Archive for December, 2010

Estonia Joins the Euro Area

By Philip Lane

Friday, December 31st, 2010

Estonia has now joined the euro area (10pm Irish time is New Year in Estonia) - over the years, it will be interesting to see the difference it makes in shifting from a ‘hard peg’ to the euro to full membership of the euro area.

“Global warming linked to harsh winters”

By Brendan Walsh

Friday, December 31st, 2010

This headline appeared in the Irish Times on 20th December 2010. In the article that followed Frank McDonald admitted this was “paradoxical” but explained that recent research has linked severe winters in northern Europe to diminishing levels of ice in the Arctic sea. A more detailed account of the same reasoning is contained in this article published in the New York Times on December 26th 2010.

This new view of the effects of global warming is quite an about-turn.

In 2009 the Irish Environmental Protection Agency (EPA) published a Summary of the State of Knowledge on Climate Change Impacts for Ireland. This document provides predictions for key climatic variables for the rest of 21st century based on extrapolations of observed changes relative to the 1961-1991 averages. Here is how some key trends are summarized in Tables 2.1, 2.2, and 2.7.

“All seasons are warmer but more so in winter”

“Less frost; trend of decreasing frost nights and decrease in duration.”

“Less (sic) snow days”.

“Increases in Irish coastal water temperatures”.

“Drier summers”

All but the last of these generalizations were made with a “high degree of scientific confidence”. The deluges of the summers of 2007, 2008, and 2009 reduced the confidence attached to the last point to “medium”.

If instead of the the recent extreme weather events there had been comparable deviations in the other direction (dry, hot summers and mild, snow-less winters) confirmation bias would have led many commentators to view such events as strong support for the predictions contained in the EPA document. The same bias now leads commentators to label the actual recent pattern of extreme events “anomalies” and to offer ad hoc explanations for them. One has to wonder about a science that flip-flops from predicting one extreme to the other in so short a space of time. If climatologists are now saying that our winters may be  going to get colder rather than warmer, it will be very hard to test the various hypotheses associated with the idea of “global” warming.

A longer term perspective is needed if we are to talk about “climate” as opposed to “weather”. In an earlier post I drew attention to absence of a positive trend in the Dublin’s annual average temperature over the period 1958 to 2008.  Two more years of data have reinforced the main points I made in that contribution. In 2009 Dublin’s temperature was slightly below the long-term average, while 2010 was the coldest of the past 52 years, with an average temperature of 8.3º C - more than two standard deviations below the 1961-1991 average used by meteorologists to represent “the long run”. During last winter (December 2009 – February 2010) the average temperature was three standard deviations below the long-run winter average. It is very likely the winter of December 2010 – February 2011 will also be unusually cold.

However, it would be a mistake to believe that the recent downward trend in annual temperatures is due only to colder winters.  June and July were the only months of 2010 when Dublin temperatures were above their long-run averages.  The warmest year of the past half century was in 1989. The average temperature during the naughties was lower than during the 1990s

A longer term perspective is needed if we are to talk about “climate” as opposed to “weather”. The graph of Dublin’s annual average temperatures (below) does not convey an impression of a consistent upward trend in annual temperature since 1958. This is confirmed by standard statistical tests, which reveal that there has not been a significant trend (positive or negative) in the annual data over the entire 52-year period.  Nor has there been a consistent trend in temperature in any of the four seasons. More detailed investigation shows that there was a significant positive trend for some 30-year windows between 1958 and 1993, but for all such windows between 1971 and 2010 the trend has been negative although not statistically significant. The trend in Winter and Summer temperatures has been negative but not significant since the 1970s. Similar graphs of Dublin’s rainfall reveal no significant trends.

The fairest summary of this evidence would seem to be that Dublin’s climate has not changed significantly over the past half century.

The evidence for an upward trend in temperatures over the past half century is stronger for weather stations outside Dublin. Dublin has become colder than other parts of Ireland.  Belmullet, for example, shows strong evidence of a positive temperature trend for much of the period and the Dublin minus Belmullet differential widened markedly in the 1990s. But here, too, there is a puzzle: Belmullet’s temperature showed no positive trend between 1958 and the mid-1980s but for the next twenty years there was a strong positive trend, while the last three years have been cooling again.  Here, as for the other stations, the volatility of the data is very striking.

