Bad news from Brussels

Eurointelligence kicks off today with an FT story which makes depressing reading: European finance ministers appear to have turned down Larry Summers’ eminently sensible call for a coordinated global macroeconomic stimulus package. The eurozone is not the gold bloc, to be fair, but one wonders whether a political generation that has invested so much political capital in the SGP will be capable of averting the disaster that faces Europe. (And even if individual policy makers do understand what is needed, European fiscal fragmentation appears an almost insuperable obstacle to the Europe-wide Keynesian policies that are needed now, as events in our own little country dramatically illustrate.)

Europe may be a second class political power on the world stage, but it is a first class economic power, and so all of this is very bad news indeed. Has the April conference failed before it even opens?

ECB on Asset Support Schemes

The ECB released what looks to me like an important document on Friday.  In response to a February 26 Communication from the European Commission,  it sets out the ECB’s recommended guidelines on “asset support schemes”, i.e. over-priced purchases of impaired assets by the state or under-priced state insurance of these assets.  I have described my objections to these proposals a number of times and won’t go into them again here.  A quick look at the ECB document didn’t reveal anything that made me more convinced of the merits of these proposals (though I may report back after I’ve had a bit more time to read the document in detail).

In the Irish context, my concern is that the EU and ECB documents seem likely to convince the government that these schemes should be pursued.  However, there are other ways to go about dealing with our banking problems and a broader debate needs to be had than simply focusing on the details of how asset support schemes should be implemented.

Don’t make the children of Sub-Saharan Africa pay for the failures of northern hemisphere bankers.

The lack of exposure to the international banking system had led many to hope that the Developing world would be somewhat sheltered from the fallout of the financial crisis. However it is becoming clear that this will not be the case.

 The global economic downturn has already pushed 100 million people back into poverty, and the developing world is likely to experience a growing crisis of external finance over the coming months. Commodities prices (on which most of the developing world’s economies rely) have already begun to fall, and there are predictions of a 20% drop in non-oil commodities over the coming year. Similarly, as access to credit in the developed world contracts, sources of foreign direct investment and commercial lending to the developing world will dry up. So too will remittances which totalled an estimated $24 billion last year, and in Lesotho’s case, one quarter of its GDP.  Household donations to NGOs are falling dramatically.

 Worst of all, though is the risk that developing governments will begin curtail their foreign aid budgets. For sub-Saharan Africa, foreign assistance accounts for approximately half of all its external financing. Ireland was the first donor to cut its foreign aid budget. If other donors follow suit the developing world will be facing an economic downturn of massive proportions. History shows us that even the most resilient of donors, such as the Nordic Countries, can cut back greatly on Foreign Aid during a banking crisis. In the years after the Nordic Banking Crisis in 1991 we see the Aid budget, in real terms, falling in Sweden, by 17 per cent, in Finland by 62 per cent and Norway by 10 per cent.  

 Already economists are predicting that the effects will lead to significant human costs, with average life expectancy in Africa dropping by three years, and child mortality rising by up to 700,000 annually. Such volatility of aid supply will causes untold economic and fiscal difficulties for countries in the developing world, at a time when they need financial stability most. All the recent good work of Governments, Private Companies and NGOs will be lost.

 It was only a few months ago we saw rising food costs as a real threat to our standards of living. Africa’s potential in agriculture was seen to be part of a global solution.  The global problems around water, energy, food security and infectious diseases have not gone away but will get worse and haut us well after the current crisis is over. 

Let’s maintain our commitment to Overseas Development Aid. Irish Aid has earned a massive international reputation for its work and the world has a lot of respect for the Irish Taxpayer and her drive to reaching ODA of .7 of GNP by 2012.  
Niall Morris and Patrick Paul Walsh,
 UCD SPIRe  & Geary Institute



Tax breaks for pensions

The Sunday Independent reports that an important debate is taking place within the Commission on Taxation:

“But its report may also call for a reduction in tax relief for ordinary private sector pension-holders and a “fierce argument” is raging within the commission over the €2.9bn cost of this relief versus the incentives that it gives to provide for the future.”

The idea of limiting tax breaks on pension contributions has received a good deal of attention, with Fintan O’Toole a notably vocal advocate (see here).  This focus is understandable given that the better off are the primary beneficiaries of the tax breaks.  

