Article for Eolas Magazine

Here is a short article on crisis resolution strategies that I wrote for Eolas magazine.   It was written before the debate over Morgan Kelly’s new resolution proposals.    The piece contrasts a Plan A — involving a phased fiscal and banking adjustment, offiical assistance to cover funding shortfalls, and absorption of significant banking losses — with a Plan B that has an earlier focus on debt reduction.   Morgan’s proposals — a Plan C? — combine immediate elimination of the borrowing requirement with eschewal of both official assistance and responsibility for bank losses.

Jean-Claude Trichet, 2004: “no design flaw in the euro project”

I mentioned on this site before how a number of academic economists, during the debate on whether Ireland should adopt the euro, referred to a design flaw that had been well recognised by US economists: the lack of a federal budget.

It was known that the Irish business cycle was out of sync with the eurozone core and that the timing of ECB interest rate changes would not be appropriate for Irish conditions. A large part of such asymmetries (or ‘region-specific shocks’) are offset in the US at the federal level: a $1 decline in US regional income relative to the national average induces a fall of around 25 cents in federal tax liabilities and an increase in inward transfers of about 10 cents.

Karl Whelan’s recent proposal re Irish bank debt was to federalise it. Morgan’s was similar to one I advocated recently on this site: monetize it. Both entail responsibility being shared at the federal (i.e. European) level.

Paul de Grauwe warned, as far back as 1999, that the “failure (to create a European government with similar responsibilities to present national ones) creates the risk of the break-up of the monetary union”.

I have just now stumbled on a speech made by ECB President Jean-Claude Trichet in Dublin in May 2004 which rejected claims of such a design flaw, as follows: “Moving to the second topic of my speech, i.e. fiscal policies, let me stress that we Europeans have been very bold in creating a single currency in the absence of a political federation, a federal government and a federal budget at the euro area level. Some observers were indeed arguing that without a federal budget of some significance the policy mix would be very erratic, depending on the random behaviour of the different national fiscal policies of the member countries. They were also arguing that without a federal budget it would be impossible to weather, with the help of the fiscal channel, asymmetric shocks hitting one particular member economy. In this respect, the very existence of the Stability and Growth Pact actually allows (us) to refute these two arguments: first, the Maastricht Treaty and the Pact provide a mutual surveillance by the “peers”- i.e. the Ministers of Finance – of national fiscal policies; second, by calling upon Member States to maintain their budget close to balance or in surplus over the medium term, the Pact allows the automatic stabilisers to play in full in countries facing an economic downturn, without breaching the 3 % ceiling for the deficit.”

The full text of Trichet’s speech is here.

Improving the bailout terms

The Government rightly continues to make the case that there is a common interest in lowering the interest rate on EFSF/EFSM borrowings, among other adjustments to the programme.   Writing in the Sunday Independent today, Peter Mathews – in one of the milder articles in the paper – goes quite a bit further and accuses “EU partners” of “profiteering” (see here).    

Last January, the European Financial Stabilisation Mechanism charged Ireland an interest rate of 5.51 per cent for money that it borrowed at 2.59 per cent. A month later, the European Financial Stabilisation Fund charged Ireland an interest rate of 5.9 per cent for money that it borrowed at 2.89 per cent. On this basis, the EFSF earns a profit margin of 3.01 per cent and the EFSM earns a profit margin of 2.93 per cent.

These margins are draconian. The majority of the interest that Ireland pays is not used to pay for the EU’s borrowing costs. It is excessive profit for the countries that are lending us money. For every €1m that Ireland pays in interest costs, Ireland must pay another €1.08m so that our EU partners make a profit. This, clearly, is not a bailout. It is exploiting our vulnerability. It is financial bullying.

It would appear that Peter believes that the EU is taking on zero risk in lending to Ireland.   (Formally, at least, the EFSF has eschewed IMF-style preferred creditor status.)   I would be interested if readers agree that these official funders can rest assured their loans are riskless. 


The Sunday Business Post provides its usual welcome calm analysis of the options (no web access until Monday).   Understandably frustrated with the pace at which EU governments are responding in terms of providing a mutually-advantageous exit route from the crisis, its lead editorial advocates taking a tougher line, notably with Anglo (and presumably) INBS) senior debt. 

