Month: June 2010

Resolution of Banking Crises: The Good, the Bad, and the Ugly

This new IMF working paper by Luc Laeven and Fabian Valencia compares the current banking crisis to previous episodes across a range of dimensions – it is especially interesting on the fiscal and output costs of banking crises.  You can download the paper here.

Summary: This paper presents a new database of systemic banking crises for the period 1970-2009. While there are many commonalities between recent and past crises, both in terms of underlying causes and policy responses, there are some important differences in terms of the scale and scope of interventions. Direct fiscal costs to support the financial sector were smaller this time as a consequence of swift policy action and significant indirect support from expansionary monetary and fiscal policy, the widespread use of guarantees on liabilities, and direct purchases of assets. While these policies have reduced the real impact of the current crisis, they have increased the burden of public debt and the size of government contingent liabilities, raising concerns about fiscal sustainability in some countries.

Economic Policy Advice to the Government Prior to the Financial Crisis

Economic policy advice on reducing the risks to macroeconomic and financial stability from the housing market, restoring competitiveness and preparing to adjust in a downturn was available to the Government prior to the financial crisis.

In a research paper which I presented in the plenary session of the Annual Economic Policy Conference in Kenmare on 13 October 2006 (attended by a good number of senior civil servants), after discussing the adjustment mechanisms available to Ireland as a member of the European Economic and Monetary Union, I pointed out four main challenges facing the Irish economy and suggested a combination of policy measures to respond to these challenges. The four challenges that I identified were as follows: 

a)      maintaining a high potential output growth rate

b)      restoring competitiveness

c)      managing potential risks to macroeconomic and financial stability from the housing market

d)      adjustment to a slowdown in the United States and an expected appreciation of the euro against the dollar

 The policy measures suggested to respond to these challenges included the following:

     a)      fiscal tightening to reduce domestic demand pressures

     b)      a wage restraint in the public sector

     c)      fiscal measures to reduce the risks to macroeconomic and financial stability such as phasing out the tax relief on mortgage interest payments, a tax on imputed rents, a broader capital gains tax, or  a property tax on vacant of secondary dwellings (as options available to the Government)

    d)      limits on the use of real estate as collateral to protect the banking system against over lending and bad loans

    e)      running a large fiscal surplus during the current boom to prepare for a downturn in the world economy

The Irish Times of 14 October 2006 covered extensively my main points. The paper was published in the Quarterly Economic Commentary in March 2007.    

Completing the Eurozone Rescue: What More Needs to Be Done?

Edited by Richard Baldwin and Daniel Gros, this new CEPR e-book features a number of short essays on this topic.  The overview chapter can be read here; the full PDF is here; the individual chapters are available here; my own contribution is here.

Considine and Duffy on Expansionary Fiscal Contractions

Paul Krugman continues his campaign against the expansionary fiscal contraction hypothesis here.    In making his case, he links to a 2007 paper by UCC’s John Considine and University of Portsmouth’s David Duffy.   I don’t think the paper provides the slam-dunk evidence Krugman contends, but it is a very interesting read. 

 Abstract:

It is ironic that the potential expansionary effects of fiscal contractions have become known as non-Keynesian effects. This paper highlights the fact that Keynes and his contemporaries were aware of such potential perverse effects. It is clear that the important indirect effects of budgetary policy via expectation were known in the 1930s. Moreover, the economists of the time recognised the possibilities before they occurred. This paper supplements the existing research on the Expansionary Fiscal Contraction hypothesis by comparing two periods in economic history, Britain in 1930/1 and Ireland 1986/7, and the accompanying economic thought.

Honohan at the Finance Committee

Here‘s the transcript of Governor Patrick Honohan’s appearance before the Oireachtas Finance committee on Tuesday.