These small pieces of evidence may, of course, be dismissed as irrelevant to the “global warming” debate. But to adapt Tip O’Neill’s aphorism, all climate is local. The Dublin data draw attention to the fragility of some of the evidence on which recent predictions of climate change have been based.

Happy New Year!

Reading List

By Philip Lane

Wednesday, December 29th, 2010

Landon Thomas compares the current predicament of the euro area to the predictions made before the single currency was launched in this article.

Stephen Kinsella pointed me to this site: the NSF in the US has requested ‘white papers’ on the future of economic research  - the current list of contributions is available here.

Simon Head writes on the “The Grim Threat to British Universities” in the NYRB: here.

More on sectoral financial balances

By Alan Matthews

Wednesday, December 29th, 2010

David McWilliams discusses the Irish version of the ‘Gavyn Davies’ sector financial balances graph in the Irish Independent today. He makes two points. The first is to highlight the restoration of the foreign sector balance in recent years, which he interprets as meaning that, absent the banking crisis, the government would not have needed to seek EU/IMF funding given the availability of sufficient domestic savings to fund the government deficit.

His second point is that the chart shows that austerity will not work because, if the private sector keeps saving, then either the government deficit remains high (as a result of a further contraction of the economy) or there is a build up in the current account surplus on the balance of payments, which he also sees as undesirable because it means that “we will export capital to the rest of the world for them to use, while projects in Ireland are starved of capital”.

While the first point may be true in the sense that the state would not have faced the downgrade on its sovereign debt in the absence of the banking crisis, I think the second conclusion is wrong. (more…)

A German Perspective on the Crisis

By Michael Moore

Sunday, December 26th, 2010

Hans-Werner Sinn provides a provocative assessment of the current crisis in Europe here.  His take on the recent robustness of the German economy is novel. The slides are particularly entertaining though not always flattering to Ireland.

Climate Change Response Bill 2010

By Richard Tol

Thursday, December 23rd, 2010

The Climate Change Response Bill 2010 was published today for consultation, together with an explanatory memorandum.

Art 1-3 are preliminaries. Art 4 has the emission reduction targets:

  • Emission reduction should be 2.5% per year on average between 2008 and 2020. The bill seems to say that 2020 emissions should be 28% below 2007 emissions (i.e., 52 mln tCO2eq). The memorandum says that 2020 emissions should be 26% below 2008 emissions (i.e., 50 mln tCO2eq).
  • 2030 emissions should be 40% below 1990 emissions.
  • 2050 emissions should be 80% below 1990 emissions.

(In fact, the base year is 1995 for the F-gases and 1990 for the other greenhouse gases. Between 1990 and 1995, emissions of F-gases rose from 0.06 mln tCO2eq to 0.20 mln tCO2eq so the dual base year just complicates things.)

The 2030 target seems to follow from the fact that 2030 is halfway between 2010 and 2050 and 40% is halfway between 0% and 80%. Annual emission reduction is to be 2.5% between 2010 and 2020, 3.9% between 2020 and 2030, and 5.3% between 2030 and 2050.

Art 5 creates a National Climate Change Plan. Art 6 establishes an annual statement to the Dail. Art 7-10 create a National Climate Change Expert Advisory Body. (The memorandum clarifies that no new expert will be hired.)

Art 11 orders public bodies to have regard for the climate bill and report progress to the Minister of the Environment.

Compared to the Oireachtas bill (discussed here), the Government bill creates much less bureaucracy. That is a good thing. Like the Oireachtas bill, the Government bill has nothing on how the targets are to achieved. This is a serious omissions. It is all good and well to announce a target, but there is more to policy.

The targets are very ambitious, as discussed here. Fortunately, the memorandum assures us that “[t]his Bill does not have immediate significant financial implications for the Exchequer.” The crucial word is “immediate”. The 2020 targets are notably more stringent than the EU targets, and we’re well on track to miss those (at least, according to the EER2010).

