Gormanston, Tarbert and regulation

The Examiner has a story on the proposed LNG terminal at Tarbert in the Shannon estuary. This is a privately funded project and a welcome stimulus for North Kerry. As long as the developers play within the rules, public policy analysts should have no opinion on such matters. But as the gas market is so heavily regulated, private actors affect the public good. The LNG terminal would, for instance, improve the security of supply, which is very valuable.

Minister Rabbitte argues that Shannon LNG would increase the price of gas. This is absurd at first sight. Increased competition should reduce the price. The minister is right, though. To see why, we need to consider the gas interconnector from Scotland that lands in Gormanston in Co Meath, or rather the way in which its price is regulated: The annual cost of the pipe is distributed over the gas it carries.

The interconnector is a competitor’s wet dream. If you capture a small part of the gas market, the interconnector will increase its price — because its annual cost is distributed over a smaller volume. You can then increase your price to just below that of the interconnector and gain yet more market share. And the interconnector will raise its price again.

The solution surely is to change the regulation of the interconnector rather than to block the LNG terminal. The current regulation, which may date back to the days of Minister Woods or Fahey, is a neat example of something that makes sense in the short run only.

Note the separation of powers. Minister Rabbitte is the executive branch of government and an influential part of the legislative, he appoints and controls the budget of the regulator, and he is the trustee for the shareholders (us) of the dominant company in the market.

The Medium-Term Fiscal Strategy

On the budget documents is The Economic and Fiscal Outlook. This goes beyond the details of the 2012 Budget and provides guidance on the government’s medium-term plans and projections out to 2015.

Some of the noteworthy details in this publication include

  • pages D16-D17 show how the government intends to meet its revenue targets without raising income tax rates or touching income tax bands or personal credits (and also no more increase in the top VAT rate).  What is required is a big increase in local charges (property tax etc) and other measures to broaden the tax base (cutting back on various income tax reliefs, reduction in tax related costs of private pension provision, broadening of PRSI base).
  • Table 11 on page D19 shows the evolution of various expenditure and revenue categories over 2010-2015
  1. total revenue very flat as a ratio to GDP (34.6 percent of GDP in 2010 and 2015)
  2. government consumption down from 17.0 percent of GDP in 2010 to 13.7 percent of GDP in 2015
  3. public investment (row 21) down from 3.7 percent of GDP in 2010 to 1.4 percent of GDP in 2015
  4. social transfers (row 18) down from 18 percent of GDP in 2010 to 13.6 percent of GDP in 2015
  5. interest payments up from 3.1 percent of GDP in 2010 to 5.7 percent of GDP in 2015
  • Table 14 on page D23 shows the decomposition between cyclical and structural components. Here, the government is using the official EU estimate of Ireland’s level of potential output and, as in previous publications, is quite critical of this measure, especially since it implies that Ireland will be operating above potential in 2014 and 2015.  It would be desirable for the government to also report its own preferred measure of potential output, since the split between structural and cyclical imbalances is so critical in interpreting the fiscal position. Going further, it would be desirable for the government to indicate the role of ‘special factors’ in determining the underlying structural fiscal balance. Just as the property boom, relatively high inflation and the large current account deficit led to a revenue windfall during the boom,  the usual relation between the fiscal balance and GDP is distorted during this adjustment phase due to deleveraging, the under-shooting of construction adjustment, real exchange rate depreciation and external rebalancing.
  • Page D15 outlines risks to the outlook.  Under the Troika MoU, the fiscal targets are minimum thresholds. It would be interesting to know the contingency plans in the event that an undershooting of GDP requires further spending cuts or tax increases. (That said, it is possible that the existing spending and revenue targets have implicit built-in contingency allowances on a prudential basis.)

Worse than Sinn

I have told myself to stay out of the Target 2 debate, partly because this pretty much sums it up and I’ll just end up repeating myself and partly because the brave Olaf Storbeck has taken this on himself so many times.