With our government bond interest rate soaring and our banks locked out of the markets, we haven’t got a lot to lose.   We are most unlikely to be able to return to the markets on the schedule set down in the EU/IMF programme late next year, or in early 2013.   It would be much better realise this and arrange some restructuring of the deal now – and there are many ways this could be done.  [Emphasis added]

Just looking at the first sentence, my interpretation of the first clause is that the resulting dependence on external support means, unfortunately, we do have a lot to lose.   With popular pressure for a tougher line ramping up, it seems a worthwhile issue to debate. 

Guest Post from Daniel Gros: How to Make Ireland Solvent

Daniel Gros from CEPS has provided the following guest post based on his recent IIEA talk.

How to Make Ireland Solvent

The Republic of Ireland can no longer raise funds on the capital market and has had to accept a bail-out financed jointly by the IMF and the European Financial Stability Facility or EFSF (the EU’s rescue fund).  Many investors fear that by the time European support ends as planned in 2012, the country will not have market access, and might then be forced into default if anti-bail-out forces are determining policy in Germany at that point. 

But this dependency of Ireland on foreign support is difficult to understand given that the country has not lived continuously above its means in the past.  Ireland has run a current account deficit (which means the country uses more resources than it produces) only for a few years; and if one totals the current account balances over the last 25 years, one arrives at a foreign debt of about €30 billion.  This should not be too difficult to finance given that it represents only about 20% of the country’s GDP of €150 billion. Moreover, Ireland is on track to run a current surplus this year and should thus not have any need for additional foreign funds.

So why does the government need a continuing bail-out?  The reason is that the government has a huge foreign debt whereas the Irish private sector has huge foreign assets.  To make matters worse, the government pays exorbitant interest rates on its large foreign debt whereas the private sector earns very little on its foreign assets (and keeps these meager returns for itself).  If this is allowed to go on, the government could indeed still have to default.

This was the case in Argentina where the private sector had large foreign assets while the government had an even larger amount of foreign liabilities.  The Republic of Argentina went bankrupt with only a moderate net foreign debt because wealthy Argentines had spirited their assets out of the country, and thus out of the reach of the government, while the poor Argentines refused to pay the taxes needed to satisfy the claims of the foreign creditors. 

Ireland is not Argentina and should be able to avoid its fate; but only if the government can mobilize private foreign assets.  This should be possible given that these foreign assets are mostly held by institutions, such as pension funds and life insurance companies. 

The little data published by the associations of Irish pension funds and that of (life) insurance companies suggest that these two groups of financial companies own over €100 billion in foreign assets, of which about €25 billion are in non-Irish government debt and about €72 billion in foreign equities.[1] 

From the point of view of the country, it makes no sense that Irish pension funds invest in Bunds which yield about 2-3%, whereas the government pays close to 6% on fresh money to foreign official institutions (and Irish government bonds promise yields of close to 10%).  A very strong case can thus be made that Irish pension funds and life insurance companies should somehow be ‘induced’ to invest their entire portfolio of gilts in Irish government bonds.  The €25 billion in financing that this would yield for the government is equivalent to the entire contribution of the IMF to the rescue package.

A similar case can be made for the €72 billion in foreign equity investments. If two-thirds of that sum (or €48 billion) were also be invested in Irish government bonds, the total financing available for the government would rise to over €73 billion, more than all the foreign funds made available to Ireland under the rescue package. 

Would this mean robbing retirees of their future?  The opposite seems to be the case: the rate of return achieved by the average Irish pension fund has been only around 1.7% over the last decade (as claimed in a recent report of the public pension fund).  A massive investment in the bonds of their own government, which offer a return of close to 10% (on the secondary market), should actually be in the interest of present and future Irish retirees as well.  Moreover, by doing so, the probability of a state default would actually be much reduced, which in turn will preserve growth prospects for the economy – the most important determinant of future pensions.