The fact remains that many households – even better off ones – are not saving enough to sustain their living standards in retirement.  This is compounded by staggering losses in both defined contribution and defined benefit pension plans.  (See Brendan Walsh’s post from December on the crisis in occupational pension plans.) 

The tax incentive can be viewed as a device to overcome the inertia that keeps people from making adequate pension provision.  As such, I would agree that it is not particularly efficient.  But it is encouraging to see that at least some on the Commission believe it is important to approach pension reform in a comprehensive manner rather than simply eliminating the existing incentive.

The Green Paper on Pensions looked at the possibility of moving to some sort of mandatory or “soft mandatory” (with default) contributions to retirement savings accounts.   Unfortunately, with households being squeezed from so many different directions, it is hard to see from where they would find the money.  In a post a few weeks back, I proposed the idea of a Swedish-style system of unfunded – or “notional” – defined contribution accounts that could at least reduce the pressure for other tax increases.

What is most important is that reforms take place in the context of an overall plan for the retirement income system.   The complexities and importance of pension reform are such that it should not be driven solely by short-term fiscal considerations. 

Valuation of Anglo Irish Golden Circle Deal

There has been some discussion on this blog site about the value of the secret deal provided by Anglo Irish management to a circle of ten wealthy Anglo clients.  The deal was done last summer, in order to prop up the Anglo Irish share price.  Each of the clients was lent Euro 45,100,000 by Anglo Irish with the requirement that all the loaned funds be spent on Anglo shares. Clients were only responsible for repaying one-quarter of the loaned amount (Euro 11,275,000) in cash; they were permitted to repay the remainder of the loan by returning the shares.

At the time of the deal, the Anglo share price was approximately Euro 6.01 per share.  The share price has since collapsed to zero.  Each of the wealthy clients in the secret circle has lost Euro 11,275,000 (unless they now avoid repaying through bankruptcy or restructuring).  Meanwhile, the “shareholders” of Anglo have lost the remainder of the loaned cash (Euro 33,825,000 for each of the ten circle members).  Everyone has lost on this deal ex post.  It is particularly vexing since the Irish taxpayer now serves as the Anglo Irish “shareholder” and suffers a loss of Euro 338,250,00 on this secret deal. 

It is worthwhile to analyse, under reasonable assumptions, the ex ante value of the deal, both to the clients and to the Anglo management acting on behalf of shareholders (as if).  An accurate valuation is not possible with the information available to me, but a reasonable approximation can be made, and also a reasonable analytical framework provided for anyone who wishes to substitute other parameter values.

Last July Anglo had total shares outstanding of 749,585,405 and a share price in the range 4 – 7 Euros (quite volatile during the month), see the data here.  If we use a share price of Euro 6.01 then this gives a total cost of Euro 451,000,000 to purchase 10% of shares outstanding, which corresponds to the stated amount in later government reports.  Hence I assume that this is the share price at the time of the deal.  The one-year LIBOR interest rate last July was 3.2796% so I use a slighly higher interest rate of 3.75% as the two-year borrowing/lending rate.

Suppose that the clients have no insider information telling them that Anglo Irish shares are over-valued.  Also suppose that they are not liquidity-constrained.  In this simple case, the loan-plus-share-purchase is window-dressing designed to hide the real value of the deal. The client takes a loan of Euro 45,100,000 from the bank, and puts the proceeds in an interest-bearing account which exactly pays off the loan.  The client also purchases Euro 45,100,00 worth of Anglo Irish shares with true value of Euro 45,100,000.  Neither of these transactions adds or subtracts any value for the client.  The real value of the deal comes in the free put option which Anglo management has provided to the client.  If the client’s Anglo shares fall in value, the client can pay Anglo only ¼ of initial loan value, plus hand over the shares, in full restitution of the loan.  This put option constitutes the only source of value in the deal (admittedly under these strict assumptions).

The put option can be valued reasonably well using the Black-Scholes option pricing model; see here for details.  These estimates of value are conservative since empirically the Black-Scholes model tends to undervalue out-of-the-money put options.  I assume that the loan is for a two-year period and that the Anglo Irish shares have annualised volatility of 60% per annum.   The put option has an exercise price of (1-.25)(Euro 6.01) = Euro 4.512.  Using normdist and exp in excel it is easy to compute that the value of the put option for each client was Euro 6,757,469.  The put option is given to the client for free, in exchange for acting as a go-between to allow Anglo Irish management to secretly use bank-deposited funds to purchase their own shares.

