Year: 2012

Those interested in the fortunes of the real economy, and specifically the agricultural sector, might find my assessment of the prospects for farming in the current issue of eolas of interest. The editorial tagline does a good job of summarising its gist.

The agricultural sector is recovering. However, dependence on direct payments, climate change [targets] and ageing farmers are potential problems.

By the way, there are many other interesting articles in the magazine, its well worth a read.

Thanks to Eoin Bond for the link to the text of Jörg Asmussen’s talk to the Institute for International and European affairs (see here).    While it will undoubtedly be controversial, I think it is a balanced take on Ireland’s crisis and crisis-resolution efforts, and in particular the support that has been received from the eurosystem.

However, I do wish to take issue with the account of the recent efforts to restructure the repayment schedule on the promissory notes, something that has been receiving a great deal of attention here in recent weeks. 

Mr. Asmussen says:

I understand the strong desire of the authorities to minimise the costs associated with the banking sector rescue, including costs incurred to date, and those still to come. Let me make some comments in this area. When the programme for Ireland was designed, the costs of the banking sector measures already in place, including the promissory notes, were fully factored in. The annual cash repayments of promissory notes is thus financed by programme resources. That programme is on track. Any deviation from that programme should be considered very carefully indeed. The perceptions that have built-up around Ireland’s successes in the programme should not be jeopardised. It has been hard-won and it is worth fighting for. Therefore, the ECB remains of the opinion that Ireland should honour its commitments stemming from the promissory notes, as foreseen. This in our view is the best way to regain sustainable market access.

I don’t disagree that Ireland’s best interests are served by honouring its commitments to both market and official funders.   But there is a significant difference between reneging on a commitment and a renegotiation with official creditors aimed at the shared goal of resolving Ireland’s funding crisis through re-entry into market funding.    While there has been a sustained improvement in Irish bond yields, the extent of near-term funding needs will be a barrier to market re-entry.    The originally agreed repayment schedule on the promissory notes envisaged reasonably rapid repayment of the principal and interest – with payments of €3.1 billion beginning in 2011.   It is true that the resulting funding needs were recognised at the time of the design of the programme.   What was not known at the time was the how broader euro zone tensions would escalate, making it more difficult, despite significant progress in demonstrating the capacity to honour commitments, in bringing bond yields down to levels consistent with robust debt sustainability.   It is hard to see how a negotiated rescheduling of the repayment schedule based on the common interest in Ireland’s success would have any adverse reputational spillovers.   Indeed, the improved maturity profile on the outstanding obligations of the State should have a significantly beneficial effect on creditworthiness.  

Interestingly, Mr Asmussen appears supportive of a restructuring of the promissory notes that would involve paying them off through a long-maturity loan from the EFSF, and paying off the Emergency Liquidity Assistance (ELA) ahead of schedule.   This would improve the maturity profile.   But it would come at the cost of a higher interest rate given the very low ultimate interest rate on the ELA.   It is possible that the ECB thinks Ireland is asking for too much – a low interest and a long maturity.   (And we must recognise the ECB’s general discomfort with the ELA arrangement to begin with.)   But an overly purist position can be self defeating in terms of the broader goal of finding a route through the euro zone crisis.   The Irish authorities have worked steadily to make the necessary and hugely difficult adjustments and avoid a default that would be both damaging domestically and damaging to the euro zone.   Given the quite particular remaining challenge that Ireland faces in regaining market access, I do not think it is unreasonable to expect this particular targeted change in the negotiated supports in the common interest of euro zone stability. 

Martin Wolf has another excellent piece in today’s FT, which also appears without the need for a subscription in the Irish Times.    A major theme of Martin’s recent analysis has been the asymmetries in the current account positions across the euro zone, and as a result the need for a more balanced crisis-resolution strategy that involves expansion in the core.   While his analysis has been incredibly useful in many ways, I have always felt that he underemphasises the “capital account” nature of the crisis.  It seems partly under the influence of the recent excellent Breugel paper on “sudden stops” in net capital flows, this latest article provides what I think is a more balanced perspective.   For our own debate, the piece provides a useful opportunity to reflect on the relative roles of current and capital account aspects of the euro zone crisis. 

Much of the discussion of the crisis has cast it as a crisis of the current account of the balance of payments.   There is much to this; it is undoubtedly true that improvements in the relative competitiveness of the periphery and the relative demand growth of the core are critical elements of the solution.   However, the crisis is even more immediately a crisis of the capital account, with – as documented in the Bruegel paper – a “sudden stop” in net private capital flows to the periphery.  (Everybody interested in the crisis should read the Bruegel paper.) 

It is useful to consider what would have happened if large-scale official funding — including the funding of periphery banks through the eurosystem — had not taken place.  (The Breugel paper documents how massive the official funding has been.)  Current account deficits in the periphery would have declined massively, and (absent default) would have swung to large current account surpluses as existing credit lines were not rolled over.    This would have resulted in even deeper depressions and widespread defaults.   Care must be taken in interpreting the current account balance – or turnarounds in that balance – as a sign of economic health.

Without in anyway playing down the importance of the need for more balanced adjustment across the euro zone (which requires more expansionary policies in the stronger countries of the core), the “sudden stop” in private capital flows highlights the critical need to re-establish creditworthiness.   This is critical to facilitating more phased adjustment without putting an intolerable strain on the willingness of the core to fund the current account imbalances of the periphery.  

The re-escalation of the crisis in late 2011 – which may be raising its ugly head yet again with the renewed pressures on Spain and Italy – shows how fragile creditworthiness is to bad expectational equilibria within a monetary union.    This has led to efforts to shore up the lender of last resort function within the euro zone.   But a reliable lender of last resort means that the stronger countries face potentially huge liabilities for their weaker partners.   It should not be surprising that assurance is needed that adjustments will take place without default on official lenders in return for providing the financing to allow those adjustments to take place in a more phased way.  

The fiscal compact must be seen in this light.   Focusing on the unbalanced-current-accounts aspect of crisis, there is substance to the criticism that the compact forces excessively restrictive fiscal policies on the core.   But the capital account – i.e. creditworthiness – aspect cannot be ignored.   A commitment to shared discipline appears necessary to allow both the massive official funding to continue and to make it sufficiently reliable to make the market creditworthiness of the periphery less fragile.