The EU might of course protest that any restrictions on the investments of Irish pension funds and life insurance companies smack of capital controls.  But this could be finessed by either a waiver under Article 65 of the EU Treaty, or a clever wording of the ‘directed’ investment.  Moreover, the public pension fund has already been obliged to accept a ‘directed’ investment, without any opposition from the EU.[2]

Given the scale of foreign assets owned by Irish residents there should be no need for the government to depend on the funds of the EFSF and the IMF, which are very expensive in both political and economic terms. There will be practical and political obstacles to mobilizing pension fund assets, but they should be overcome if the future of the entire country hangs in the balance.


Daniel Gros,

Director CEPS,

Brussels, May 2011

[1] Sources available from the author.

[2] A technical note: Pension liabilities are bond-like in nature, so the present heavy weighting in equities represents a substantial mismatch and investment risk in itself.  There may thus be scope within appropriately framed solvency requirements to facilitate/encourage pension funds to more closely match their bond-like liabilities with instruments issued by their own sovereign.

Central Bank Balance Sheet April 2011

The Central Bank balance sheet for the end of April 2011 has been released. It shows a decline of €12.6 billion in the famous “Other Assets” category which is where the Bank’s ELA operations show up. It also shows a decline of €8 billion in lending under the Eurosystem umbrella. These are large declines for a one month period and it’s not clear how they came about, i.e. whether there was a large increase in deposits at the guaranteed banks, whether any new market funding was sourced (unlikely) or whether there were significant deleveraging deals involving selling off foreign loan books and using them to pay off central banks.

As Namawinelake notes, these questions will be clarified at the end of this month when the balance sheet of the guaranteed banks for April will be released. Certainly, the decline in emergency borrowing from central banks is welcome and is a first concrete sign that the March 31st announcements have had a positive effect on the health of the banking system.

Update: Thanks to Eoin and Lorcan for coming up with the real story. NTMA have deposited €19 billion in cash resources into the banks. Reuters have a story here while Lorcan had already figured it out. NTMA apparently couldn’t be bothered putting out a press release.  So all of the above out positive effects etc. is hereby withdrawn.

Maarten van Eden: Applying same analysis to all Ireland’s debt makes no sense

Maarten van Eden, outgoing CFO at Anglo, has an interesting article in today’s Irish Times (see here).    One useful feature of the second half of the article in particular is that he focuses on what is needed to allow the banks to play their normal lending function in the economy.  

In order for lending to the private sector to resume, the good banks need to be delevered [through debt-funded buybacks of NAMA bonds and promissory notes, with the cash used to pay back the ECB], recapitalised and their funding put on a firm footing.

I am not convinced by his specific solution, but this focus is important given that the debate sometimes seems to have lost sight of the ultimate objective of fixing the banking system.   

As an aside, one of the best papers produced on the Irish crisis is Gregory Connor’s “The Irish Risky Lending Gap”, written back in 2009 (see here).   Greg focuses on the lending decisions of a risk-averse bank holding a distressed asset portfolio with a value that is correlated with the value of potential new lending opportunities.   He shows how the level of lending can be socially sub-optimal, and how various balance-sheet restructuring policies can change the size of the lending gap.  It might be useful to re-read along with the van Eden piece.

Regaining Creditworthiness

Much of the pessimism about Ireland’s predicament has centred on the challenge of stabilising the debt to income ratio.   Undoubtedly this will be challenging, with good outcomes on nominal GDP growth and fiscal adjustment capacity required.    Of course, it has been made much more difficult by the massive bank losses the State has had to absorb.   But I think a focus on the stabilisation challenge misses a critical issue, which is regaining market access at a high if stable debt to GDP ratio (probably somewhere in the region of 120 percent of GDP).   

Martin Wolf’s column from last week provides a useful starting point for a diagnosis of the problem – an article that garnered all of one comment on the blog (from DOCM).   It draws on Paul de Grauwe’s insightful work on the susceptibility of countries in a monetary union to a debt crisis (see here), where a country without its own currency and central bank to act as lender of last resort is vulnerable to self fulfilling expectations that it will not be able to roll over its debts.   The EFSF/ESFM/ESM were put in place to help fill this LOLR gap, but have so far proven to be a poor substitute.   It is understandable that Germany and other likely net funders want to eventually reinstate market discipline, and so demand losses are borne by private creditors as part of any new bailout.   It is also understandable that they want to protect themselves from losses under the permanent bailout mechanism (the ESM) by demanding preferred creditor status.   But it is becoming increasingly evident that crisis-hit countries will find it extremely hard to regain market access with a half-hearted LOLR facility in place given any doubts that they will not be able to pass a debt sustainability test under the ESM. 