The client is earning excess return of Euro 6757469 on risk capital of Euro 11,275,000 which is 59.93% or 29.97% abnormal return per year.   So even allowing for some liquidity-constraints or client nervousness about Anglo Irish share values, it seems a good deal.  Admittedly, it turned out disastrously for the clients, but this was due to a worldwide bank share meltdown plus the emerging scandals (notably this one) at Anglo Irish.

Perhaps Anglo Irish management raised the borrowing rate on the loans to account for the free put option.  This seems unlikely.  Again using the case of 2 years and 60% volatility, in order to recoup an option value of Euro 6757469.675 on a loan with principle value of Euro 45,100,000 they would need to add roughly (1/2)( 6757469.675/45,100,000) = 7.49% to their  base interest rate.  So if the base rate is 3.75% they would need to use a loan rate of 11.24%.

Bob Dylan has a song “The Lonesome Death of Hattie Carrol” about a shameful incident in the early twentieth century when a wealthy, well-connected young man bludgeoned to death a poor, African-American female servant, and escaped with virtually no punishment.  In his lyrics, Dylan makes the point that the truly horrifying aspect of this event was not the murder (there will always be violent individuals) but the reaction of the judicial establishment in ignoring it.  Analogously, in the Anglo Irish scandal, it is not the presence of greedy, underhanded individuals in Irish financial services (such people exist around the world in all countries and all industries) but the horrifying approach of the Financial Regulator, condoning and even encouraging such behaviour.  To quote from Dylan’s song:

In the courtroom of honor, the judge pounded his gavel

To show that all’s equal and that the courts are on the level

And that the strings in the books ain’t pulled and persuaded

And that even the nobles get properly handled

Once the cops have chased after and caught ‘em

And that the ladder of justice has no top and no bottom,

Stared at the person who killed for no reason

Who just happened to be feelin’ that way without warnin’

And he spoke through his cloak, most deep and distinguished

And handed out strongly, for penalty and repentance

William Zanzinger, with a six-month sentence.

Oh, but you who philosophize disgrace and criticize all fears,

Bury the rag deep in your face

For now’s the time for your tears.


JP Morgan says Irish position strong

Business World and RTE are reporting on a new research note from JP Morgan that gives Ireland a vote of confidence by telling clients not to bet on the state defaulting on its debt. The note describes Ireland’s financial position as “remarkably strong” despite the banking crisis and economic downturn. On the issue of banks’ bad loans, the analysts at JP Morgan are pencilling in a worst-case scenario of €27bn in write-offs over the coming years. Not trivial, but certainly manageable.

Fitch Puts Ireland On Rating Watch Negative

Fitch said….
“Fitch Ratings has today placed the Republic of Ireland’s ‘AAA’ Long-term foreign currency Issuer Default Rating (IDR) on Rating Watch Negative.
The rating action reflects recent disappointing news on government revenue performance which points to very sharp declines in tax receipts across the board in January and February. This will intensify the policy challenges facing the government as it seeks to tighten fiscal policy further than anticipated in the midst of a steep recession and raises the risk of fiscal slippage.
In the first two months of this year revenues were again below the already low expectations built into the government’s January forecasts. In response to these forecasts Government took action designed to produce savings this year of EUR2bn and thereby reduce the government’s deficit to 9.5% of GDP. The latest information suggests, in the absence of any further Government action, the 2009 deficit could be increased by another EUR4bn, equivalent to over 2% of GDP, implying a revised deficit of 11.5% – 12%. The Prime Minister has said that new tougher measures on both taxation and public expenditure to rectify the further slippage in the fiscal position will be announced and a supplementary Budget is scheduled for the first week of April.
Fitch will re-assess the medium term prospects for Ireland’s public finances in light of the deterioration in revenue prospects, forthcoming policy announcements and worsening economic conditions, which could raise the potential call on government funds to support the Irish banks. A Rating Watch Negative is typically resolved within three to six months.”

As a reminder, there are 2 stages in the process of changing ratings with S&P and Fitch (Moody’s is a bit different).
“Rating Watch Negative”
This means action imminent in days (max 4 weeks), and is typically almost certain.
“Negative Outlook”
This means action possible within months (sometime years for sovereigns).
(Ireland is still AAA/Aaa neg outlook with S&P, Moody’s)
The worst damage to spreads is done with the Outlooks… but if the day wants it, any statement is as good an excuse as any to sell risk…
Irish – Bund 2013 and 2018 back to near their highs in terms of yield spread, at 262bp and 284bp respectively.

