The Euro and Banking Stability: Lessons from Ireland

Patrick Honohan has a new paper on this topic, to be presented at the Dubrovnik conference next week: you can download it here.

5 replies on “The Euro and Banking Stability: Lessons from Ireland”

Interesting paper alright, it shows the scale of the hole we’re now in, re causes:

“So was euro membership to blame? The answer to this question is one that must be exercising other potential eurozone members. Our conclusion is that, despite being clearly implicated in the Irish experience, euro membership was neither necessary nor sufficient for a crisis. It did help trigger the low interest rates that launched the property bubble and eased its financing, weakening some traditional automatic restraints on the emergence of imbalances. But the Irish authorities did retain sufficient policy instruments to have combated the emergence of imbalanced; they simply did not use them effectively.”

The link is made with lax monetary policy above and then partially abandoned? surely it would be impossible for a process of higher prices feeding on higher prices to continue without increasing credit, in this case ultimately from the ECB? George Soros talks about bubbles as being engineered by credit.

I find it odd that the role of credit in triggering and feeding bubbles is little discussed, the implicating of central banks as the ultimate cause being implicit in all this?

@ Ciaron D

I think Prof Honohan is fairly consistent on the causes. He stresses that the role of the (Irish) central bank in restricting credit (when necessary) changed after the ECB took over interest rates. The last paragraph contains the following:

“Irish policy antennae were not re-tuned to take account of the fact that, following euro membership, financial markets (hitherto so sensitive to currency risk) were no longer offering an early warning system. Corrective action that could and should have been taken (fiscal policy, bank regulation, centralized wage negotiations) were neglected as a result.”

I think you conflate low interest rates and increasing credit. That’s obviously fair enough in a way, but their are other mechanisms which can (and should) be used to dampen the effect of low interest rates. I’m certainly no expert, just a thought…

Granting Patrick’s argument that Euro membership was neither necessary nor sufficient for the Irish bubble (vide Latvia and Portugal respectively) leaves the question whether the bubble would have been smaller had we stayed out? This is a perfect academic question, since it has no consequences. For Ireland anyway – maybe some for potential entrants.

Had we stayed out (i) interest rates would likely have been higher (ii) the emergence of a BOP deficit would have been noticed (iii) banks would have found it harder to pump up their balance sheets through acquiring foreign liabilities. Possibly fiscal and other policies would have been more cautious (exchange rate to defend, remember 1992/3). I find it difficult to believe the bubble would have been as big.

Interestingly, the economists who were unconvinced by the case for joining the Euro were not concerned about bubble risk; the main objection was the risk of exposure to weak sterling, which has come along on cue right after the bubble. Proponents of entry acknowledged sterling risk, but not bubble risk. The dangers of regime change for financial systems (in SOEs with capital mobility) were under-estimated all round.

“But the Irish authorities did retain sufficient policy instruments to have combated the emergence of imbalanced; they simply did not use them effectively”

That conclusion is hadnwaving.

Would those policy instruments have been enough? Would they have worked as planned? Would they have been legal (Ireland is no longer an autonomous market and that includes money and capital markets?

The best we can do is say Ireland was a (willing) victim of an outrageously large monetary bubble. That monetary policy was Euro (German) policy accepted willingly by the country and its authorities.

This is nothing new. The role of the gold standard in 1930s Britain; Bretton Woods in the 1960s-70s.

plus ca change, plus ce meme chose

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