the more pressing issue is to have a resolution regime in place for the period after the current guarantee expires and before existing subordinated bonds mature.  If the banks are insolvent, or at least incapable of reaching minimum capital adequacy requirements on their own, there should be a willingness to impose these losses on creditors, most likely as part of the debt-equity swap long advocated by Karl Whelan.  Read the rest of this entry »

The current issue of The Economist has a leader on the growing imbalance between males and females in birth cohorts in China and India and some other countries. The sex ratio at birth, or “masculinity ratio”, is normally about 1.05. Amartya Sen and Ansley Coale drew attention to the high ratios emerging in China and India some twenty years ago. The ratio has continued to rise in these countries and has now reached 1.30 in some Chinese provinces.

The Irish sex ratio at birth was 1.058 in 2008. This is exactly the median for western European countries. Moreover, there has been virtually no change in the Irish ratio over the past fifty years – it was 1.0523 in 1960 and 1.0589 in 2000. This suggests that changes such as the increased availability of pre-natal scans and the rise in pregnancy terminations by Irish women since 1960 have not had any differential gender impact.

As The Economist points out, the sex ratio is an important indicator of the place and status of women in society and the economy. The normality and stability of the Irish ratio is therefore not without its significance.

Here’s a new report from UCD’s Urban Institute by Brendan Williams, Brian Hughes and Declan Redmond titled “Managing an Unstable Housing Market” (summary here.)  It supports earlier calculations from NIRSA (see this post from the Ireland After NAMA blog) suggesting a very large stock of empty houses.

This is a truly dreadful story which should concern all academics (HT 9th Level Ireland).

Gregory Connor, Thomas Flavin and Brian Kelly write on this topic in Irish Economy Note No. 10.

The Icesave talks have collapsed (Update: Elaine Byrne is right. They didn’t collapse, they just didn’t come to an agreement prior to the referendum.)  Most likely, negotiations will resume after the referendum gets a resounding no. More positively, Iceland’s economy grew by 3.3% in the last quarter of 2009. This is good news. If indeed it is the case that the difference between Ireland and Iceland is one letter and six months, then we should see an economic recovery here during the summer.

It is obvious that the Irish banks will need very large amounts of new equity capital in the near future, given their NAMA-related loss crystallisation, along with prospective losses on their retained loan portfolios. This confirms the year-ago forecasts of Brian Lucey, Karl Whelen and others, and contradicts the contemporaneous claims of bank and government spokespersons that there would be no need for additional equity capital. It seems clear that the amount of new equity capital needed is equivalent to majority ownership (Lucey was quoted on Frontline stating that the newly issued equity might constitute 95% of total equity after issuance).

There are three ways to inject new equity capital into the two surviving[1] banks: 1) the government directly purchases more equity shares from the banks, 2) the banks try to raise the equity from existing shareholders using a rights offering, or 3) the banks accept a big block acquisition of equity capital from a large foreign institution probably a foreign bank. The Central Bank and Department of Finance should be pushing hard on the banks to use method 3, since this method is in the best interest of the Irish taxpayer and Irish economy.

Read the rest of this entry »

The Economist provides an analysis of the difficulties in reducing fiscal deficits: you can read the article here.

John McHale writes on the importance of public investment in assisting recovery in today’s Irish Times: you can read his article here.

The February ECB bulletin carries an interesting article on commercial property markets across the euro area; it is striking to compare the boom-bust cycle in Ireland relative to other countries: you can download the bulletin here.

Olivia Kelly had a remarkable sense of precognition in yesterday’s Irish Times. The Independent, the Examiner and Irish Times report again today. See also FinFacts.

Paul Gorecki sums it up nicely: There was only one valid criticism of the report and it did not change the substance of the report or its conclusions.

Here’s the abstract:

The report sets out an economic approach to municipal waste management policy in Ireland and then applies that framework to two recent policy developments. First, the proposed Section 60 policy direction to cap incineration and other matters, and second, the international review of waste management policy. These complementary policy developments sponsored by the Department of the Environment, Heritage and Local Government are designed to provide a roadmap for a new municipal waste management policy. The report questions whether these developments provide a coherent and feasible basis on which to develop waste policy. Indeed, apart from some unexceptional lessons which are consistent with current waste management policy, implementation of these proposals and recommendations is likely to lower societal welfare and increase the chances that Ireland will miss important Landfill Directive targets with consequent EU fines. The report puts forward a number of suggestions consistent with raising societal welfare while at the same time meeting the Landfill Directive targets.

The report was previously discussed here.

Update: The IWMA still does not accept the ESRI waste projections (even though EPA and DEHLG do).

Update2: Dr Dominic Hogg of Eunomia continues to think that the ESRI is wrong.

Update3: Minister Gormley argues that the international review is flawless.

The German municipality of Niederzimmern does not have the money to fix potholes. They are now selling the right to fix the road to anyone. In return, the owner of the fixed pothole can put on the road a text of her choice.

(from today’s Volkskrant)

Here’s a link to the exchequer returns for February and here’s the release comparing tax outcomes to the targets set out in the budget. (Here are the full set of targets for the year.) Tax revenues are 1.3% behind target for the year.

If replicated over the year, that would imply a shortfall for the year of €310 million which isn’t such a big deal. That said—and I don’t claim to be an expert on the month-to-month stuff and I know lots of this stuff is really noisy—income tax receipts being down 6% relative to target seem like bad news, More generally, I’m starting to get worried at how we keep falling short of targets.

The GDP and unemployment statistics from last year showed the really steep declines in activity ended in the second quarter. I’m looking for an unwinding of the huge year-over-year declines by April or so. If that doesn’t happen, we could end up pretty far off target.

The new National Pensions Framework is available here (press release here). 

Details are surprisingly sparse in places for a document so long in the making.   But the proposed reforms are generally sensible.   It is also good to see recent behavioural economics research having an impact on policy.   Some highlights:

·         The retirement age is to rise in stages, reaching 68 by 2028.   While this is unlikely to be the end of the increases, it provides a good start in terms of reducing long-term fiscal imbalances.   Getting better control over long-term finances will also help boost near-term creditworthiness, especially as the NTMA attempts to issue 30-year bonds

·         The new auto-enrolment scheme (to be launched in 2014) is well informed by work in behavioural economics.   The design details generally make sense: automatic enrolment (with automatic re-enrolment after two years for those who opt out); matching government and employer contributions; low administrative costs through utilising the PRSI system, and low-cost investment defaults

·         Tax relief standardised at 33 percent rather than at the marginal rate.   This is high enough to provide an incentive for pension provision, while getting rid of a regressive feature of the old system