What makes fiscal consolidations successful?

Athough I don’t detect that much interest in the expansionary fiscal contraction hypothesis, I think it is important we don’t try to reinvent the wheel.   The determinants of successful fiscal consolidations was the subject of a large research effort in the 1990s.   The following passages from a paper by Alesina, Perotti, and Tavares give a flavour of the findings:

“Empirical work on the effects and sustainability of fiscal adjustments has consistently reached two conclusions.  First, long-lasting adjustments rely mostly (or exclusively) on spending cuts, in particular, in government wages and social security and welfare; by constrast, short-lived adjustments rely mostly on revenue increases.  Second, fiscal adjustments are not always associated with reduced growth, or with a deterioration in the macroeconomic environment in general.” (p. 200)

“Fiscal adjustments that rely on cuts in government transfers and wages and are implemented in periods of fiscal stress are long lasting and not contractionary.  On the demand side, the expansionary aspect of such fiscal adjustments works through an expectation effect, which is stronger the worse are initial fiscal conditions.  On the supply side, the interaction of certain types of adjustment — those without tax increases but with cuts in government employment and wages — lead to wage moderation, reduced unit labor costs, and increases in profitability, business investment, and production.” (p. 214)

The Minister for Finance might be interested in this:

“Furthermore, governments do not seem to be systematically punished at the ballot box for engaging in fiscal adjustments, nor do they lose popularity, as measured by opinion polls.  In principle, one can think of two explanations for this result.  One is that voters do not like fiscal profligacy.  The other is that governments are particularly skillful at choosing the appropriate moments to implement unpopular policies   While it is difficult to decide definitively, we conclude in favor of the first interpretation.” (p. 241)

Alesina, Alberto, Roberto Perotti, and Jose Tavares. (1998). “The Political Economy of Fiscal Adjustments,” Brookings Papers on Economic Activity, 1998.1, pp. 197-266.

Déjà Vu

“Indeed it was entirely through increases in taxation that the reduction in the primary deficit was achieved.  This also weakened the credibility of the government.   The failure to reduce public expenditure, or indeed the growth in the share of current expenditure in GNP, was a result of three factors.   First, the operation of automatic stabilizers, especially through a mushrooming of income support resulting from the sharp rise in unemployment.  Second, a conscious decision to maintain (and even, to improve) the real value of income support payments in an attempt to shelter the worst off from the fiscal adjustment.  Third, the inability of the government before 1987 — a coalition of trade-union and middle class interests without a parliamentary majority — to agree on the elimination or curtailment of any significant programmes [fn. Other than the deferment of some public investment plans] or to implement real wage rate reductions in the public service.   This last factor had a most debilitating effect on confidence in the government’s determination to set things right, especially considering the repeated government announcements that such retrenchment would be inevitable.” (p. 205)

Honohan, Patrick. (1989), “Comment on Rudiger Dornbusch, Credibility, Debt and Unemployment: Ireland’s Failed Stabilization,” Economic Policy, 4(8), pp. 202-5.

Income tax exemption limit

In my post on income tax of a few days ago, the sample structure that I presented went part of the way back to the rates and bands in effect in 1996, a good year.

One feature of the mid-1990s income tax structure was the much lower exemption levels effectively achieved nowadays through tax credits. Should this trend be reversed?

Two comments on my earlier post point to problems in lowering the effective threshold. Colm McCarthy worries about incentive effects given the interaction with social welfare. Aedin Doris finds it difficult to justify taxing a low income single mother with two kids.

I have sympathy with both views, and this is not a make or break issue for revenue (though there is some revenue potential even at the low end).

I also note counterpoints. The more revenue we seek from the system as a whole, the more a high exemption threshold/general tax credit pushes other workers into higher marginal tax rates; bad for incentives. And, depending on their family/household circumstances, not all low income part-timers have low consumption.

Then there is the political/ideological view that as wide a range of citizens should feel involved in the national housekeeping by paying some income tax (though all pay expenditure taxes anyway).

The impact of a lower exemption threshold on low income tax payers could be considerably eased, as has been suggested, by re-introduction of a third low income tax rate.