UPDATE:

ETS emissions are controlled by the EU rather than by the Irish government. That implies that the additional emission reduction effort for 2020 will fall entirely on the non-ETS sectors. The EU targets are to reduce ETS emissions by 21% in 2020 (relative to 2005) and non-ETS emissions by 20%. The government target is to reduce non-ETS emissions by 37% in 2020 (relative to 2005).

In 2008, non-ETS emissions were about 48 mln tCO2eq, 38% in agriculture, 30% in transport, 16% in households, 9% in services, and 7% in manufacturing.

Note that I assume throughout that LULUCF is as defined for the Kyoto Protocol. Note also that the climate bill is silent on this.

UPDATE 2: See Times, Independent, Examiner

UPDATE 3: There is a Regulatory Impact Assessment, which contains the gem that if you raise energy prices through a carbon tax it would affect the vulnerable and competitiveness, but if you raise energy prices through other means there would be no such impact.

Irish Version of Gavyn Davies’ Graph

By Brendan Walsh

Thursday, December 23rd, 2010

Tony Leddin and I have included a version of this type of graph in successive editions of our textbook The Macroeconomy of Ireland.
Here are two slides showing the data for Ireland from 1970 to 2009.

(It proved easier to post a link to Flickr than to go through to rigmarole of uploading via this site!)

Happy Christmas!

Gavyn Davies’ suggestion for most important macro graph of the year

By Kevin O’Rourke

Thursday, December 23rd, 2010

Has anyone seen an Irish equivalent of this? A good way of framing macroeconomic debates…

John Bruton on the EU response to the Irish Banking Crisis

By Edgar Morgenroth

Wednesday, December 22nd, 2010

John Bruton has an interesting opinion piece in the Irish Times - the headline is “Europe also responsible for Ireland’s Banking Crisis”. He is of course absolutely right to point out, as others have done, that this crisis would not have happened if German, UK, Belgian and other banks had not lent to Irish banks, just as much as it would not have happened if Irish banks had not lent to Irish developers. What he does not point out is that other EU members benefitted greatly from the Irish boom e.g. where were the BMWs, Mercs, Audis etc. built?

John Bruton is very critical of the EU response and highlights that it is very narrow and one sided. For example he points out that the agreement reached at the last summit only provides a mechanism for help if the crisis threatens the entire Euro-zone - no scope to help out countries hit by an asymmetric shock. He also points to other crises facing the EU that need serious action.

To me the approach taken at the summit (and during other recent decisions) implies a departure from the principle of solidarity between the EU members that was supposed to underpin the EU. Of course all EU members can start looking after domestic interests only - Angela Merkel might end up with a nasty surprise the next time she is looking for a decision that requires unanimity. In that sense, far from solving problems, the last summit has added more uncertainties for the EU. No doubt the markets will use the Christmas break to sharpen their knives!

The Mechanics of Funding under the EU/IMF Deal

By Philip Lane

Wednesday, December 22nd, 2010

Yesterday, the EFSF explained its funding strategy for the Ireland deal: the details are here.

The schedule for IMF funding was contained in last week’s IMF Country Report.  The relevant table is reproduced below:

President Signs Bank Stabilisation Bill Into Law

By John McHale

Wednesday, December 22nd, 2010

Irish Times story here.  Irish Examiner story here.

Did the Council of State really reassure the President of the Bill’s constitutionality?  Or is it that the risks of financial instability are seen (by the Council and/or the President) as outweighing constitutionality concerns?

Ajai Chopra: Conference Call

By Philip Lane

Wednesday, December 22nd, 2010

Here is the transcript of the press conference on Ireland.

Institutional Sector Accounts

By Philip Lane

Tuesday, December 21st, 2010

The CSO has put out institutional sector accounts to end 2009: the release is here.

