Jim O’Leary discusses Ireland’s EMU membership in his Irish Times column today. An interesting question is whether Ireland would have avoided a bubble had it opted not to join EMU. The issue here is the relevant counterfactual. Since quite a number of non-member European peripheral countries that were growing quickly for convergence reasons also enjoyed credit booms due to the global decline in risk aversion and compression of spreads, it is not so obvious that staying outside EMU would have delivered stability (think of Iceland and various CEE countries).
If expectations of price appreciation grip the housing market, small differences in the level of interest rates do not make too much difference. To the extent that high levels of immigration helped to fuel perceptions of strong fundamentals in the housing market, that dimension is orthogonal to EMU: the two other countries that were early liberalisers were also not members of EMU (Sweden and the UK).
Accordingly, if the relevant comparison set is composed of other non-advanced European countries (in terms of income levels relative to potential in the late 1990s), then it is not clear that EMU was a fundamental factor. Rather, key differentiating factors may include the quality of banking regulation and the probity of fiscal policy.
Clearly, this is a very open debate that calls for more research!
7 replies on “Did the Euro contribute to the Irish bubble?”
While we may have had a bubble outside of EMU do you not think that the severity of our situation is related to inappropriate (for Ireland) ECB monetary policy?
In line with the previous Response I believe that the resumption of the Irish housing boom after 2002 did owe a lot to the “one size fits all” monetary policy of the ECB. It is hard to believe that an independent Irish Central Bank would not have taken some measures to rein in credit expansion – although it should be acknowledged that the Irish monetary authorities did not even exercise the less effective instruments that remained at their disposal as members of the monetary union. Tony Leddin and I looked at this issue in an article in the Irish Times before Christmas:
i often thought that our much vaunted tax policy created such a distortion between income and capital that it was bound to lead to asset price bubbles and an eventual collapse.
Instead of counter balancing EU monetary policy with conservative fiscal policy, we turbo charged ours with low taxes. irish citizens subsidised business by stealth – indirect taxes became the the primary revenue generators for the company. The tax base was hollowed to the bone; yet we all celebrated – sure werent we getting wealthier as the day as house prices soared.
Now we are faced with falling asset prices and consumer spending. The potetial future tax revenues from capital gains look negligible and we can no longer rely on the crutch of indirect taxes as people choose to de-leverage rather than to spend. Our dependence on loss making IFSC cos means that our future corporation tax take will diminish substantially. Not to mention the fall in property taxes. It would seem our ‘low tax’ regime is dead, particlarly given the need to service our ballooning deficit.
Making postive noises about tax harmonisation and common tax bases will not only restore our credibilty with the EU and the US, but will also give us a chance to rebalance our fiscal basis and give us some hope of addressing our fiscal defict in the future.
I agree that other countries got into trouble without EMU. Iceland being a clear example: but the domestic economy was only a secondary aspect to the reckless expansion of the Icelandic banks and conglomerates.
Nevertheless, EMU surely contributed significantly to the Irish residential property bubble, first in 1998 with the very sharp fall in interest rates — we certainly wouldn’t have had such a fall at that time without EMU membership. Also, this interest rate fall created uncertainty about the new equilibrium price of housing. Clearly equilibrium prices had increased, but by how much?
The second way in which EMU contributed is in eliminating exchange risk in bank foreign borrowing. Though similar things have occasionally heppened in history (cf. Chile before 1982), it is hard to imagine that international lenders would have lent so much (50% of GDP) into a property bubble on a small island with exchange rate risk.
Might active monetary policy have choked-off the demand? Irish monetary policy history offers little indication that policy would have been countercyclical.
At the end of the day it is the regulatory tools, which were still under national control, that could have been most effective to prevent this happening. Anglo Irish bank should never have been allowed to grow so rapidly, ramping up lending recklessly and relaxing credit conditions as even as the bubble became undeniable. This bank’s expansion was not only self-destructive, it destabilized competition and helped bring down the whole market.
Arguably, we would have done better if not only monetary policy, but bank supervision, had been outsourced to Europe.
Those of us who had been a little sceptical about EMU and its one-size-fits-all monetary policy viewed the housing bubbles in Ireland, Finland and Spain as validating our scepticism. That is pretty much the way the Economist magazine reported things, for example.
The assumption was that there would then be a bust, and that interest rates might be inappropriately high at that stage. In a way, I wonder whether viewing things in this EMU light didn’t blind people to the more systemic banking-related problems which standard OCA theory doesn’t address?
Patrick is surely right that the exchange rate risk would have put a lid on banks’ foreign borrowing. Interest rates would have been higher too, and I reckon we would have had a smaller bubble. When we scrapped the independent currency, we killed, not Cock Robin, but the Coalminer’s Canary. I spotted the killers leaving the scene!
Even if you believe that joining the Euro was a big gamble for Ireland, as many economists did, it would be a far bigger gamble to quit, as Jim O’leary argues in the IT today. There is a huge asymmetry here, and recent talk about countries leaving sounds like hedgies’ chatter to me.
I agree with Philip, there are many more factors expalning the Irish housing bubble. Ireland is the only country in the OECD where mortgage payments tax relief is not accompanied by a property tax or a tax on imputed rents. To protect the banking system against adverse developments, proper banking regulation sould have limited the use of real estate as collateral.