My guess is that, for a Minister of Finance, lowering the effective threshold (by lowering personal tax credits) offers too big a hostage to fortune to be worth the revenue it would raise.

What do others think?

(Update: the first version of this posting used misleading language about thresholds, I have modified it without changing the intended sense).

Both tax and spending need attention

Now that we all recognize the way in which the tax system has gone wrong and the need for adjustment so that it collects more revenue, it’s time to have a look at the balance between tax and spending adjustments needed to get back to the kind of reasonable budgetary structure that we had in the late 1990s.

To this end, I thought it would be useful to post charts showing total government expenditure and total government taxation as (i) % of GDP; (ii) Real terms.

I’ve used the latest NIE and the data in the October 2008 budget book, together with the ESRI’s latest GDP forecast. So this is all a little out of date.

Both charts reveal both the sudden collapse in taxation.

They also show the way in which real spending had a strong upward momentum which ran ahead of economic growth, especially as soon as this started to slow in 2007. (Some of this is the operation of automatic stabilizers, so important not to overcorrect.)

Pretty clear then that, if we’re to get back to the comfortable zone we were in in the late 1990s, it’s not just a tax adjustment that’s needed,  but also a reining in and rollback of spending.

Expansionary Fiscal Contraction

The February exchequer returns combined with ongoing default risk perceptions mean the government has little choice but to bring forward its fiscal adjustment.  I have doubts, however, about one argument for front-loading the adjustment that seems to be gaining currency – that it will be expansionary.  

The classic argument for an expansionary fiscal contraction focuses on cuts to government spending.  Permanent cuts in government spending lead to expectations of permanent cuts in taxes.   The expenditure effect of the latter can outweigh the former (especially if starting from a large and distorting tax burden).   In contrast, the current Irish debate is focused on adjustment through tax increases.   With apologies for oversimplifying, the argument seems to be that households and businesses already expect higher taxes, but uncertainty about the precise nature of those taxes is causing increased precautionary savings and investment delays.  Eliminating this uncertainty would lead to increased domestic demand.   

Two comments:  First, if the economy contains a significant share of myopic/liquidity-constrained individuals as well as forward-looking Ricardians, the reduced precautionary savings effect of the latter would have be very strong to offset the reduced spending of the former.  Second, and less speculatively, the empirical work of Alberto Alesina, Roberto Perotti and co-authors finds that fiscal adjustments based on tax increases tend to be less durable and more likely to be contractionary.

I draw two tentative lessons.   The first is that a cautious approach should be taken to front-loading until we understand better the role of discretionary fiscal contraction in the extremely sharp slowing of the economy.  The second is that a narrow intertemporal macro perspective suggests a significant part of any adjustment burden should fall on expenditure.   I would be very interested to hear views on the relevance of the expansionary fiscal contraction hypothesis to the current Irish situation.

No Room for Tax Increases?

During last night’s Prime Time, former Department of Finance official Cathal O’Loghlin made the following comments:

There’s a €16.5 billion gap to be filled by 2013 … If we go down the tax route to fill the whole of that, we’d be talking about a tax burden which is way above European levels … solving one-third of that problem by raising taxes would push our tax burden to the same levels as the Euro area average.

If true, these figures suggest that the room to use taxation to close our deficit is very limited and this should be a central issue in public debates about the fiscal crisis. However, I would not have characterised the tax burden in this way and thought I’d explain why.  Continue reading “No Room for Tax Increases?”

Valuing the Anglo 10 Loans

I’m afraid I must disagree with my distinguished colleague Eamonn Walsh’s arguments in today’s Irish Times about the Anglo 10 loans.   Walsh argues that “to state in the Dáil or elsewhere that the Anglo 10 “were given” €450 million is patently incorrect” and that “The most likely outcome is a wealth transfer that was somewhat less than €40 million.”

Let’s recall the details here. Continue reading “Valuing the Anglo 10 Loans”

Unemployment Rate up to 10.4%

In a further indication of the rapidity of the decline in Irish economic activity, the CSO‘s Live Register release reports a standardised unemployment rate of 10.4% in February up from 5.0% one year earlier.  One reason the figure is so high is that unemployment rates from previous months were revised up (January’s rate was revised up from 9.2% to 9.6%) as they were benchmarked to the QNHS estimates for September-November.   (Brendan Walsh had predicted such a revision in his post on the QNHS release.) Even controlling for that, the pace at which the economy is contracting is remarkable.

