In Irish Economy Note No.12, Greg Connor and Brian O’Kelly consider the costs of lax regulation during 2003-2008
Abstract: This paper develops a restrictive procedure for evaluating economic policy decisions, by comparing actual economic history to a simulated history where a specific policy decision is replaced with a counterfactual, but credible, alternative. Our procedure is theoretically straightforward, but empirically problematic since it requires the identification of a feasible policy alternative and a model linking a specific policy choice to subsequent economic outcomes. We apply the procedure to the mistaken decision to maintain an excessively lax financial regulation regime in Ireland during the period 2003 – 2008. We measure the differences in banking sector stability and national income that would have occurred if the stricter regulatory regime imposed in Ireland in 2009 had been put in place six years earlier. We find that a few simple, reasonably prudent regulatory controls on the Irish banking sector would have greatly limited the vulnerability of the domestic sector to the 2008 global credit freeze, and almost certainly prevented the 2008-2009 collapse of the domestic banking sector and the consequent deep Irish recession of 2009-2010. On the other hand, the risky and unsustainable inflow of foreign capital mediated by the domestic banks accounts for a substantial part of Irish economic growth during the 2003-2007 period. Without this net
foreign borrowing inflow, cumulative gross domestic product over the early period would have been substantially lower.