Ireland and EMU

The Daily Telegraph gives prominence today to the recommendation by David McWilliams (made on RTE radio over the weekend) that Ireland should consider leaving the euro area: you can read the article here. The notion that Ireland or some other member country might leave the euro area is now a factor in the government bond market.

However, the adverse economic consequences of leaving the euro area are so large that this option should not be taken seriously. Barry Eichengreen has written a comprehensive paper on this topic, which you can download here.

The benign scenario described in the comments attributed to McWilliams in the Telegraph article envisages Ireland being able to use monetary independence to achieve real exchange rate depreciation in a stabilising fashion. However, a new Irish currency would be emphatically not trusted by the markets (a government that is willing to take the steps to exit the euro area is not a government that can be counted upon to keep its promises), such that either the new central bank would have to offer high interest rates or the government would have to impose capital controls. Neither is a recipe for a growth recovery.

22 replies on “Ireland and EMU”

I think further fiscal and regulatory centralisation is a much more likely scenario than an EMU bust-up myself.

I think we see here some of the risks of rhetorical commentary. When I heard David McW on the Marian Finucane show on Saturday say that “this is a war”, I didn’t expect any shooting, or any enemy. He went on to say that Ireland should look for assistance from other euro members. If he waved a euro exit around I heard it as only rhetorical.

Compare Wolfgang Munchau — more measured, even though he is not one to munchau words either — in today’s FT. He too foresees cross-border assistance in a crisis, but describes as “mad” anyone contemplating the exist option as a solution.


I saw the user titled KerryNorth on suggested that one option would be to switch to sterling. I have to say that it struck me as out of the box thinking but am not certain that its a great choice at the moment. Any thoughts.

I think we will see a lot more of this kind of commentary from those in the UK and elsewhere who wanted the Euro to fail. No serious person could contemplate the disruption which leaving EMU would entail. With a banking system with a huge net foreign liability any suggestion of leaving EMU would further aggravate funding pressures, if further aggravation were possible.
The example of the huge disruption Argentina experienced breaking the link with the dollar highlighted the huge costs which such a process would entail. Argentina was any way not even part of a monetary union and was at a very different stage of development.

so an award but its the booby prize. i have to say i thought it was at least a different suggestion. To be purely political it would certainly have the Unionists scratching their heads trying to figure the angle out.

A quick check of Argentina’s GDP figures show real GDP slumping by 10.9% in 2002, after it broke its link with the dollar. But growth then jumped back to 8.8% in 2003, 9.0% in 2004 and averaged 8.1% in the three susbequent years, mainly on the back of renewed export growth (thanks to the currency depreciation). Looking at those figures, the political temptation to abandon the euro seems likely to grow as the recession bites.

Forgive me if I am stating the obvious, but as an occasional undergrad teacher of this stuff, this is how I think about it. If the world were all flows and no stocks, as in our undergrad textbooks, then I would agree with David. But a world with no stocks would be a world without banks, bank liabilities, lousy property portfolios, government debt, and reputational capital. In such a world we would not be in the crisis we are in. Why do the undergrad textbooks ignore this stuff? I guess because time and history are too tricky for undergrads to handle.

The state of the flow variables in our economy, particularly unemployment, cry out for a devaluation. But the stocks which have been bequeathed to us by history make this impossibly costly.

Just because the political temptation to leave the euro can be expected to grow, doesn’t mean that leaving the euro is the right decision, for the reasons you mention. But if the economy implodes, it might come to be seen as a viable political option in the face of mass unemployment. As for the stock of debt and reputational capital…well take a look at Argentina’s sad economic history. But political decsision makers, with a short time horizon, might be willing to pay these costs.

I guess standard EMU theory says that we should hope for (a) recovery overseas so that emigration can pick up; and (b) greater fiscal centralisation at Eurozone level. And that aside from hoping for things beyond our control, we should cut wages decisively now. I have to say though, I am beginning to wonder whether that will be politically possible with the present government in power.

An independent monetary policy for a small and open economy like Ireland in a free capital mobility environment would be more a liability rather than a benefit. It would make a currency crisis more likley. One of the biggest benefits of EMU membership for Ireland has been the insulation from speculative attacks on the currency. Furthermore, while a devaluation would restore competitiveness quickly, this relief would be only temporary. Higher import prices would lead to demands for higher wages. To restore competitiveness we need to bring wages in line with productivity. High wages can be only sustained by high productivity.