A Eurozone Safety Net?

From the FT:

Eurozone authorities would help a member-state in serious economic difficulties before it needed to turn to the International Monetary Fund because of a risk of debt default, a senior EU policymaker said on Tuesday.  “If crisis emerges in one eurozone country, there is a solution before visiting the IMF,” Joaquín Almunia, the EU’s monetary affairs commissioner, said. “It’s not clever to tell you in public the solution. But the solution exists.”


Mr Almunia’s comments made clear not only that EU policymakers would not remain impassive in the face of a crisis in a eurozone country, but would act pre-emptively before a bail-out became necessary. “By definition this kind of thing should not be explained in public. But we are equipped intellectually, politically, economically,” he said.

I’m not sure that it’s really so clever to keep this solution a secret.  As the FT piece notes, there are serious legal restrictions in place that can hinder this kind of thing, such as restrictions on ECB lending to governments (The ECB website states “The Eurosystem is prohibited from granting loans to Community bodies or national public sector entities.”) and the so-called no-bailout clause in the Maastricht Treary prohibiting collective liability for debts (considered “an important pillar on which the European Union was founded” by reliably hard-line ECB Executive Board member Juergen Stark.)

Would it not be better for the Eurozone countries to have an explicit debate about this and, if necessary, outline a strategy and explain why it is legal?  Wouldn’t financial markets be less jittery if they could be genuinely assured that a coherent Eurozone strategy was in place?

IBEC on Financial Regulation

Today’s Irish Times contains a thoughtful and well-argued piece by Brendan Kelly of Financial Services Ireland, the group within Ibec that represents the international financial services sector.  In the piece, Kelly notes that “the financial services industry warned the Financial Regulator about the risks of increasingly complex financial markets for many years” and that the Regulator’s consultative panel of industry representatives “warned the Financial Regulator’s office about the increasingly complex nature of international financial services”  and also “highlighted the lack of financial services experience on the board of the Financial Regulator, and the need for a dedicated unit to anticipate the regulatory hazards caused by financial innovation.”

These are all good points and hopefully will be taken on board within the new structure.  However, it is important to remember that the key regulatory failure in the Irish case did not involve complex financial instruments.  Instead, regulators allowed banks to make loans to property developers on a scale that threatened their solvency once house prices started to decline.  Continue reading “IBEC on Financial Regulation”

Guest Post by Jonathan Westrup: Major Regulatory Reform?

We are pleased to bring you this guest post by Dr Jonathan Westrup of the IMI and author of the 2002 TCD Policy Institute Studies in Public Policy No. 10 Financial Services Regulation in Ireland – the Accountability Dimension .

” Further to Karl Whelan’s post, the government has clearly decided to radically reorganise the present unwieldy structure that, for the past 6 years, incorporated the financial regulator within the Central Bank.

Two features of the proposed reform immediately stand out. First, the decision to put responsibility for stability and supervision into one organisational structure rather than to have them divided between the Bank and the Regulator. Second, the decision to set up a presumably stand alone Financial Services Consumer Agency with responsibility for consumer protection incorporating the existing consumer directorate of the Regulator and the Office of the Financial Services Ombudsman.

What is intriguing is the Taoiseach’s reference in his speech to “international best practices similar to the Canadian model”. A quick look at the Canadian regulatory system, as Karl mentions, shows that a distinguishing feature of the model is that the Central Bank has never had a responsibility for regulation. Instead, since 1987, the Office of the Superintendent of Financial Institutions (OSFI) has regulated both the banking and insurance sectors while Canada remains the only major country without a securities regulator, with responsibility devolved to the individual provinces. In terms of a consumer protection mandate, the provincial securities regulators all have a responsibility while, since 2001, the Canadian government established the Financial Consumer Agency of Canada with a mandate “to strengthen oversight of consumer issues and to expand consumer education in the financial sector”. However, according to its website, it has a budget of only 8 million Canadian dollars.

So on the face of it, the relevant part of the Canadian model to which the Taoiseach refers, is the hiving-off of the consumer protection aspect of regulation.

There is little further detail at the moment of the new regulatory system but there are some very important questions. We are told that a new Head of Banking Regulation will be appointed, but how will insurance and securities regulation fit into the Commission?  What will be the relationship between the Governor of the Central Bank and the Head of Banking Regulation, given the demands of the Maastricht Treaty in terms of determining the governor’s accountability towards the domestic political system? Will the present 50/50 funding arrangement between the industry and the Central Bank continue with the new model? What will be the powers of the new consumer agency outside the Banking Commission?