The official funders have to be willing to take on some additional risk if a mutually damaging combination of default and ongoing dependency is to be avoided.   One element is to clarify the way the debt sustainability test will be applied.   A current problem is that austerity measures weaken growth, thus making it harder to pass the test.   A useful amendment would be to assess growth in the debt sustainability calculation assuming a neutral fiscal stance.   Another useful amendment would be to set a ceiling on the size of any haircut, thereby limiting the uncertainty faced by potential new investors.   

As a quid pro quo for these amendments the government could offer to speed up the fiscal adjustment (along the lines recommended by the ESRI in its Spring QEC).   Of course, more fiscal adjustment is the last thing the economy needs as it struggles to pull out of recession.   Yet a quasi-permanent loss of creditworthiness and dependency on unreliable official support looks to be the bigger threat, as it saps confidence and undermines the perception of the economy’s stability.   Those resisting fiscal discipline must realise that the situation changed profoundly when Ireland’s creditworthiness disappeared in the second half of last year.   Some observers are putting forward the same fiscal policy prescriptions as they did when bond yields were around 5 percent.   They must see that the ground has fundamentally shifted.  

It is hard to see how further public sector pay cuts could not be part of any balanced additional adjustment.   A credible new regime for long-run fiscal discipline is also essential.  

The government should take the offensive in pointing out the incoherence of the current international support approach, while avoiding playing a self-defeating grievance card.   What is needed is a hard-headed look for a mutually advantageous set of policies that allow Ireland to shed its dependency.    The first step is a proper diagnosis of creditworthiness challenge. 

Corporate Tax Saga, May 11 Edition

The saga over Ireland’s request for a reduction in the interest rate on its EU loans continues, with the French continuing to link this issue with Ireland’s corporate tax, a role they swap every so often with the Germans (media stories from today here and here). As Christine Lagarde’s recent comments show, having made such a big deal of the issue, the French are now motivated to achieve the crucial goal that “Everybody will have to save face.”

It is worth noting, however, that the French signed this document “Conclusions of the Heads of State of Government in the Euro Area” on March 11. It stated:

Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles.

Note the absence of any mention of corporation tax or renegotiation of deals.

Despite the constant repetition of the line that Ireland is somehow looking to change the status quo, it seems to me that there is a strong case for the opposite position. Having agreed to change the pricing of EFSF loans on March 11, the EU’s principle political leaders have reneged on this agreement for the moment, most likely because the political kudos that come with appearing tough on Ireland outweigh those associated with honouring agreements made at Heads of State level.

Those who believe that Ireland’s situation will end well because European institutions have our best interests at heart may wish to consider how things have played out over the past few weeks.

The Pension Levy

For tomorrow’s Farmers Journal:

The government announced a package of measures, described as a jobs initiative, on Tuesday. There is to be a reduction in the VAT rate for tourism-related spending and the travel tax is to end. Both measures should help a recovery in this important sector. There are also to be some modest capital spending allocations for schools, road-works and home insulation. Employers’ PRSI is to be cut for low-paid employments.


These measures will be offset by a sharp increase in the minimum wage. In the United Kingdom, the minimum wage is £5.93 per hour, which translates to €6.74 at today’s exchange rate. The Irish minimum wage is currently €7.65, well ahead of the UK figure. The unemployment rate in the UK is only about half the Irish level, but the Irish government, while acknowledging the need to restore competitiveness, has decided to increase the minimum wage to €8.65, bringing the premium over the UK to no less than 28%.