Assessing business schools and scholars (4)

By Richard Tol

Tuesday, December 21st, 2010

The working paper is now available. Conclusions are by and large as before (2, 3), but details are different. This is the abstract:

The research performance of business scholars on the island of Ireland is evaluated based on their number of publication, number of citations, h-index and the same divided by the numbers of years since the first publication. Data were taken from Scopus. There is a large variation in both life-time achievement and annual production. Almost half of the 748 scholars have not published in an academic journal. Men perform better than women. More senior people perform better. There are distinct differences between disciplines, with accountancy performing poorly. On average, scholars in Northern Ireland perform better than scholars in the Republic. However, Trinity College Dublin has the top rank among the eleven business schools; Queen’s University Belfast and University College Dublin share the second place; and NUI Galway and the University of Ulster share the fourth spot. Irish business schools specialize in particular research areas so that mergers would lead to schools that can support a broader range of cutting-edge education.

This is the last opportunity to correct the data. (UPDATE: One name removed because of a legal threat.)

FT on climate policy

By Richard Tol

Monday, December 20th, 2010

McDermott, Verde, Laing and Mejean take on Lomborg in the Financial Times.

As I have argued before, Lomborg plays a useful role in cooling down the overly ambitious climate policies promoted by European leaders — but he also tends to get his details wrong.

Münchau on the summit fiasco

By Kevin O’Rourke

Monday, December 20th, 2010

The other day in the FT, Klaus Regling suggested that it was ignorant ‘outside “experts”‘ — Americans, one presumes — who are the most pessimistic in their assessment of whether the euro will survive. On the contrary: knowledgeable Europeans, and especially those of a pro-EMU bent, are among the most alarmed right now, since they can see what way this thing is heading if Europe’s leaders continue to muddle through, kicking cans down the road, and erecting firebreaks around burning bushes (to use Olli Rehn’s unintentionally brilliant metaphor).*

Here is Wolfgang Münchau’s take on the summit, and here is a round-up of reaction on the Eurointelligence website.

* Rehn is so fond of this metaphor that he has now used it twice: first in May, when discussing Greece, and second in November, when discussing Ireland. If you’re living in a burning bush, you don’t need a firebreak. How far will the fire have to spread before the fire brigade gets called in?

ECB Opinion on Credit Institutions (Stabilisation) Bill 2010

By Karl Whelan

Monday, December 20th, 2010

The ECB have issued a legal opinion on Credit Institutions (Stabilisation) Bill 2010 (documents here).  One highlight: “these emergency powers interfere significantly with the property rights of institutions’ shareholders and creditors. Thus it is important for any regime to properly balance these fundamental rights with the general interest in the financial system’s stability.”

Trade policy humour

By Kevin O’Rourke

Sunday, December 19th, 2010

The festive season is almost upon us and we all need a bit of cheering up. I have always found Swiss trade policy to be good for a giggle myself, and apparently their Finance Minister agrees with me. Bündnerfleisch: an old one but a good one.

Colm McCarthy in today’s Sindo

By Kevin O’Rourke

Sunday, December 19th, 2010

Colm has an article in today’s Sunday Independent which is well worth reading.

Sex discrimination at Spanish universities

By Richard Tol

Sunday, December 19th, 2010

Bagues and Zinovyeva have an intriguing piece over at Vox. There’s evidence that all-male promotions committees discriminate against female candidates (in Spain). The solution is sex quotas for committees. As women are underrepresented in higher ranks, this would put a disproportionate burden on the current generation of female senior academics. A neat intergenerational trade-off so.

Bagues and Zinovyeva’s propose to use sex quotas, but small ones. This may satisfy all concerns.

Reputation

By John McHale

Saturday, December 18th, 2010

Some blog readers have bristled at invoking reputational damage as an argument against policies such as defaulting on bank liability guarantees. I have sympathy with this reaction given the elasticity of the concept, and because it is often thrown out as a sort of argument stopper. But there is still no getting away from the fact that Irelands reputation for institutional soundness matters for both domestic and international investment. It is hard not to worry that this reputation is being damaged by some recent crisis management policies. (more…)

IMF Staff Report on the Ireland Deal

By Philip Lane

Friday, December 17th, 2010

The detailed IMF report is available here.