However, this article by Tornell and Westermann is worth bringing up because the appearance of two people who are not Hans Werner Sinn making Sinn-like claims might suggest there is a point here. In fact, this piece has even less to add (and more to subtract, if believed) to the stock of useful knowledge than Sinn’s various pieces. (Unfortunately, its points were repeated on the usually-excellent FT Alphaville.)

Tornell-Westermann (TW) repeat the fallacy that the Bundesbank has loaned money to the so-called GIPS central banks. Their new twist on this story is that “In order to fund these loans, the Bundesbank sold its holdings of German assets.”

They back this up with a table showing information from the Bundesbank balance sheet. A line labelled “Private securities owned by central bank” shows a large decline in recent years.

What does this line correspond to? Well, TW’s line for “Private securities owned by central bank” equals €224 billion in 2009 and €277 billion in 2008.

Let’s go consult the Bundesbank’s own description of its balance sheet for these years (page 148 of this file). It tells us that “Lending to euro-area credit institutions related to monetary policy operations denominated in euro” equalled €223.61 billion in 2009 and €277.425 billion in 2008. I’m going to guess that the resemblance between these figures and those reported by TW is not coincidental and that TW’s figures correspond to the same entries.

Is “Private securities owned by central bank” – as best I can see a terminology invented by TW – a more accurate description than the terminology used by the Bundesbank, which effectively means “loans”?

Well, no. These entries correspond to loans. They are securitised loans, specifically repurchase agreements, so the Bundesbank holds a security as collateral for the (usually short) maturity period of this loan. But the value of the loans are less the value of the corresponding securities (i.e. a haircut is applied to the collateral) so the asset on the Bundesbank’s balance sheet is the value of the loan, not the value of the asset. Also, the asset remains on the balance sheet of the borrowing bank because the bank regains the asset on repayment of the loan and thus the transaction does not correspond to the accounting requirements for “derecognition” of assets.

So, this item – lending by the Bundesbank to German banks – has declined in recent years, from €277.425 billion in 2008 to €37.6 billion in August 2011 (the latest figures I could find – page 111). The reasons for this are not too surprising. There has been enormous capital flight from the periphery into German banks which, as a consequence, have had far less need than previously to borrow funds from the Bundesbank for liquidity purposes.

Note also that Eurosystem policy in recent years has been to supply banks with a full allotment of funds requested in refinancing operations, so the Bundesbank has not made any conscious decision to reduce the amount of lending it has done.

If “the Bundesbank has done less lending because German banks have asked for a smaller amount of loans” sounds different from “the Bundesbank has had to sell off securities to fund loans to peripheral central banks” that’s because it is. The first statement is true and the second isn’t.

The rest of Tornell and Westermann’s article is not much better.

· The presentation of the Bundesbank’s “Other claims within the Eurosystem (net)” (i.e. the Target 2 credit) as some kind of enforced loan to the rest of the system rather than the accounting entry that reflects a transfer from the rest of the system to Germany mirrors Professor Sinn’s ability to make something that is good for Germany appear to be Germans getting ripped off.

· The idea that the Bundesbank is about to “run out of money” – “the Bundesbank will soon exhaust the stock of securities that it can sell to fund further loans to the Eurosystem” – is completely without basis in reality. Still, the stuff about the Bundesbank’s gold holdings and the German public not wanting to sell it will appeal to paranoid goldbugs everywhere.

· The material about Target claims being collateralised by, for example, Greek bonds sounds scary but, in reality, is just false.

· The less said about TARGET being “overwhelmed” because “the ECB has a relatively small capital base” the better.

The crazy thing is that the Euro area is undergoing a real crisis and there is a huge need for an informed public debate on potential solutions. We don’t need academics making up fake crises and stirring intra-European resentments based on a misunderstanding of central bank arcania.

