Fiscal Causes and Consequences

A common narrative has developed that the euro zone crisis is being misdiagnosed as a crisis requiring a fiscal cure.   See, Larry Summers here, for example; or Paul Krugman here.  

I think most of us can agree that the Irish crisis was predominantly the result of an interacting property and credit bubble.   Rising property prices fuelled credit inflows, which in turn fuelled the property bubble.   What made the Irish property bubble ultimately so damaging was the fact that it was both a property price and construction bubble.   Usually a strong supply response can help deflate or at least limit a price bubble.   But the forces driving the price bubble were so strong that the supply response did little to tame it.   When it burst it led to both a massive wealth shock and a massive structural shock to the economy given the resources that had been misallocated by the bubble to construction.   This in turn led to a series of adverse feedback loops: banking, growth and fiscal.   The policy challenge has been so severe because policies to try to stabilise one element of the crisis – e.g. debt stabilisation – tends to make another worse – e.g. growth.   The interacting crises reached a second stage of severity once the banks and Government began to lose their creditworthiness.   Official support was all that stood in the way of complete meltdown. 

It now seems rather beside the point to focus on the fact that the original source of the crisis was not primarily fiscal.   (Even the idea that fiscal imbalances were not a major part of the initial vulnerabilities is exaggerated.   For Ireland, a large structural deficit was hidden by revenues directly and indirectly associated with the property bubble, as expenditure grew strongly and non property-related revenues lagged.  It is true that the design of the Stability and Growth Pact was poorly designed to identify this imbalance.   The new Excessive Imbalance Procedure should go some way to rectifying this.)  But whatever its cause, restoring debt sustainability and State creditworthiness is now an essential part of the solution to exiting the crisis.  

One thing that has become evident is how fragile creditworthiness is in the monetary union for countries with high debts and doubts about political capacity to achieve debt stabilisation.   Not having a domestic central bank available to print money as a last resort to repay debt and avoid default is a major source of vulnerability.   Euro zone countries have shown themselves to be subject to bad expectational equilibria, where concerns about default risk leads to high market yields, which can make the initial concerns self-fulfilling. 

Stronger mutual support mechanisms are needed to give vulnerable countries a reasonable chance of sustaining or regaining creditworthiness.   But stronger countries – who themselves have vulnerabilities – are understandably reluctant to take on large contingent liabilities and weaken incentives for fiscal discipline (moral hazard) without reasonable assurances of disciplined fiscal policies from their euro zone partners.   Even with beefed up mutual support mechanisms, potential bond buyers are also looking for strong fiscal frameworks to support the political capacity to work back towards debt sustainability and ultimately less vulnerable debt levels.   Of course, the solution to the crisis goes beyond the fiscal – a more growth-oriented response from the ECB, for example, would be hugely helpful.   But pointing out that the original cause was not primarily fiscal does not seem particularly enlightening or helpful in charting a way out. 

Access to EU Funding

At the EU summit of the 21st of July last the leaders’ statement said that:

“We are determined to continue to provide support to countries under programmes until they have regained market access, provided they successfully implement those programmes. We welcome Ireland and Portugal’s resolve to strictly implement their programmes and reiterate our strong commitment to the success of these programmes.”

This was reiterated as recently as the EU summit of the 30th of January when the statement of the EU leaders said that:

“We welcome the latest positive reviews of the Irish and Portuguese programmes which concluded that quantitative performance criteria and structural benchmarks have been met. We will continue to provide support to countries under a programme until they have regained market access, provided they successfully implement their programmes.”

These both seem pretty unequivocal to me and have not been contradicted in any subsequent EU statements I have seen.

Why are Irish house prices still falling?

Gerard Kennedy and Kieran McQuinn from the Central Bank give their view on where house prices should be in Ireland, and why they haven’t stopped falling in this new paper (.pdf). This paper is a kind of update to Morgan Kelly’s 2007 piece on the likely extent of house price falls (.pdf) as well as other papers.

From the abstract of Kennedy and McQuinn, then:

In this note, the continued fall in Irish house prices is examined. The increased rate of decline in 2011 resulted in Irish prices being almost 50 per cent down from peak levels of mid 2007. Accordingly, in over forty years of house price data, the fall is now one of the most significant across the OECD. We outline the current state of activity in the housing market and, using a suite of models, assess whether the fall in house prices is in line with that suggested by current fundamental factors within the Irish economy. Given that the analysis suggests prices may have overcorrected since 2010 we discuss possible reasons for this continued decline.

