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EMU Fiscal Policy

Single currencies and fiscal federalism

Barry Eichengreen has an interesting article comparing the Irish and Californian experiences here.

7 replies on “Single currencies and fiscal federalism”

Well spotted, Kevin. This is a very interesting piece. Apart from anything else, it suggests that there is some upside in Ireland’s current notoriety: our high profile means that there are a few fine minds in other parts of the world applying themselves to our problems, and perhaps with a clarity of vision that distance helps create.
A cautionary point though. California’s fiscal crisis was caused by an impending budget deficit of just 2.5% of GDP. The total gap we have to bridge is getting on for five times greater, of which the estimated structural component alone is more than three times greater.
More on the Californian story and what they’ve had to do here:
http://www.dof.ca.gov/budget/historical/2009-10/documents/Financial_Disaster-Presentation-w.pdf

I believe that Barry Eichengreen’s article is consistent with my personal belief that there is a strong case for the operation of a dual currency regime in Europe comprising the use of the Euro for trade in goods and services, with the trade in real estate priced, traded and financed exclusively in the various national currencies.

The adoption of such a regime which has a precedence in the Green Currency regime used in the past to operate the Common Agricultural Policy, would give national authorities levers such as devaluation of their currencies or interest rate changes which could be used to inhibit or prevent counter cyclical, localised property market bubbles, such as that which has caused so much economic and social problems to Ireland in the recent past.

The restoration of the Irish Punt as the sole currency in which the Irish real estate market would be denominated, also points to a possible way to alleviate the current mess in which the Irish financial sector finds itself, by permitting a technical means of minimising bad or non-performing property related loans and allowing the banks to account for likely future upswings in the economy and the property market.

What I am proposing is that the banks be required to denominate all Irish property related assets, liabilities and transactions in Irish punt at the existing conversion rate, with all other assets, liabilities and transactions continuing to be priced in Euro.

I am further suggesting that a subsequent devaluation of the newly restored Punt by a percentage equal to the average fall in property values, together with a guarantee to revalue the currency back to the existing rate over a period of say 10 years, might allow the banks to account for and leverage the likelihood that they will eventually recover much of the value of their risky loans over time, as the property market recovers, the economy grows and the international financial system is rebuilt.

In this context it is recommended that the bank’s share prices and financial results should also be denominated in Irish Punt during this period.

It is further recommended that Irish pension funds be required to invest a significant proportion of premiums collected in Irish sovereign bonds as a condition of attracting tax relief for those premiums in order to support the market for Irish sovereign debt.

This proposal has a number of advantages including:

(a) allowing the banks to maintain the nominal value of their property related loan books and real estate portfolio on their balance sheets, with a real prospect of them recovering much of the value of these investments over time;
(b) permitting the banks to borrow from the Central Bank of Ireland against these Punt denominated assets in order to provide Punt denominated mortgages and service their money market Euro denominated borrowings;
(c) reducing the short-term property related loan service costs (in Euro) for customers, thus reducing the level of bad debts;
(d) reducing the financial pressure on the Irish authorities.

The operation of a dual currency regime as suggested here will not on its own solve the crisis in the Irish financial sector. The banks will still struggle to rollover their Euro denominated money market borrowings and will thus still most likely require re-capitalisation by the Government in Euros. However there are many positive features in this approach which might help alleviate the current crisis and prevent a similar crisis occurring in the future.

Gerard Moran, PhD Researcher, Smurfit School of Business, UCD

“…there is no question that political compromise and the prospects for economic stability will be enhanced by temporary outside help.”

This raises an interesting point – why is our entire economic debate focused around the goal of avoiding having to be “rescued” from the outside? Whatever about the IMF, should we be thinking of an EU aid package as some catastrophe to be avoided or as an essential policy goal to be pursued diplomatically? It might be embarassing to be bailed out but then some of our woes can be put down to EMU (as Eichengreen points out) so maybe we should be a bit bolder?

@gerard moran:

if you bring in any other currency the debt remains, the assets remain, and all you are doing is changing the name over the door, how do you value a currency that is only good for property transactions?

I have seen dual currency in much of latin america and frankly i’m not impressed.

Further to that, you can devalue a ‘punt’ but given that we still live in the eurozone the idea is nullified by relativity, sure we can manipulate the money supply (the question of who would actually want to back Punts2.0 is a big question, how do we repay bond debt if we rely on property only? in euro?) but isolating this to a currency that serves the property market doesn’t remove the problem, in any case butter vouchers would equally suffice.

forcing pensions into what may be a loser would only compound the 40%+ losses already faced! if a person had been in the ISEQ that figure is even worse! in fact, it would amount to state sponsored confiscation because the state doesn’t have the right to tell anybody what they can and can’t invest in. i’d rather pay tax than ‘invest’ in such an instrument.

am i way off on these observations? if so let me know.

Interesting comparison by Eichengreen that sheds real light on our situation. The logical implication of the single currency does seem to be fiscal federalism or co-ordinated fiscal policy which I think Germany is starting to accept but we will, rightly, pay a price for any bailout. We need protecting from our own government!

People will obviously have major problem with centralised monetary and fiscal policy (federal state) in the long-term but there seems no way out of it in the short-term. I doubt Germany will accept euro members having divergent fiscal policy in future.

As a member of a single currency and lacking control over monetary policy, the government will need to get fiscally innovative to close gaps in its finances. With the country facing rising unemployment and increased borrowing on international markets, on which there is no guarantee of obtaining all moneys sought, I believe the Government should consider the introduction of a voucher system for all/percentage of transfer payments such as social welfare payments, children’s allowance, pensions etc. These vouchers when used could then be netted off against a company’s tax liability. Such a system would have the benefit of potentially reducing the Governments borrowing requirements by billions of euros, whilst saving it hundreds of millions of euros. By issuing vouchers with expiry dates would ensure that this money is spent within a certain time-frame and not just saved. It would also ensure that the money is spent in tax paying businesses within the economy, thus reducing leaks. Any voucher that exceeds the expiry date would be an additional saving to the Government. If the Government acts sooner rather than later to plug these holes, then fiscal federalism may be just avoided!

We better hope that much of the rest of the eurozone is in trouble. Eurozone-wide depression would mean deflation throughout the eurozone and the European Central would happily try to devalue and cause a little inflation. The Dublin government can’t decide itself to devalue, but don’t forget that the Brussels and/or the ECB can. We talk wistfully about how we could have devalued the punt but we forget that the euro can be devalued just as easily.

Germany will eventually realise that it’s better to have healthy debtors paying off a devalued debt, then it is to continue with the status quo which is destroying German exports. So sooner or later, Germany will happily support printing euros to fund stimulus and cause inflation, gradually eating into the real debt levels Irish people and businesses face today. The danger is that ‘later’ could mean 10 years of 10+% unemployment.

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