The Irish Economy

NAMAWineLake blog performs yet another valuable public service and points out that Brian Lenihan’s statement of October 30 told us that “AIB’s upcoming €5.4 billion will be fully underwritten by the National Pension Reserve Fund Commission (NPRFC) at a fixed price of €0.50 per share.”  Unfortunately, the shares closed on Friday at €0.337.

This means the Pension Reserve Fund looks set to make an instant loss of €1.8 billion when it purchases these shares. There is, of course, an alternative. Cancel the underwriting, nationalise the bank and appoint an assessor to value the shares. If, for instance, the shares were valued at their closing price on Friday, this would cost us €364 million. Which sounds better? Losing €1.8 billion or losing €364 million. Is it worth €1.4 billion to retain a tiny private ownership share?

It is also worth raising the question of whether the current process we are going through with AIB is the right one. Rather than being so sure that the bank just needs another €5.4 billion to fix it, why not remove the current upper management immediately, introduce new management charged with fully assessing the bank’s loan book and then decide what to do with it?

If AIB is deemed to be deeply insolvent at that point, we are already (albeit slowly) developing a template for dealing with banks of this kind. This would involve splitting AIB into a good bank and a bad bank, leaving the €4.5 billion in subordinated debt in the bad bank and perhaps negotiating with with the holders of these securities to reduce the amount of public funds required to cover the losses.

If the losses at AIB are larger than the authorities currently envisage, then there are strong arguments against continually putting taxpayers money in to protect other providers of risk capital.

Apologies for what Paul Krugman would call a “wonkish” post. 

As we enter some critical weeks for Irish fiscal policy, there is still wide disagreement about the nature of the creditworthiness-demand trade-off facing the government.   At one of the spectrum are those who think Ireland is placed to have an “expansionary fiscal contraction”: a cut in the discretionary deficit would raise confidence and lower the risk preimum sufficiently so that we could simultaneously improve creditworthiness and demand.   At the other end are those who think that discretionary cuts will slow the economy so much that the actual deficit will rise, leading to both a shrunken economy and shrunken creditworthiness.   I think I share with most economists the view that we are actually in the boring middle – deficit cuts will slow the economy but will improve creditworthiness.

Readers might find this graphical representation of the trade-off useful in putting the different views in context.   It attempts to capture the potentially complex relationship between creditworthiness and demand, allowing for different trade-offs over different ranges.   (The “dismal” vicinity around point C has been subject to notable discussion on this blog, where the government is seen as effectively powerless to avoid bailout or default.   At least this is how I interpret commenters such as Simpleton, Paul Hunt and Tull Macadoo, though I’m sure they will correct me if I’m wrong.) (more…)

Here’s an article I wrote for Business and Finance on the current budgetary situation (complete with a nice picture of Mrs. Merkel). The article emphasises the importance of getting the upcoming budget right rather than worrying too much about the 3% target for 2014.

The results of the review of the ESRI are here.

Details here.

The CSO has released institutional sectoral accounts for 2009 - the release is here.  These detailed data provide a lot of useful information about the shifts in income and savings in recent years.  Among the highlights:

• Household net saving ratio jumped from 3.9% in 2008 to 12.3% in 2009. Behind this ratio: net disposable income fell by €2.1 billion but consumption fell by €10 billion.
• The Net Operating Surplus (profitability) of Financial Corporations and Non-Financial Corporations fell by over 22% and 6% respectively, between 2008 and 2009. Investment by Non-Financial corporations fell from €13bn to €7bn over the same period. Investment by Financial Corporations also declined - from €0.9bn in 2008 to €0.6bn in 2009

Congratulations to Cormac O Grada who has been awarded 2010 Royal Irish Academy Gold Medal.  This is the premier Irish academic award and in Cormac’s case it is richly deserved.

PS: I released this yesterday but then quickly withdrew it as I thought it was embargoed!  But I think its OK to release the news now - just tell one person at a time!

I have posted links to this piece in the comments section before, but never on the front page. This seems like a good time to do so, given that the question of what markets want is beginning to exercise people (see for example here, or here). The essential point is that markets understand that governments face political constraints, and take this into account when assessing the credibility of their economic policies. (And, moreover, market participants tend not to believe in tooth fairies or negative fiscal multipliers.)

We’ve known all along that fiscal adjustment here would be contractionary, and that our economy thus needed substantial export growth if it was to avoid falling into the hands of the IMF. That in turn requires a buoyant European economy; hence my alarm regarding austerity measures in countries like the UK and Germany. One of the key insights of Barry Eichengreen’s work is that you have to analyse international monetary arrangements as systems: it makes little sense to analyse policies in one country at a time as if countries are isolated from each other. Ireland has no choice right now concerning what policies to pursue, but other countries do, and if those with fiscal space (as measured by the interest rates at which they can borrow) choose to embark on contractionary policies now, for what appear to be nothing more than ideological reasons, then that is profoundly irresponsible from the point of view of the fragile system that is the European economy.

