Central Bank economists have released two new technical papers on the Irish banking sector:
Modelling the corporate deposits of Irish financial institutions: 2009 – 2010
The financial crisis and the pricing of interest rates in the Irish mortgage market: 2003-2011
The article below was published in today’s Sunday Business Post.
The Irish electorate will soon be asked to express its opinion on the new EU Fiscal Compact Treaty. Although the treaty document is quite short, its content is quite abstract and addresses issues that have been mainly debated so far within a fairly small technocratic circle of economists. So, what are the economics of the fiscal compact?
The economic logic behind the treaty is that a deep commitment to fiscal sustainability provides a key anchor for macroeconomic policy. If the domestic population and international investors are confident that a government will maintain public debt at a level that does not pose default risk, sovereign debt will be considered a “safe asset’’. In turn, this avoids the incorporation of risk premia into the sovereign bond yield, which is an important saving to the government in terms of its debt-servicing bill. Furthermore, a low sovereign yield lowers the funding costs faced by the banking system, in view of the close financial connections between banks and the government.
The ECB provides some suggestions to improve the detailed processes that lie behind the Fiscal Compact in this opinion.
Eamon Quinn has an interview with Lucinda Creighton here.
In addition to the 0.5% ‘structural deficit’ rule in the fiscal compact, there is also a requirement that any excess in the debt ratio over 60% be eliminated in annual steps of one-twentieth, the glidepath rule. (This requirement dates back to Regulation 1467 of 1997). It is repeated, but not introduced, in the fiscal compact. The compact says we really, really, mean it this time.
In an economy with a zero or low deficit and even moderate growth in nominal GDP, the debt ratio tends to fall without fresh fiscal effort. The conditions in which Ireland regains market access and exits official borrowing are likely to be conditions in which the glidepath rule will not be a constraint.
If Ireland gets back to, for the sake of argument, a measured deficit of zero in a future year (say 2016 for resonance), is back in the market and able to borrow for roll-overs without any extended official lending, would this rule bind and how would it bind?
If Ireland was still in an official lending programme in 2016, the fiscal targets would be whatever was specified in that programme and would supercede other requirements. Note also that the 0.5% rule would hardly bind – there would probably be a structural surplus at a zero actual deficit, or at least it could plausibly be argued that there was one.
The glidepath rule is in terms of the actual debt/GDP ratio and accordingly would constrain the actual, not the structural, deficit. However the constraint looks unlikely to bind in a benign scenario. To get back in the market Ireland will need borrowing rates that can be afforded and that means growth rates of 2 or 3%, combined with inflation of say 2%. For simplicity, let’s pretend that the debt/GDP ratio at the end of 2016 is 100% and that nominal GDP is expected to grow at 5% (3% growth plus 2% inflation).
If debt is 120% and nominal GDP growth below 5%, chances are we would still be in a programme. If you think we can exit official lending without some relief on bank-related debt, you can do the sums for alternative high debt ratios and higher nominal GDP growth rates.
On the 100% debt assumption, with nominal GDP growth at 5% and with an actual deficit of 0, the debt ratio at year’s end will be 100/105, = 95.2%, well within the glidepath ceiling of 98%. Even a deficit at the Maastricht 3% would be almost inside the glidepath limit.
So we could still be in a programme in 2016, or in the clear. But it seems unlikely that we would be both in the clear and in trouble with the glidepath.