The Consolidated Foreign Claims of the Irish Banks

By Philip Lane

Friday, December 17th, 2010

The Irish Central Bank has developed a new data series that shows the consolidated foreign claims of the six domestically-active banks headquartered in Ireland (ie it does not include the activities of the affiliates of UK banks in Ireland and it corresponds to the list of ‘guaranteed’ banks).

This note clarifies the vast differences between these claims and those reported in the BIS database.

New Issue of ESR

By Olive Sweetman

Friday, December 17th, 2010

Vol 41 Issue 4 (Winter 2010) of the Economic and Social Review is available online here.

The Economic and Social Review invites high-quality submissions in economics, sociology and cognate disciplines on topics of relevance to Ireland. Contributions based on original empirical research and employing a comparative international approach are particularly encouraged.

Published papers are listed in the Social Sciences Citation Index.

Reading List

By Philip Lane

Friday, December 17th, 2010

Today’s FT carries op-eds by Lorenzo Bini-Smaghi on the costs of sovereign default (here) and by Klaus Regling on the feasibility of monetary union without fiscal union (here).

This week’s Economist compares Iceland and Ireland here.

Hump-Shaped Dynamics

By John McHale

Thursday, December 16th, 2010

A few weeks back, Harvards David Laibson gave a fascinating keynote lecture at the Geary Institutes Economics and Psychology Conference. A key theme was the way people form expectations when macroeconomic time series have what he calls hump-shaped dynamics. These dynamics and their implications for expectations are described in a recent paper for the Journal of Economic Perspectives:

Many macroeconomic time series have long‐horizon hump‐shaped dynamics – processes that show momentum in the short run and some degree of mean reversion in the long run.  Such dynamics will generally not be captured by simple growth‐regressions.  Hence, agents with natural expectations will make approximately accurate forecasts at short horizons, but poor forecasts at long horizons, because the economy has more long‐run mean reversion than the agents impute from their intuitive models. In other words, agents with natural expectations will overestimate the long‐term persistence of good news or bad news.

David explained how even a skilled econometrician facing relatively short time series will tend to miss the longer-term mean reversion. The difficulty of seeing the mean reversion can mislead us into believing that a string of good draws on the fundamentals reflects a permanent improvement with Irelands property bubble a good candidate. But equally a string of bad news can lead us to excessive pessimism Wolfgang Munchau’s expectation that Irelands nominal growth will not exceed 1 percent for a decade comes to mind as a possible example.

We have certainly experienced a string of bad news on both economic growth and fiscal cost of the banking losses. Just as during the boom, extrapolation has led to extreme expectations about the economy and solvency. Of course, this pessimism could turn out to be justified. But it is no harm to remember that mean reversion works both ways.

Todays Q3 growth numbers can be considered mildly good news. It is still too early to tell if we will be bumping along the bottom for some time or have turned the corner. (See here for graphs of real and nominal GDP/GNP based on todays release.) For a mild antidote to the competition for who can come up with the biggest number for the banking losses, it is worth taking a look at Ronan Lyons’ analysis of potential mortgage-related losses.

New targets for greenhouse gas emission reduction

By Richard Tol

Thursday, December 16th, 2010

Minister Gormley has announced new targets for greenhouse gas emission reduction: 2020 emissions are to be 10% below 1990 levels (29% below 2005 levels) , 2030 emissions 40% below 1990, and 2050 emissions 80% below 1990.

EU legislation has that Ireland should cut 2020 emissions by some 20% below 2005. The EU has committed itself to 30% if there is a meaningful global agreement on emission reduction (which is as unlikely as ever). The Environment Council has repeatedly tried to remove the conditionality of the 30%, but has been rebuffed by the European Council. The government now argues that Ireland should unilaterally adopt the 30% (well, 29%) target.

It will be hard enough to meet the EU target, as illustrated here (after Devitt et al., 2010). According to the low growth scenario, Ireland will fall short some 5.5 mln tonnes of CO2 equivalent of the EU target — and 13.5 mln tonnes of the new government target. Today’s permit price is 14 euro/tCO2. Under the EU target, Ireland would need to spend 80 million euro per year on importing permits (the model imposes a carbon tax equal to the permit price, so buying permits is cheaper than increasing domestic emission reduction). Under the new government target, this would by 190 mln euro.