With consensus on the likely size of a four-year adjustment unlikely to emerge (and perhaps not particularly relevant anyway) the key fiscal policy question for now is what the size of the adjustment is going to be in the upcoming budget.

Yesterday’s Fine Gael Dail questioning on this subject was interesting. Deputy Noonan:

Now that we have agreed that 3% in 2014 is the finish of the race, what is the Minister’s starting point on 7 December? Will he go soft? Will the budget deficit be 11%, 11.5% or 10.5% of GDP? Will he go below 10%? He needs to come up with this figure pretty quickly. I will not press him any harder on this; I am simply speculating. I have no information as to his thinking on this but this is an essential piece of information. Unless we know the starting point we do not know where the Minister is going.

I’m pretty sure that Noonan knows that an adjustment of €7 billion would be required to reach the 10% target but hasn’t yet said that he would support it. His lack of enthusiasm for the €15 billion four-year adjustment figure suggests he wouldn’t be too keen.

However, others in Fine Gael are calling for the 10% to be met. Here’s Simon Coveney

My understanding from the briefing from the Department of Finance is that the key requirement from bond markets to allow Ireland to issue bonds is that we will need to bring our deficit below 10% of GDP next year from our current position. No Government speaker, including the Taoiseach and the Minister for Finance, addressed that issue as to what figure will be necessary in the 2011 budget to bring down the deficit to 10% or less of GDP. That is the guideline figure we have been given to issue bonds and raise money in order that we can keep Ireland functioning and keep our economic and political independence in terms of budgetary decision-making.

And here’s a bit of cat-and-mouse play from Damien English

Deputy Coveney is correct in stating that we must bring the deficit down below 10% of GDP next year, and I ask the Government to give us the figure now. Tell us what it is, whether it be €5.5 billion, €6 billion, €5 billion or €4.5 billion, and let us work to that.

Well, Deputy English, it’s not going to be €4.5 billion!

Labour’s participants in this debate seem to have stayed away from this issue. However, on the Vincent Browne show last night, Pat Rabbitte indicated he wouldn’t support more than €4 billion in adjustments. If this is the party line, then it means that Labour are not supporting reaching the 10% target.

Yesterday’s Dail debate shows that Fine Gael’s approach to the upcoming budget and four-year plan debates appears to be to emphasise the idea that economic growth may be higher in future years so that €15 billion in cuts will not be needed.  The ESRI’s high growth scenario gets a lot of play in these discussions.

From Enda Kenny’s speech in the Dail:

There are better possible outcomes. For instance, if the ESRI’s updated high-growth scenario of an average growth of 4.5% were to materialise, a smaller package of fiscal measures would be needed to hit the 3% target by 2014.

That is why Fine Gael believes it is necessary, over the coming weeks, to put a relentless focus on the ways to support growth and jobs as the country attempts to repair its public finances. That is why Fine Gael believes that any fiscal plan has to operate in parallel with a credible growth and jobs plan to turn the present downward vicious cycle into an upward virtuous cycle. We have a different approach from the Government. Fine Gael offers real hope that we can rebuild our economy and restore trust in politics and in Government.

This was backed up by Michael Noonan, who was pretty clear about the political costs to the opposition of agreeing to the €15 billion figure:

When the €15 billion is a forecast and when minor adjustments in the growth rate can make such vast variations, would we not be desperate clowns to tie ourselves in to the Minister’s figure, especially when the Taoiseach could not answer Deputy Gilmore this morning when he asked what was factored into the estimate of growth?  …. The key element is the forecast for growth and there is a vast variation between Davy’s forecast, which would take us over €20 billion, and the ESRI high growth forecast, which would bring us down to €9 billion.  The Minister is on the mid point so maybe he is right, but we are not buying in. We need more information.

I’m pretty sure that Fine Gael are aware that the previous budget’s growth projections are now considered to be highly aspirational by the European Commission and that any plan that is agreed will have to be on the basis of lower growth figures than contained in the ESRI’s high growth scenario.

You can call this unfair if you want (and some will—no doubt we’ll have comments here about the need to wear shades due to the brightness of our economic future.) However, that’s the way things are going to work and with the EFSF waiting in the wings to bail us out, the government probably doesn’t have a lot of bargaining power to make the case for a more optimistic scenario.

Indeed, I’m sure even the ESRI don’t believe that their high-growth scenario is the appropriate basis for fiscal planning over the next few years. Recall that the Recovery Scenarios document gingerly raised the question as to “whether a more rapid fiscal adjustment than currently planned would have a more beneficial outcome for the economy.” Note also that, on its own, the news about €1.5 billion per year in promissory note interest would take us to €9 billion even on the basis of the government’s December 2009 calculations. 

What this emphasises, I’m afraid, is that the current political situation makes a cross-party consensus on multi-year budgeting essentially impossible. Opposition parties do not want to campaign at the next election on the basis of €15 billion in adjustments and who can blame them?  However, this will gravely undermine the credibility of any four-year plan introduced by the government and will also worry financial markets.