The Fiscal Treaty in the Sunday Papers

The Sunday papers/blogs have some good contributions to the Fiscal Treaty debate.    In the Sunday Independent, Colm McCarthy cuts through much of the confusion with his usual clarity:

This referendum has consequences and is not just an opinion poll on whether people are pleased that we have an enormous debt and an ongoing deficit.

There are two net issues. The first is whether a ‘Yes’ vote would result in additional constraints on Irish budgetary policy in the years ahead.

The second is whether a ‘No’ vote would make the financing of the Government more difficult once the EU/ IMF programme ends in December 2013.


You should read the full article for Colm’s analysis of the two issues.   But it is worthwhile to note the conclusions:

The fiscal treaty does not, in the short or long term, create new commitments to budget cuts beyond what is in store anyway. But rejection could result in a sudden drying up of access to finance — and hence an immediate requirement to balance the books — and would be highly disruptive.

This treaty will not solve Ireland’s problems, but voting it down could make a bad situation worse, for no obvious gain.

Cliff Taylor echoes these conclusions in the Sunday Business Post.   The article is behind a paywall, but a fair-use quote gives the gist:

So there is no additional austerity for Ireland which will result from voting Yes.   Austerity is inevitable – we just have to hope that some pick-up in growth will make the sums easier.   And let’s not fool ourselves that a vote here would in some way change the course of what might happen in Europe.   That will depend on the big countries.  Full stop.

If a No vote brings no obvious advantages, it does bring risks.   As the rules stand, we would not have access to the European Stability Mechanism, the new permanent bailout fund.   So, if we need more cash after this bailout runs out – or other forms of support, such as further underwriting – we will not qualify if we vote No.   Sinn Féin has argued that the EU and IMF will not see us stuck.   But why try to find this out?

Finally, Nama Wine Lake, our new national treasure, provides a useful overview of the arguments here.

Reminder: IMF loans more expensive than EU loans

The Sunday Times reports that the IMF could be an alternative source of funding in the event of a No vote.

One point to keep in mind in this debate is that the IMF charges a penalty premium of 200/300 basis points on large loans, whereas the premium has been dropped from EU loans, as decided at the July 2011 summit.

The relevant IMF funding schemes  (Extended Fund Facility, Precautionary and Liquidity Line) are described here and here.

Mrs Merkel gives Ireland the perfect reason to postpone the referendum

In this interview, Mrs Merkel gives the forthcoming Irish referendum as a reason why the treaty should not be renegotiated.

Almost no-one in Ireland thinks this treaty is a good one, and that includes the people who believe that we have no realistic option but to ratify it. Indeed, almost no-one outside Germany seems to want it, including the governments who signed it. It follows that if M Hollande were to lead a push to have it renegotiated, we should support that effort. If our May referendum is an obstacle in the way of achieving that goal, we should postpone it.


The news that Spanish unemployment is now at 24.4% deserves a thread. It is the latest reminder of the complete and utter failure of the Eurozone’s absurd strategy of generalized, undifferentiated austerity for all, simultaneously. What is so frustrating is that it was obvious in 2010 that this would be the result, which is why some of us objected at the time to what was happening: you didn’t have to be a genius to figure it out. I don’t see any way that the Eurozone will survive in its current form unless the macroeconomic policy mix changes, and I’m not sure it will change, even if M Hollande gets elected.

Current Account Imbalances in Europe; IEA Meetings

The revised version of my paper (joint with Barbara Pels) on current account imbalances in Europe (focusing on the pre-crisis period) is available here.

The current account was also the topic for the keynote Edgeworth Lecture delivered by Maury Obstfeld last evening at the Irish Economics Association annual meeting – his paper is here.

Today’s keynote ESR/DEW Lecture will be given by John Van Reenan on “Horrible Bosses? The New Economics of Management”.  He also has a VOX column today “Fiscal Consolidation: Too Much of a Good Thing?

The fall in GNP

Over the past week or so there have been a number of references to the fall in GNP that occurred in late 2011 as reported in the most recent set of Quarterly National Accounts released by the CSO.

Vincent Browne in particular has focused on the 7.1% fall in GNP recorded in Q4 2011 when compared to Q4 2010 as if it is indicative of some of cataclysmic collapse in the economy.  The seasonally adjusted quarterly real change was a drop of 2.2% in Q4 but even that may not be reflective of changes in the economy.

GNP is often referred to as a better indicator of the domestic economy than GDP because it “excludes the impact of the multinationals”.  That is not necessarily true.  GDP includes the net exports of the MNC sector and it is worth noting that in 2009 the top 10 MNCs accounting for one-third of Irish exports and imports (see slide 14).