The new government target is less stringent than that proposed by the Oireachtas Joint Committee on Climate Change and Energy Security.

The cost of wind (ctd)

By Richard Tol

Thursday, December 16th, 2010

Referring to my earlier remarks about an ESRI paper, here’s the verbatim conclusions of the paper.

Seán Diffney, John Fitz Gerald, Seán Lyons, Laura Malaguzzi Valeri, “Investment in electricity infrastructure in a small isolated market: the case of Ireland”, Oxford Review of Economic Policy, Volume 25, Number 3, 2009.

The new All-Island market structure appears to have performed broadly as expected. The rules provide for a transparent and efficient operation of the market, encouraging plant availability. Investors are clearly relying on the capacity payment regime to ensure that electricity is priced at long run marginal cost in the future. Lyons et al. (2007) suggest that the calibration of the capacity payments regime is broadly appropriate. The one area which may need further consideration is the handling of wind generation within the capacity payments regime.

In this article we evaluate the costs and benefits to the Irish system of meeting the government’s target for 2020 for 40 per cent of electricity to be generated by renewables, primarily wind. We find that high wind generation is economic when fuel prices are high and that a high level of wind penetration will occur without further expensive incentives. Unless fuel prices or carbon prices are low in 2020 consumers are likely to benefit from a high level of wind generation on the system. This is consistent with the results in DCENR and DETINI (2008) and CER and NIAUR (2008). The target for a high level of wind generation in the Republic will not adversely affect consumers in Northern Ireland and may actually benefit them in the case of high energy prices. While low fuel or carbon prices could see consumers in both jurisdictions paying a higher electricity price, this premium would be likely to be small. A high level of wind generation would provide a hedge against high fuel prices.

To be sure of the net effects of wind generation it would be important to not only measure its positive externalities, but also its negative externalities. In this study we have internalised part of the negative externalities wind generation imposes on existing thermal plants by curtailing wind generation to limit thermal plant cycling. We have not however attempted to estimate the possible negative environmental externalities of wind farms.

We find that investing in a lot of wind generation is economic only if there is also parallel investment in interconnection. This allows wind to generate whenever it is available instead of being curtailed at times of low demand or imposing additional costs on thermal plants by making them ramp up and down. This implies that the total capital costs associated with an investment in high wind generation will be substantial. Therefore, in order to minimize the cost of the system to the consumer policy should concentrate on minimising the cost of this investment. One measure to achieve this is already in place, regulatory certainty: because the establishment of the new market required co-ordinated legislation in two jurisdictions it will be difficult to change. This should provide additional reassurance to investors.

Second, given the comparative youth of the SEM, avoidance of regulatory risk is at a premium. The regulators should avoid making unnecessary changes to the framework or parameters while market participants gain confidence and knowledge about how the system works.

Third, the financing of the essential network infrastructure, including interconnectors should be done on the basis that it is part of the regulated asset base of the state owned (or in the case of Northern Ireland mutual owned) company. As such it should attract a low cost of capital which will be crucial to ensure that the costs for consumers on the island of Ireland are minimised. In any event, merchant interconnectors would be unlikely to supply the socially optimal level of interconnection, given their higher cost of capital and decreasing returns to investment. It should be noted that these results are based on the assumption that interconnection operates as a perfect arbitrageur, allowing electricity to flow from the low price to the high price jurisdiction when ever there is a price difference. In practice this is unlikely to hold, so studying the specific behaviour of interconnection flow is important to assess the returns to the system. If the interconnector does not operate optimally a much larger infrastructure investment could be needed to obtain the same effect, possibly causing the high wind scenario to become too expensive. This highlights the importance of implementing an appropriate regulatory regime to cover all of the interconnectors between Ireland and Great Britain.