The government has clearly decided, yet again, not to set up a stand alone single financial regulator, but to go for a variant of the Twin Peaks model where all prudential regulation is the responsibility of the Central Bank and conduct of business regulation is regulated separately. However, in the Dutch case, which is the Twin Peaks exemplar, the conduct of business function is more comprehensive than appears to be the case with the proposed Financial Services Consumer Agency.  With details so limited at this stage, this assumption may not be accurate.

Many governments are wrestling with reforms at the moment, with the UK’s Financial Services Authority promising “a revolution” in financial regulation in their proposed reforms due before the end of the month. The government has moved quickly but more detail is required before making assumptions about how the system might work. Given the fairly immediate need to hire the new head of banking regulation, questions about the model will presumably be clarified very quickly.”

Labour Market Trends

The publication by the CSO on Friday of the Quarterly National Household Survey (QNHS) sheds light on recent developments in the labour market.  Naturally the headlines were grabbed by the fall over the year of almost 87,000 or 4.4% in the numbers at work.  Even larger proportional decreases were recorded among men and full-time workers.  A small decrease was recorded in the participation rate, which is reflected in a rise in the number of “discouraged workers” (outside the labour force, but expressing some interest in employment).

So these figures do not in any way modify the gloomy picture of recent economic trends available from other sources.

Nor does a comparison of the QNHS data with the more up-to-date Live Register (LR) releases give any cause for optimism.  In fact, the contrary is the case because – somewhat surprisingly in my view – the QNHS shows unemployment (measured on an International Labour Office basis) rising faster than the numbers on the LR.

Comparing September-October-November of 2006 with the same months of 2008, the QNHS measure of unemployment rose by 89% (114% for men, 50% for women), whereas the LR measure rose by 69% (88% for men and 42% for women).

It might have been expected that the LR would show a bigger jump in the earlier stages of the recession, as short-time working and other partial-employment arrangements lead the increase in full unemployment and the latter are more likely to be reflected in the LR than in the QNHS numbers.  However, there is no evidence of this trend in a comparison of the two data sources over the past year.

Looking ahead, since the LR numbers showed a very large increase in December 2008 and January 2009 over the corresponding months one year earlier, it is to be expected that the next QNHS will display even gloomier trends that those revealed on Friday.  Using the LR data, the CSO estimates that the standardised unemployment rate for January 2009 was 9.2% (compared with only 4.2% in the last quarter of 2006).  When the next QNHS data are released (and they will be based on normal quarters from now on), the estimate of the standardised unemployment rate is likely to be revised upwards.

A Canadian Model?

In Saturday’s Ardfheis speech, the Taoiseach announced:

I will create a new central banking commission. This will incorporate both the responsibilities of the Central Bank and the supervision and regulatory functions of the Financial Regulator. This will build on best international practice similar to the Canadian model. And it will provide a seamless powerful organization with independent responsibility.  It will have new powers for ensuring the financial health, stability and supervision of the banking and financial sector.

I interpreted this statement as implying that Canada has something called “a central banking commission” which incorporates both central banking and financial supervision.  It turns out, however, that Canada does not have such a structure.   Continue reading “A Canadian Model?”

Politics for beginners

Ireland is a small country with a very odd political system, and so we don’t necessarily expect our politicians to be economic experts.

We do however expect them to get the politics right.

The title of this post comes from a piece by Brendan Keenan in yesterday’s Sunday Independent, in which he adds his voice to the growing calls for a broad-based and front-loaded approach to solving the state’s financial crisis. I fully understand the initial reluctance by the government to take too much demand out of the economy too early, but as Philip, Patrick and others have pointed out, growing levels of uncertainty may be doing more damage to consumer spending at this stage than would be associated with the increase in taxes that everyone knows is going to have to take place sooner or later. And clearly demonstrating that the government is in control of the state’s finances is important, not just in its own right, but because of the implications for the credibility of the bank guarantee.

To these economic arguments can be added a political one that is to my mind equally compelling: trying to solve the fiscal crisis in a piecemeal manner will be politically extremely difficult, if not impossible. As Jeff Sachs used to say in a very different context long ago, you can’t cross a chasm in a series of short steps.