The other eye-catching wheeze is a levy of 0.6% per annum on the capital amounts saved in pension funds. The retirement incomes of workers in the private and commercial semi-state sectors are paid out of the assets contributed over the years to occupational pension funds. Many of these funds are inadequate due to improving life expectancy and the weak investment returns of the last decade. As a result both employers and employees are facing higher contributions in future as well as reduced benefits. Those with the foresight to choose employment in the public service are exempt from the new levy, since the public service does not bother to fund its pension obligations. The Minister for Finance, Michael Noonan, looked a bit uncomfortable while explaining this measure on television on Tuesday evening. His justifications included an argument to the effect that much pension fund saving is invested abroad, and that his plan will see these funds ‘brought home to invest in jobs.’ Sadly some pension funds were foolish enough to invest in Ireland, in safe Irish banks and even safer Irish government bonds for example, and are nursing the biggest losses for their pains. But they will have to fork out the levy regardless, since it applies to all funded pension schemes.


Money accumulated in private sector pension funds belongs to the people who have saved it up, and is capital rather than income. The funds are trapped given the trust law and this makes the assets a sitting duck for a cash-starved government. In October 2008, the government of Argentina, unable to borrow in the international markets, simply expropriated $29 billion of assets from private retirement accounts to plug a budget gap. One wonders if Mr. Noonan’s advisers have been studying any other elements of Argentinean policy, which also features an export tax on agricultural produce.


Around 520,000 people own the €80 billion in these funds, an average of about €154,000 per person. The levy will cost them about €920 per annum on average. About 330,000 employees have entitlements under public service pension arrangements. These schemes are unfunded and thus have no taxable assets, but the total liability has been estimated by the Comptroller and Auditor-General at €108 billion. It follows that the average sum standing to each member in these unfunded schemes is about €327,000, more than double  the amount standing, on average, to those in funded schemes and liable for Mr. Noonan’s levy. The jobs initiative is being funded, in effect, not by those who are fortunate enough to have occupational pensions, but by those who have small occupational pensions. Those with the bigger pensions, public servants in the main, will not be contributing. Interestingly, since the new levy is a levy on assets, it will affect disproportionately the older members of the private sector workforce who have more substantial funds already saved. Younger workers can relax: they have too little in the way of retirements savings at risk.


It is of course true that tax concessions for private sector pensions were excessive for those on super-duper incomes, and there have been sensible reforms over the last few years designed to place a cap on these tax breaks. Some people were able to duck tax and accumulate multi-million pension pots while managing the banking system into spectacular insolvency. Others have retired from their labours in the vineyard of public service with enormous pensions to which they never had to contribute. But the sins of these fortunate folk are now being visited on the workers in the private and semi-state sectors prudent enough to have made funded retirement income provision. In March of last year, the government released a document on pensions policy which expressed alarm at the condition of private sector funded pension schemes, including the inadequate level of contributions and limited coverage. The new government has sent a clear signal that it is content to see these problems get worse.       

Bank Credit Flows and Eurozone Stability: Conference Panel QA Session

The excessive flows of bank credit during the bubble, and the shortage of bank credit after the crisis, are key elements in Ireland’s current economic distress. Prior to the crisis, economists thought they understood the behaviour of bank credit flows, but we were sadly wrong.  The talks at the conference next week explore the new research frontiers regarding bank credit flows and stability. The conference website now includes a google talk link where participants can pre-submit questions for the panel session, and links to some research papers associated with the presentations. There will also be an opportunity to pose questions during the conference panel session. The panel session will be chaired by Professor Karl Whelan of UCD.

There will also be opportunities for discussion/interaction during conference breaks. If you are a (quote) “faintly dim former rugby player” or a faintly dim rugby dad like me, there will be a corner of the coffee room where we can converse in whispers about the sport and its undeserved bad publicity.  

Men Without Work

The rise in the unemployment rate reveals a grim picture of the impact of the recession. The overall unemployment rate has risen from 4.4% at the beginning of 2007 to 14.6% today. Male unemployment is now 17.3%, while unemployment among men aged 20-24 is 32.3%.

Concentrating on the situation of males in some key age groups, the first Chart shows the unemployment rates for those aged 20-24, 25-34, 35-44 and 45-54 (four-quarter moving average of the Quarterly National Household Survey rates). Unemployment rose dramatically in all fours age groups, but younger men were most severely affected.

During a deep recession unemployment rates do not tell the whole story because people tend to withdraw from the labour force, cease to search for work and are no longer classified as ‘unemployed’ according to the International Labour Office conventions.