If bank assets and liabilities are denominated in different currencies, then having a floating exchange rate which is vulnerable to speculation is asking for trouble. Since the Irish splurge has been based on credit and the Irish haven’t been saving en-masse, bank liabilities lie outside the state. Devaluing would increase these liabilities and make matters even worse than the current dire state.

On the other hand, the threat of secession from EMU might be a useful tactic to deploy in Brussels and Frankfurt. IMO, the EU needs its own IMF-type bail out body. Clearly, monetary union and fiscal independence is a much less viable macroeconomic strategy than everyone expected at the outset.

Yes, prospects for maintaining a low corporate tax rate in the event of an EU/IMF conditioned bailout look slim. In this respect, Ireland is threatened by a perfect economic storm. Raising the corporate tax rates to levels prevalent in the main EU economies could deal a further blow to tax revenues and the attractiveness of doing (and pretending to do) business in the country.
On a possible euro exit: true, the cost of servicing foreign debt will soar (assuming the New Punt falls in value, which would be the point). But doesn’t that always happen when a country devalues and its debts are denominated in a foreign currency. And while such devaluations can be catastrophic in their impact, at times they have functioned well. The ERM devaluations of 1992-93, for example, were beneficial for most of devaluing countries. And the UK pound left the system altogether with no adverse effects for the economy. Also, there was next to no inflationary impact after these devaluations.
I am not defending a euro exit, and I think there would be huge costs to pay in terms of political standing and influence, economic self-confidence, reputational capital, the administrative costs of reintroducing a national currency, etc (on top of higher debt-servicing costs and interest rates). The point I want to make is that devaluations are not always bad, and are certainly an easier way to engineer a real depreciation than deflating domestic prices and wages. Clearly, the best case scenario is that the government addresses the absurdly inflated public sector wage and pension bill. But what if it doesn’t?

I agree: it is pretty clearly the case that devaluations are not always bad. I would warmly recommend Paul Krugman’s Return of Depression Economics, and Barry Eichengreen’s short history of the international financial system, to anyone interested in these issues.

The chances of Ireland leaving the eurozone are as slim as UK entry into EMU.

However, questions still linger about the efficacy of the Euro. For instance, the Eurozone countries have shown little appetite to utilise the Euro as an instrument of financial stability (its original purpose) in the international markets. As spreads widen between bonds issued in stronger economies (Germany, France) and more vulnerable economies (Ireland, Spain, Greece), surely there is ample space for the ECB to begin issuing Eurozone bonds.

This pooling of risk within the Eurozone would significantly reduce the costs of public borrowing for countries like Ireland and represents an obvious mechanism to stabilise the Eurozone. So why is it not happening?

Is this a political problem rather than an economic problem? If so, it’s clear that for all the wishful thinking, of European unity, European governments do not sing from the same hymn sheet.

Kevin, I have read both Krugman’s and Eichengreen’s books. I am still convinced that Ireland is better off inside the EMU rather than outside. Even Barry Eichengreen who has been doubtful about the single currency agrees that leaving the euro area would be catastrophic, in his own words “would be the mother of all financial crises” (see his post on Vox at That the current recession is a common shock to all euro area countries makes the case for a common monetary policy even stronger. Barry has a nice piece on this posted yesterday on Vox

The jury is still out on whether or not the exchange rate is a shock absorber or a shock propagator. In a recent paper Giancarlo Corsetti shows that a common monetary policy could be efficient even when shocks are asymmetric.

Coming back to the Irish economy, I do not think that a depreciation of the exchange rate would have kept jobs at Dell in Ireland. We can only compete successfully in the high value segment of the manufacturing global value chain. Our manufacturing exports are in fact concentrated in the high and medium-high technology intensive industries. Also the import content of our exports is one of the highest among OECD countries which suggests that cheap imports are helpful for our exporting sector. Cheap imports are also helpful to restore consumer confidence. A strong euro also helps US multinations in Ireland.

Iulia, I never said that Ireland should leave EMU. I said that devaluations are in some circumstances helpful, which is rather different, and in my view a position clearly supported by history.

I don’t see leaving EMU as a runner and I can’t envisage the ECB providing the monetary policy that would be optimal for Ireland. However, I do believe that the current circumstances will result in greater fiscal integration – and probably the loss of our tax advantages.

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