Working for Recovery from within the euro zone

In this article in today’s Irish Times, I explain why EMU is neither a primary source of our current woes nor an obstacle to recovery.

4 replies on “Working for Recovery from within the euro zone”

Can someone answer these questions for me:

How did Irish banks get access to the money they loaded to fuel the property boom?
Was the Irish government prevented by EMU rules from preventing this money entering the country?
Could the government stopped this flow?
Could the Central Bank have prevented the change in mortgage lending requirements (from 3 time prime income plus 1.5 times secondary income to whatever nonsensical amounts the banks convinced themselves borrowers could afford) ?

I am not an economist BTW and always had a problem with the propery boom, to wit:
1) The prices of property are normally determined by the size and number of mortages.
2) Although there was an increase in the number of people looking for their own homes, increases in mortgage size should have only reflected increases in incomes.
3) Even if, as an exception to 1) there were suddenly a lot of extra investors pushing property prices up at a rate beyond the rate of increase in incomes, those looking to buy their own home would not have been able to afford the increased prices.
4) Instead, by permitting such people to get much much larger mortgages, we fed the boom.

I’d like to know why the Central Bank allowed this.

Excellent article. Just two points:

1) I am unconvinced that interest rate policy did not play a role the housing boom. And while it may have been possible for tighter bank regulation to mitigate the effects, the role of higher interest rates on housing demand in a “British Isles” sterling area would not have been small.

First, there was the fact that Sterling had interest rates consistently higher than our own throughout the housing bubble (1 to 2.5 percentage points). But also, it is likely that the Bank of England itself would have had more discretion to tighten monetary policy – when Ireland joined the euro, the UK lost its 4th biggest trading partner to a foreign currency area, and competitiveness fears of an ever-appreciating Sterling were never far from the MPC’s minds. This might help explain why from 1999 to 2004, UK lending rates fell by nearly 2 percentage points, even as inflation was going up.

2) While it is true that the two other countries that opened up their labour markets to the NMS were not in the euro area, the migratory flows they received were small in comparison to what Ireland got: In the first two years Ireland registered 140k NMS workers, or 6.8% of the labour force(Comp stats for Sweden .5%, UK 1%) It is hard to argue that interest rate policy had nothing to do with this, given how many of them worked in construction in Ireland.

3) The most detrimental effect of leaving the Sterling link was doubtless the influx of British hen and stag parties into the Temple Bar area, encouraged by cheaper euro prices. The economic cost are difficult to quantify, but the social costs have been ghastly 🙂

Under the counterfactual scenario of not having joined EMU, one important question is: What monetary rule would the independent Irish Central Bank have followed? Presumably, inflation targeting. In that case, what weight would domestic inflation have got versus imported inflation? What is probably true is that statements from the Central Bank expressing concerns about house prices would have received more attention, since the Bank could have raised rates in response. That surely would have affected expectations.

A second question is to what extent would households would have borrowed in euros (at possibly considerably lower interest rates than in punts) and accepted the exchange rate risk?

I don’t even know why leaving the euro is getting coverage – other than from eurosceptics. It would be like South Carolina leaving the dollar, what would the world think of our new ‘punt 2.0’! we’d have to offer massive yields to get investors and frankly I rather see a 300bps spread on german bonds than what the former might attract!

@graham stull: low interest rates fuel asset prices, mix that with high levels of liquidity and you get a boom.

@alan ahearne: I would feel that we would have had a boom one way or another, the whole world experienced a property boom and that tide would raise all boats equally. if we didn’t buy ourselves foreign money would have entered the market and done so for us. I saw that in Uruguay with Argentinian buyers (not that we are the same as south america, just for example), forex lending may have come in as you mentioned and in order to stay competitive with europe we’d likely have to peg to the euro anyway and follow similar policy no?

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