The CSO publishes broader measures of unemployment as well as the main ILO rates. The broadest of these includes those marginally attached to the labour force and others not in education who want work and it now stands at 23%.

This broad unemployment rate is not available by age and sex. However, the ‘employment rate’ (the proportion of the population that is employed) is available by demographic group and it sheds light on labour market trends that supplement the information in the conventional unemployment rate.

The second Chart shows the employment rate in each of the four age groups. As we would expect from the unemployment figures, the fall in employment has been most dramatic among younger men. Since the end of 2009 fewer than 50% of males aged 20-24 have been classified as ’employed’, compared with over 75% as recently as 2007.

It is instructive to look at the distribution of ‘non-employed’ men between ‘unemployed’ and ‘not in the labour force’. This is shown in the following four Charts. The proportion of the population ‘not in the labour force’ is lowest among men aged 35-44 and highest among those aged 20-24. But in all four groups there has been a significant rise in non-participation during the current recession. In fact the rise in ‘non-employment’ was split approximately 3:1 between increased unemployment and increased non-participation in all groups. While some of the rise in the numbers not in the labour force may be attributable to increased retention of younger males in the educational system, most of it is likely to reflect drop-out due to discouragement and the belief that no jobs are available.

Previous research has shown that those most likely not to be employed are single males with low educational attainment living in areas of high overall unemployment. It is likely that these factors continue to increase the risk of being without work.

The rise in unemployment and fall in employment leveled off during 2011 but as in recoveries from previous recessions further improvement is likely to be slow and the adverse effects of the contraction in the economy will be felt well into the future.

Let us hope that the ‘jobs initiative’ to be announced later today can make some impression on these figures and will include measures to ‘re-activate’ those who have dropped out of the labour force as well as those who are overtly unemployed.

An Ill Wind

We do microeconomics too! From the current Farmers Journal, and apologies for the length:

Small countries can do little unilaterally to combat climate change. The planet has just one atmosphere, and every tonne of carbon dioxide, or of the other greenhouse gases, released into the atmosphere has an identical impact. It does not matter where in the world each tonne is emitted. For every tonne emitted in Ireland, about 500 tonnes are emitted somewhere else. If Ireland somehow managed to cut emissions to zero, the fate of the earth’s climate would barely be affected. The problem is global of its very nature and requires global solutions. Every country needs to accept its international obligations and indeed to encourage international agreement on faster action. But solo-runs by individual small countries aiming for very rapid emission reductions make no sense, achieve nothing environmentally but could impose serious economic costs.

Ireland has been pursuing very ambitious targets for emission reduction going beyond our international obligations, despite a sharp reduction in the measured output of greenhouse gases in 2009 consequent on the economic downturn. The 2010 figures are not yet available but chances are that emissions fell again and could remain flat until the economy begins to recover. Under current policy Ireland has been aiming for a major switch to wind-powered electricity, more bio-fuel in transport, electric cars and a long list of other emission-reducing initiatives. All of them will cost money and the overall policy pre-dates the onset of the Irish economic collapse. It is not surprising that the new government is being advised from several quarters to re-visit our emission-reduction targets, specifically to take the downturn into account and to see if excessive costs can be avoided.

A report earlier this year from the Irish Academy of Engineering argued that electricity generating capacity is no longer under pressure: reduced demand is being met comfortably given the availability of several new gas-fired plants and there is less urgency about building extra generation, at least for the next five or ten years. The report also questioned the haste in expanding the transmission system. More recently, the Economic and Social Research Institute has argued against subsidies for offshore wind projects and for reduced wind subsidies onshore. Finally the review group on State assets, as well as proposing structural changes to the electricity industry and partial privatisation, also warned against too rapid a rush into wind generation.

Continue reading “An Ill Wind”

Business and Finance Article on Debt Sustainability

Here‘s an article I wrote for Business and Finance on the question of whether Ireland’s fiscal debt is sustainable.

One correction I’d add to the article is that I miscalculated the average interest rate on existing Irish debt and reported it in the article as about 3 percent. The correct figure, as calculated by the EU Commission, is 4.6%.