We have made the list of finalists in the ‘Best Specialist Blog’ category in the Irish Blog Awards: the details are available here.
Month: February 2009
I didn’t expect to be asking this question again (I thought about it a lot a quarter century ago), but how much Government debt do contributors believe the Irish economy can support? A lot more than it has at present, of course.
But I raise the point now because Morgan seems sure in his latest newspaper article (not as incendiary as the previous one). It’s OK, he says, if the Banks have “bad debt” of only €10-20 billion; not OK if this number goes up to €50-60 billion.
OK, by “bad debt” I presume he means prospective loan losses. And I suppose he also may be ignoring the fact that the banks still have upwards of €20 billion of book equity capital to burn through before the Government starts taking the hit — but let’s ignore such details.
The interesting point is that the difference between his low figure and his high figure is only 22% of forecast GDP for 2009. Can we be so sure that one figure is affordable, and the other not?
Seems to me that the taxation collapse, and the resulting surge in the deficit on normal operations, is at least as big an issue in terms of a sustainable debt path as the prospective banking losses, large though these are.
The Irish economy is well removed from a full-blown financial crisis. (I take it that the outstanding feature of such a crisis is the inability roll over liabilities.) Even so, it is useful to review, with the Irish situation in mind, the list of crisis-prevention actions that received broad assent after the Asian crisis. A reasonable overall assessment is that Ireland is still in a relatively strong position, but it is worthwhile to concentrate on minimising the remaining tail risk. Here is a partial list:
Exchange rate regime: Avoid soft pegs. This became known as the “bipolar view” – completely fixed or freely floating exchange rate regimes are the least crisis prone for countries with open capital accounts. (See here for a recent thoughtful account.) Being part of the euro zone is an unmitigated blessing in this regard.
National balance sheet: Avoid serious currency and maturity mismatches. Here again the ability to borrow in one’s own currency is a huge advantage. It also appears that the NTMA is doing a good job managing the maturity structure of the national debt. The existence of the NPRF is also fortuitous – even if initially put in place for another purpose. It should be viewed as a critical liquid reserve and not tapped as an easy source of funding. Although no one likes to hear about IMF intervention or bailouts from our EU partners, I see nothing wrong with careful contingent planning and agreements. I think it is highly unlikely that Ireland will need such funding. But I think it is even less likely if arrangements are in place to smoothly access funding under extreme circumstances. This would be a clear signal that the government will do everything possible to pay its debts, and would limit the risk of falling into the bad equilibrium that Philip Lane discussed in yesterday’s comments.
Macroeconomic management: Avoid destabilising fiscal policies. Although Irish fiscal policy comes in for much deserved criticism, the dramatic reduction in the net debt put the country in a strong initial position. Unfortunately, the running of a structural budget deficit during the property boom and the reliance on asset-based taxes left the country vulnerable. The key question now is what deficit can safely be run. One plausible view is that significant short-term consolidation is required to protect creditworthiness. The danger is that this will deepen the recession and potentially even deepen the fiscal hole. An alternative approach is to make the minimum adjustment necessary to show that the public finances are under control – clearly not a risk-free strategy either. This debate will continue.
Transparency: The combination of non-transparent financial-sector balance sheets and implicit or explicit government guarantees is lethal. It is indefensible that analysts are still trying to figure out how bad the bank balance sheets really are. An open, Obama-style stress test is urgently needed to reduce uncertainty.
Regulation: Err on the side of prudential regulation. Evidently, the emphasis on prudential regulation lost out in the ever-present tradeoff between encouraging innovation and minimising systemic risk. We have now had further confirmation of the tendency of financial markets to produce bubbles and the incredible damage that ensues when those bubbles burst. There needs to be root and branch reform of the regulatory system to restore confidence in the system and ensure that balance sheets are never allowed to accumulate such vulnerabilities again.
On Feb 8, Ministers Gormley and Ryan announced the National Insulation Programme for Economic Recovery. There is €100 mln on the table, so I will not comment on the last three words of the title. The press release is worth a close examination for those who study spin.
There are two components to the programme, each worth €50 mln.
The Home Energy Saving Scheme subsidises / co-finances investments in energy efficiency improvements for private owners of houses build before 2006. The energy efficiency of the average Irish house is indeed not great. Better efficiency would indeed lower energy bills and reduce emissions, and retrofitting buildings is indeed a labour intensive business. So, did the government find the ultimate win-win-win policy?
Not quite. If Irish home owners do not sufficiently invest in their house, that is their business. There are externalities, such a carbon dioxide emissions, but these would better be addressed by a carbon tax. (A carbon tax is increasingly likely, and thus the prospect of double regulation.) A carbon tax has the advantage that it brings in revenue rather than increase government spending. Furthermore, it would affect office buildings too.
A carbon tax would also leave home owners the choice how best to improve the energy efficiency of their house. The government programme is heavily biased towards insulation. This is needed in many houses, but in many other houses it may be better to replace the heating system. There are subsidies for that too, but only for a very limited set of heaters that may not be appropriate for all houses.
There are many reasons why home owners do not invest in their houses. A prominent one, “can’t get a builder”, has disappeared but has probably been replaced with financial worries and constrained credit. It is not clear that homeowners will rush to avail of these subsidies.
The Home Energy Saving Scheme is clearly aimed at the middle class. The other component of the insulation programme, the Warmer Home Scheme, is aimed at the less well-to-do. Information is not easily accessible, but it is clear that the Warmer Home Scheme (1) is largely limited to insulation, (2) aims at “communities” rather than individuals, and (3) that eligibility criteria are negotiable. While it will take the sharp edges of “poverty” for some, chances are that these people would rather take the money and decide themselves whether to insulate the attic or not.
Will the insulation programme deliver? First, will it save money? Probably not. Assuming that transaction costs are zero and assuming that homeowners will not use the improved insulation to increase the comfort of their home, the payback period of the investments is 3-20 years (according to the always optimistic calculations of engineers). With more realistic assumptions and current interest rates, only some measures have a positive net present value.
Second, will it bring jobs? The government predicts “thousands of jobs”. If that means 10,000 jobs, then the cost per created job is €10,000; but if “thousands of jobs” means 1,000 jobs, then the cost per created job is €100,000. And, of course, the €100 mln in government funds and the $X mln in private funds is diverted money, not new money.
Third, will it reduce carbon dioxide emissions? Yes, if the subsidies are taken up. Direct emissions of carbon dioxide by households are some 7 million tonnes of carbon dioxide. Let us assume that 5 million tonnes of that are for home heating (too high), and that the insulation programming reduces the energy bill by half (too high) for one percent (too high) of houses. Then 25,000 tCO2 is saved this year, but this is an investment so let us multiply by 10. Saving 250,000 tCO2 for €100 mln is 400 €/tCO2. Last Friday, emission permits traded for 8.65 €/tCO2. The 400 €/tCO2 is conservative on the one hand, but it omits the benefits of warmer homes and lower energy bills. If the two cancel, the government overpays for CO2 emission reduction by a factor 50! (This factor is comparable to getting your hair cut in Florida rather than in Dublin.)
Will the national insulation programme do harm? I do not think so. But, it is a decidedly second best way of reducing emissions, creating jobs, or reducing povery.
Today’s Sunday Business Post carries this article: “Bank Rescue Package: More To Come“.
(May be helpful in thinking about Karl’s previous post.)