GNP does not remove the trading performance of the MNCs as a measure of national income; it adds in the effect of Net Factor Income from Abroad.  This will, of course, be heavily influenced by the performance of the MNCs and the profits earned from their exports will largely exit in this fashion.

The point is that GNP can move because of a change in the export performance of the MNCs or a change in the profit repatriation decisions of the MNCs.  The decisions of the MNCs have two avenues to impact our GNP figures.  The assumption may be that one will offset the other but that is not necessarily the case.

If we look at the real seasonally adjusted changes in the components of GNP.

Component Q4 2010 Q3 2011 Q4 2011 Annual Quarterly



















(C + I + G)


















(X – M)












Net Income












The annual figures are poor and there is a €2.4 billion drop in quarterly GNP over the year.  Although the seasonally adjusted figures are not additive it is instructive to do so to get an indicator of where the annual 7% drop came from.

All of consumption, investment and government have fallen but their sum contributes €1.0 billion of the drop.   Net exports (driven by the MNCs) rose by €2.4 billion over the year but this was more than offset by a €3.3 billion reduction in net factor income from abroad. 

A large proportion of the change in GNP is a result of changes in exports and net factor income.  About 90% of our exports are from MNCs and you can use the Balance of Payments to track income flows (noting though that the this does not include seasonally adjusted data).  It seems that the expected drop in the outflow of investment income in the final quarter of the year was not as large as anticipated, thus becoming a seasonally adjusted increase in the outflow of investment income as reflected in the table above.

If we look at the quarterly changes we see that both consumption and investment rose in Q4 2011 (although investment was at an extremely low level to begin with).  This is not suggestive of an economy in freefall in the latter quarters of 2011.

Ireland national income statistics are hugely influenced by the presence of MNCs.  Although GNP is a useful indicator it is important to realise that changes in GNP are not necessarily reflective of changes in the domestic economy.  The CSO do provide tables on ‘Domestic Demand’ which is the bulk of the “Irish” economy (as opposed to the economy in Ireland) but that excludes the performance of indigenous exporting firms.

Labour Costs

The question of achieving an ‘internal devaluation’ has been raised in a late contribution to the previous thread.  It deserves more attention than it tends to receive on this site.

The phrase refers to improving competitiveness in the absence of a national exchange rate by reducing costs and prices relative to those of competitor countries.

Labour costs are a major component of domestic costs and one over which we retain ‘sovereignty’.

In March Eurostat published some relevant data on hourly wage costs. (Today’s Irish Independent carries a summary of the report.)

In 2011 Irish hourly labour costs were €27.4, which was 99.3 per cent of the Eurozone (EZ) average of €27.6.  In 2008 (the peak year) Irish labour costs were 105.7 of the EZ average, so there has been some improvement in this measure of our competitiveness.

However, Irish costs remain much higher than those in several EZ countries.  Here are some relevant comparisons: Spain €20.6, Slovenia €14.4, Portugal €12.1 and Estonia €8.1.  Outside the EZ the UK figure is €20.1, while the US Bureau of Labor Statistics gives a figure of $34.2 for hourly labour costs in US manufacturing in 2010 compared with $36.3 for Ireland.

Obviously all EZ countries cannot gain competitiveness relative to each other by reducing labour costs, although the EZ as a whole could become more cost-competitive relative to the rest of world by this strategy.   However, I think it is clear that we would have to wait a long time to see any dramatic results from this source either in Ireland or in the EZ as a whole.

NERI Research Seminar – Why we need an Economic Plan B

Details here.

Speaker Tom Healy – 25th April Wednesday at 4pm (tea/coffee from 3.45pm)


Economies across Europe are entering recession once again. Following a sharp fall in output and employment in 2008-2010 and a continuing contraction in the ‘domestic economy’ – only temporarily counteracted by a surge in exports in the first half of 2011 – there are mounting concerns about future growth prospects here. Unemployment is at crisis level especially as young people remain without work over a long period. This is proving very damaging to communities and individuals and is a major cost to the Exchequer. ‘Plan A’ has focussed on domestic deflation through decreases in labour costs, cutting public spending, raising taxes and charges across the board as well as growing exports as the preferred way to recovery over stopping the decline in domestic demand.
It is argued, in this paper, that a ‘Plan B’ is urgently needed to stop the fall in domestic demand and generate growth through job creation, investment in priority infrastructure and measures to raise skills. It is possible to do this through a combination of measures allied to a gradual increase in the tax take arising from growth in the economy as well as taxes aimed specifically at high-wealth and high-income individuals and households. The choice of spending or taxing is a domestic (Irish) one and not one that has been imposed externally. This has been confirmed on numerous occasions by the Troika. In the long-term a strategy to develop a much stronger and export-orientated indigenous sector offers a more sustainable approach to developing a social and economic model that fits the needs of a 21st century society.