NY Times on Irish Austerity

Paul Krugman links to this New York Times piece on Ireland’s recent experience with austerity, which reminds me to link to something Seamus Coffey wrote recently on exactly how much austerity we’ve endured. Seamus goes beneath the headline 21 billion and looks at where cuts have actually (or probably actually, this isn’t an exact science) happened. He finds the figure should be closer to 10 12 billion euros.

Krugman’s point is more basic than Seamus’, because most of the people reading this blog in Ireland probably know the difference between GDP and GNP in our context. Here’s the monthly economic bulletin (.pdf) from the Department of Finance. We can see the difference in GDP and GNP right away from the table I reproduce below which shows percentage changes by quarter. We can also see the effects on the elements of GDP and GNP here.

Fiscal Union in the 1990s…

From the FT’s rolling blog:

  • Both Sarkozy and Merkel would prefer treaty change for all 27 European Union members. However, if this cannot be reached, they are happy to move forward with a treaty for the 17 eurozone members alone
  • The treaty favoured by Sarkozy and Merkel would include automatic sanctions for countries that breach the rule on deficits below 3 per cent of gross domestic product
  • Primary tool for enforcing balanced budgets will be a “golden rule” written into the constitutions of all 17 eurozone member states; to be verified by the European Court of Justice…..


Let’s cast our minds back to, say, October 3rd. 1990. An asymmetric shock (re-unification) struck the unsuspecting Bundesrepublik. The deficit, on the Maastricht definition, stayed below 3% until 1994 and then hit, hmmm, 9.5% of GDP in 1995. Gott in Himmel! 

The ECJ then pronounced that Germany was liable for ‘automatic sanctions’ and in 1996 ……

A new referendum likely, says IT

The IT has answered Karl’s question in the affirmative:

Taoiseach Enda Kenny has publicly opposed the need for treaty changes and that remains the Government’s official position in advance of the summit.

However, there is a realisation among senior Ministers in Dublin that Dr Merkel’s commitment to treaty change and the backing she has received from French president Nicolas Sarkozy may have made that process unstoppable.

So, in a Union of 27, if Merkozy wants a new Treaty requiring an Irish referendum then, the IT assumes, this is what will happen. They are quite possibly right.

This should remind us that there are political objectives which the 25 should have in any new Treaty negotiations as well as economic ones. (If we are going to have a referendum, this will take time, and create uncertainty, anyway: so why not get it right?) Economically speaking, if you want EMU to survive in more than the immediate short run, you should logically want a new mandate for the ECB, and some method to provide counter-cyclical adjustment in depressed regions. (I guess we are not going to get this, and indeed we are probably going to get the opposite of this.) Politically speaking, we need moves to reaffirm the primacy of the Community method, or it will be more than EMU that is endangered in the long run. I guess we’re not going to get that either. Of course I would love to be proved wrong.

Bad arguments

We’ve gotten used to disingenuous arguments by István Székely regarding the EC/ECB stance on burning bondholders, but (given that the original interest rates they insisted on were a disgrace) this one really takes the biscuit:

Separately, the top European Commission official on the Irish bailout said critics of the decision not to impose losses on senior bank bondholders should recognise the benefit from the interest cut on Ireland’s rescue loans.

István Székely said the cut would yield €12 billion while moves to “burn” Anglo Irish Bank bondholders might have realised €3 billion.

Also, €3 billion?

Karl is right: it is too late to do anything meaningful about this, and the game has moved on. But that doesn’t mean that we should let these guys rewrite history.

A New Referendum?

My presumption has been that any set of “fiscal union” measures of the type mentioned here will require a referendum. Far more trivial international agreeements have required them, so surely this would too. Eoin reckons it can be avoided via some Lisbon-related maneuver.

I’m not a constitutional expert but some of our readers must be. What do people think? Can we get some concrete cites to the relevant articles or protocols.