Finally, to facilitate the continued development of competition, the ownership of the transmission system in the Republic should be transferred to EirGrid, the government-owned operator of the electricity system, and the Irish government (as shareholder) should ensure that appropriate pressure is put on operating costs in the ESB.

QNA Release for 2010:Q3

By Karl Whelan

Thursday, December 16th, 2010

The quarterly national accounts for 2010:Q3 have been released. They show seasonally adjusted real GDP increasing 0.5% quarter over quarter and seasonally adjusted real GNP up 1.1% over the same period. There are also some small upward revisions to the second quarter figures, with the change in real GDP revised from -1.2 percent to -1.0 percent and the change in real GNP revised from -0.3 percent to 0.1 percent. On a year-over-year basis, real GDP was down 0.5 percent in 2010:Q3 and real GNP was down 1.6 percent.

Nominal GDP perhaps matters more for fiscal policy and here the news is also better than we have seen in some time. Nominal GDP was up 0.8 percent in 2010:Q3 and the second quarter figure was revised up from a 0.3 percent decline to a 0.2 percent increase. Nominal GNP was up 1.9 percent in 2010:Q3 and the previous quarter was revised up from a 0.5 percent increase to a 1.9 percent increase.  Nominal GDP is down 1 percent year over year while nominal GNP is down 2.3 percent over the same period.

The growth in the third quarter was driven by a strong performance for net exports, with all component of domestic demand contracting.

Germany’s choices

By Kevin O’Rourke

Wednesday, December 15th, 2010

All countries have choices — even our own, despite assertions to the contrary — but some countries have more choices than others.

Faced with solvency problems around the European periphery, and quite possibly in core banks as well, and also with the underlying reality of intra-Eurozone imbalances, how should Germany react?

Continuing to do as little as possible, and hoping that we can all muddle through, is one option. This risks destroying the euro.

Having the ECB step in via some sort of overt or covert QE is another.

Moving towards fiscal burden-sharing, implying deeper Eurozone integration, is another.

And a big-bang approach to restructuring debts in Europe is another.

In my view some combination of the last three options is probably optimal, if you want to keep the euro. But none of these options are particularly attractive, one assumes, from a German perspective. German industry would be a major loser if the Euro collapsed. The ECB option could undermine the credibility of the euro as a strong currency. Burden-sharing is going to cost the German taxpayer money. And as for the collective restructuring option, Germany is a creditor country.

Today’s article in the FT by Frank-Walter Steinmeier and Peer Steinbrück is a good contribution, from a pro-EU-integration perspective, that can help us see how one section of the German political spectrum views these trade-offs. They are attached to EMU, and so rule out doing nothing. Nor do they like the prospect of the ECB becoming ‘Europe’s “bad bank”‘, a nice political turn of phrase. Unlike Merkel, however, they understand that ruling out these two options has logical implications, pushing the burden of adjustment onto the other two options. For Steinmeier and Steinbrück, this means haircuts for the periphery and the introduction of Eurobonds:


In the case of Ireland, abolishing full state guarantees for private banks would allow their debt to be cut off at the root of the problem, while also letting private investors take their fair share of the burden. A new European framework for bankruptcies of financial institutions should support this.

There are conditions of course:


empowering European institutions to establish tighter controls over fiscal and economic stability, alongside common minimum standards on wage and welfare policies, as well as capital and corporate taxation. In short: we need European government bonds, but we must put an end to beggar-thy-neighbour policies and harmful tax competition within the eurozone too.

It is perfectly understandable that this would be the German position, and anyone who thinks these issues are going to go away is living in cloud cuckoo land. (What our position should be if presented with such a bargain is an interesting question: plenty of costs and benefits on both sides to be considered, which is why God gave economists two hands.)

On the other hand, the Steinmeier-Steinbrück reforms would probably require a new Treaty. Anyone on the Continent who thinks that there is a hope of getting a referendum passed in Ireland, so long as the ECB and EC continue to rule out burden-sharing with senior bondholders, is probably also living in cloud cuckoo land. Time is running out as regards the remaining unguaranteed debt: federalist Europeans should logically be arguing for this issue to be dealt with, satisfactorily, as quickly as possible.