INTO Learning Centre, 38 Parnell Square (West), Dublin 1

The hidden depths of the water charge

as submitted to the Sunday Business Post:

In a somewhat haphazard style, the government this week announced more details of its reform of the water sector. Unfortunately, the plans are about as well-crafted as the announcements.

People focused on the revelation that Father Christmas will not bring water meters this year. Instead, water meters will have to be paid for. It does not matter much whether households pay upfront or over time, through higher taxes via the Department of Finance, or through lower pensions via the National Pension Reserve Fund. Households will pay.

How much will households pay? A basic water meter costs €60, a fancy one €150. (The government appears to have picked the latter model.) An experienced plumber can fit a meter in 15 minutes or so. This is not terribly expensive, but many people are hard-up.

The government, however, does not trust households to install their own meters. The government could use a flat charge for people without a meter and a volumetric charge for people with a meter. If the flat charge is high enough, many will install a meter. This is a common arrangement in other countries. It is perfectly fine with the EU, ECB and IMF.

The government does not want to give people this choice. Ireland will be one of the first countries in the world with universal water metering. The government has yet to publish the cost-benefit analysis that shows that this is indeed the best bang for what little buck is left.

Because the government suspects that some people will not be happy to have their water metered and charged – and may thus refuse the government’s plumbers access to their house – the plan is to install water meters just outside the property, on council land.

That means what holes will need to be dug. The exact location of water pipes is not always known, so there may be some searching involved. Furthermore, water meters will be far from the smart electricity meters that the ESB is installing everywhere. Water meters therefore cannot piggy back on the communication network that the ESB is also putting up. Water meter readings will be collected separately.

All this makes water metering rather expensive. The government is not very forthcoming with its estimates, but it will be at least €500 per meter. The government will be happy to lend you that money – in fact will leave you no choice – so that a few hundred euro in interest should be added.

It is easy to get excited about such details – why pay €800 or more for something that can be had for €200 or less – but they distract from the bigger picture. Water meters are only the beginning. Water is metered so that it can be charged.

The government is tight-lipped about what the water charges will be. The EU Water Framework Directive is clear. Water charges should fully recover the cost of drinking water provision and waste water disposal. Ireland spends about €1.2 billion per year on water. Only some €200 million is recovered from non-domestic users. The total amount that will need to come in through household water charges is therefore €1 billion per year – or, not counting those with private or collective wells, €560 per household per year.

Unmetered households in countries similar to Ireland use about 150 litres of water per person per day. Full cost recovery implies that the water charge would be about €3.80 per thousand litres. As metering and charging reduce water use, typically by about a third, Uisce na hEireann would be quickly forced to increase the water charge to €5.70 per thousand litres.

The government has repeatedly promised that each household will get a generous allowance of free water. This is not clever. Again, the government has left us in the dark about the size of the allowance. If it is 100 litres per household per day, the water charge would be €9 per thousand litres. If the allowance is 200 litres, the water charge would be €22.

And therein the problem lies. Uisce na hEireann will supply water to households. The free water allowance will be for households. Small families will get all their water for free. Big households will pay through the nose. The minister will spin this as a boon to little old ladies living alone. A family of four would pay €800 per year without a free allowance but €1600 with. This is a baby tax.

Uisce na hEireann could only give a free water allowance per person if it would track how many people are present in a household.

The free allowance is best done without. Water charges place a disproportionate burden on the poor. Therefore, water charges should be raised and Uisce na hEireann should pay a dividend to the government, which should be used to increase benefits and tax credits. Not everyone would trust the government to pass on that dividend. Uisce na hEireann could have been mutualized, with every man, woman and child in Ireland owning an equal share.

Instead, Uisce na hEireann will be a subsidiary of Bord Gais Eireann (BGE). The government did not want to create a new state company, and it did not want to call on the private sector. That left little choice. BGE has a sound track record in providing households with gas, and it has successfully added electricity. BGE should be well able to deal with the retail side of Uisce na hEireann.

But Uisce na hEireann will do more than charging for water. It will run the water network and the treatment plants. BGE has diversified into wind power, an unfortunate decision which led to a downgrade of its credit rating. BGE loses money on its gas-fired power plant because it relied on in-house knowledge rather than external expertise. Let’s hope BGE has learned from this, because not anyone can run a sewage treatment plant.