Time for a Deal on ELA

Whatever happens, there’s going to be a lot of Euro summitry in the coming months. It seems clear that Germany is pushing for a swift Treaty change to introduce all sorts of legal limits on debt and deficits as the solution to the debt crisis. (You could argue it’s a bit like a flood defense plan that relies on banning rain.) In return for this, the ECB will agree to provide funds to bail out Italy and others, perhaps via turning EFSF into a bank.

Personally, I still think the economics and politics of the “Debt Treaty” approach are terrible. But it’s probably going to happen.

Given that, what should Ireland’s government do? Most likely, with the EU threatening to pull fiscal and bank funding if they don’t co-operate, our leaders will just agree to sign the dotted line at the relevant EU Council meeting and then see if they can get away with not having a referendum. (Unlikely — an Irish referendum will be one of many banana skins the process could encounter).

So here’s one thing that I think they can do. If the ECB is going to move into uncharted territory, then it’s time to ask for a small favour that will barely register as relevant when compared with a huge sovereign bond purchase scheme: Delaying repayment of the IBRC’s ELA debts. While unimportant in the European scheme of things, it would give Enda Kenny a big political win if he could announce the cancellation of the €3.1 billion March 31 promissory note payment.

If you want to read more about this, here‘s a column I’ve written for Business and Finance.

The Irish Debate on the Single Currency

I was asked by an Irish Times journalist recently if anyone had written up a review of the Irish debate on joining the single currency.  This paper of mine from 1997 came close, though it doesn’t for the most part name or ascribe  positions to the participants.  Rereading it now though, it strikes me that a lot of it remains relevant.

The Bayoumi and Eichengreen material makes clear that central control of national fiscal deficits across the eurozone – the suggestion du jour – will not remove the vulnerability of Ireland and the Mediterranean economies to asymmetric (country-specific) shocks.  This is what I was referring to in my post of a few months ago entitled:  Jean-Claude Trichet, 2004: ‘no design flaw in the euro project’.

Colm McCarthy and I agreed recently that the Irish debates (in which both of us were anti) did not identify the precise fault lines that would ultimately emerge.  Centralised eurozone banking regulation and resolution regimes – the absence of which we all now recognise as design flaws – will not address the problem of asymmetries however.

The article makes the point that “those worried about the rigidity of the single currency system argue instead for policy co-ordination alongside floating rates.  In that way the destabilising element associated with ‘maverick’ macro policies would be removed but the exchange rate would still be free to adjust to counter country-specific shocks.”

Alternatively, within the single currency, “fiscal federalism” could go some way towards correcting the problem.  The Federal Budget absorbs about one-third of  the average region-specific shock in the US; the figure for Canada is around one-fifth.  We have nothing similar in Europe.  But think of the pork-barrel politics this would (will?) entail.

And have a wry smile at footnote 11, which I had forgotten about, concerning an aspect of the debate between Patrick Honohan on the one hand and Peter Neary and Rodney Thom on the other.  (The ‘foreign currency’ refers to the euro).  How times can change!

Draghi Statement on “Fiscal Compact”

Mario Draghi’s statement before the European Parliament is available here.   

Some key paragraphs from statement:

Yet we are at a difficult stage at present. We have set up these new mechanisms, but their positive effects on the credibility of government fiscal policies are not yet visible. And the government changes that have taken place in some of the more exposed countries have not yet had much of an effect on the continuing fragility of financial markets.

Fundamental questions are being raised and they call for an answer. At the heart of these questions are not only the credibility of governments’ policies and the actual delivery of the promised reforms, but also the overall design of our common fiscal governance.

I am confident the new surveillance framework will restore confidence over time. I am also quite sure that countries overall are on the right track. But a credible signal is needed to give ultimate assurance over the short term.

What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.

Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.

We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.

Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.

A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.

On the precise legal process that brings about a move towards a genuine economic union, we should keep our options open. Far-reaching Treaty changes should not be discarded, but faster processes are also conceivable.

Whatever the approach, companies, markets and the citizens of Europe expect policy-makers to act decisively to resolve the crisis. It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.