Any manager would lose sleep over Uisce na hEireann. 34 local water boards will be merged to form a national company, with 34 different IT systems, 34 different model contracts with suppliers and operators, and 34 different labour regulations. 32 counties will transfer their water assets to Uisce na hEireann. Uisce na hEireann may initially employ 4,000 people, compared to the 1,000 people that now work for BGE proper. Was it wise to limit the competition for Uisce na hEireann to BGE and Bord na Mona?

Uisce na hEireann will be regulated by the Commission for Energy Regulation (CER), presumably soon to be renamed. The CER is struggling. It is wedged between the minister for energy qua policy maker and qua owner of the dominant companies. It has to deal with the far-reaching reforms of the energy market imposed by Brussels. And now its remit will be extended from energy to energy, drinking water, and sewerage. The CER cannot expect additional resources. Will it cope?

The government has embarked on a transformation of the water sector. That is welcome, in principle. It is unfortunate that options are not thoroughly scrutinized before decisions are made. The public debate has been distracted by the minor question how meters will be paid for.

Eurostat debt figures released, Irish debt/GDP at 108.2%

Details here. The deficit is now below 10%, which should if I’m right be the talking point on official press releases and the news tonight and such. The target in the budget (here, page 18) was 10.1%. The Budget target for debt in 2011 was and from the footnotes (remember Tom Waits’ quote about the small print):

Ireland: Eurostat is expressing a specific reservation on the data reported by Ireland, due to the fact that the restructuring plans of Allied Irish Banks and Irish Life & Permanent are not yet finalised. These restructuring plans have been used by the Irish statistical authorities to calculate in the reported figures a (deficit increasing) capital transfer element of 3.7% GDP arising from the July 2011 government injections into the two banks. Eurostat awaits the finalisation of the restructuring plans, including approval by the EU competition authorities, so that the amount of the capital transfer element can be confirmed.

Eurostat is also expressing a specific reservation on the data reported by Ireland, due to the statistical classification of National Asset Management Agency Investment Limited (NAMA-IL), which is currently classified outside the general government. Owing to the nationalisation of one of its previously private beneficial owners, whose interest is currently under a process of sale, NAMA-IL has been in majority public ownership since July 2011. Eurostat’s decision of 15 July 2009 on public interventions during the financial crisis specifies that majority private ownership is necessary for such an entity to be classified outside the General Government sector.

Another reservation might be with respect to nominal GNP, where the debt ratio now stands at roughly 131% (169/129).

Irish Water (again)

I had an op-ed in yesterday’s Business Post, together with a raft of other pieces. The points raised should come as no surprise to those who read Morgenroth’s and my earlier blogs. Conor Pope independently confirms our numbers. Summary:

  • The government plan for water meters is exceedingly expensive.
  • Free water allowances are a bad idea, particularly if the allowance is per household (as is likely) rather than per person.
  • Is Bord Gais up for this? Can the Commission for Energy Regulation cope?

The Sindo also wrote about Irish Water, which highlights another issue: Bord Gais is not fully state-owned. Employees own a fair chunk too. An uncompensated transfer of water assets from the counties to Irish Water would be a windfall for Bord Gais employees, a capital gain that will be taxable at some point in the future. It would be better if Irish Water would pay a fair price for the assets, funded by newly issued equity. The county councils would then be part-owner of Bord Gais, which would further complicate the planned privatization of part of the company.

Blanchard: Fiscal Compact a gateway to eurobonds

Olivier Blanchard is quoted in the press today:

“When there was no fiscal treaty nor budgetary and budgetary discipline instruments, the Germans had good reason to reject bearing the brunt of irresponsible policies by other states,” Olivier Blanchard told the Monday edition of Financial Times Deutschland.

“But now we have a fiscal treaty. The Germans should accept that the eurozone is going by way of eurobonds,” he added.

Presentation on European Crisis Countries

The 2012 Spring Meetings of the IMF and World Bank held a session yesterday that featured presentations on Greece, Portugal and Ireland.  A video of the session of available here

Ajai Chopra’s 15-minute presentation on Ireland begins at 31:20 in the recording.  The Irish Times have some coverage of the meeting here.

The presentation from Poul Thomsen on the overall roles of the ‘Troika’ in the country programmes is also of interest, including the remark [below the fold] from around 52:50 where he says that:

Continue reading “Presentation on European Crisis Countries”