A dangerous union for small countries

Here are three papers I have read recently.

1. Reinhart and Trebesch on the way that external debts can hollow out local democracies. No need to elaborate on this I think.

2. Avdjiev, McCauley and Shin on cross-border banking: well worth a read for people not familiar with this stuff. They are talking about complicated transactions, but as we know in Ireland, much simpler transactions (banks borrowing overseas) can have dangerous consequences.

3. Athanasios Orphanides on the highly politicised nature of crisis decision-making in the Eurozone.

From 3, and from everything that we have observed during this crisis, from Ireland in 2010 to Greece in 2015, I infer that a small country is much more vulnerable inside the Eurozone than outside, if it gets into trouble. Outside, you will deal with the IMF on its own, and they have a standard policy template: debts will be written down, currencies will be devalued, and yes, there will also be austerity. Inside the Eurozone creditor countries will sit alongside the IMF at the table and you may find that neither of the first two policies will be feasible, which will make the austerity far more harmful than it would otherwise be, both economically and politically.

From 2, I infer that a small country needs to watch its banks like a hawk, especially if it is inside the Eurozone, because (from 1, and 3, and from what we have experienced since 2010) the political consequences of not doing so are just too damaging.

And from 1 and 3, I infer that government debts are something that small countries inside the Eurozone also need to be very concerned about. Especially in a monetary union without a banking union, like ours.*

So I find myself in agreement with Colm McCarthy. As was the case 15 years ago, we need to worry about the possible real exchange rate consequences of expansionary fiscal policy at this point in the cycle. And to be fair to the Irish economics profession, lots of people did worry about that then. But the main concern for me is no longer about economics, but about the risks to our Republic’s democracy. The price of freedom is eternal vigilance.


*What is a banking union? If Arizona elects a bunch of communists or survivalists to run the state, and the state budget explodes as a result, local banks will still be backed up by the Fed. My money will still be safe. I will still be able to withdraw it if I choose. This is what a banking union looks like, and don’t let anyone in Brussels or Frankfurt tell you any different.


17 replies on “A dangerous union for small countries”

“So I find myself in agreement with Colm McCarthy. As was the case 15 years ago, we need to worry about the possible real exchange rate consequences of expansionary fiscal policy at this point in the cycle.”

Guys, this might be more accessible for presented as “…the possible loss of competitiveness consequences of expansionary fiscal policy at this point”.

They aren’t going to look it up.

Agree that the real threat is to democracy.

The US is no longer a democracy; a plutocracy of Coke Bros and their ilk, a neoconservative state dept., simply ‘buy’ politicos …. and regime change wherever as the plutocracy deems it to suit its interests.

EU is now close behind; where democracy intrudes on interests of the corporate/financial system it is simply crushed. Ireland and Greece the exemplars. The ‘fighting oirish’ didn’t even lift a finger; simply embraced their chains.

Democracy is of the Lifeworld; the Lifeworld has been crushed by the Corporate/Financial/Military systems; future for serfs in the Matrix is Grimm.

@Colm McCarthy

Take the case to the ECB. If democracy exists then its intrinsic relation to law will be demonstrated: if not; then it doesn’t. QE(d)!

Further reading in this FT commentary which I posted on another thread.


The issue boils down to excessive financial risk taking, either by governments or private investors. Greece has a track record in the matter of excessive government borrowing going back two centuries. Ireland has not been independent long enough to beat that record of fecklessness.

Paper 2 takes apart simplistic financial flow models that are based on individual sovereign countries as the base component and associated “triple coincidences” which, although intellectually spuriously neat, are highly misleading.

Paper 3 reflects a continued – academic – pursuit of a world free of politics. The euro is a political not an economic undertaking but based on the fundamental economic calculation that the advantages of a common currency outweigh the disadvantages, a calculation which still stands, whether through conviction or necessity remaining to be seen.

Participants that cannot stand the heat had best stay out of the kitchen. On that point, there can be little dispute.

“The euro is a political not an economic undertaking…”

The fact that there are German lawyers who are quite determined to believe that doesn’t make it true.

The reaction of certain economists, commentators and posters on this site to the recent growth of the Irish economy is comical. Having spent the years 2009-12 claiming that membership of the euro imposed a straightjacket on the Irish economy that would ensure permanent austerity and deflation and economic ruin, then having failed spectacularly to predict the latest economic boom, then having spent the first couple of years of that boom denying its existence and claiming that it was all a statistical freak resulting from the practice of contract manufacturing, they’ve now gone overnight to claiming that the boom is not only for real but actually so strong that the government dare not let people keep more of their own money, lest it stoke the fires of inflation and cause the economy to overheat and burn in the manner of 2007/08.

Time for a reality check:

(a) Inflation in Ireland is currently 0 per cent (HICP).

(b) The balance of payments is in huge surplus (v a huge deficit in the UK).

(c) Even after last week’s tax cuts, the budget deficit is forecast to be 1% in 2016 (v 5% in the UK).

(d) Debt as a percentage of GDP is falling like a stone (v rising in the UK).

(e) Unemployment, although falling sharply, is still 9.4%, leaving ample slack for further economic growth.

(f) Houses prices are still almost 40% below their peak in the previous boom.

(g) The construction industry is still near the bottom of its output cycle, with only 12,000 or so houses forecast to be built in 2015.

Those economists (and there are many) who look at every rise in house prices and scream ‘OMG: its 2006 again; the economy is going to crash’ are bonkers. The main effect on economic growth of the collapse in house prices post -2007 was that it led to a fall in the number of houses built annually from 85,000 in 2007 to 10,000 in 2013. Since its only risen to 12,000 currently, there can not be a similar effect. Given the current low level of house building, even if house building was to cease completely in Ireland in the next few years (most unlikely), the effect on economic growth would be minimal compared to the effect of the fall from 85,000 to 10,000 between 2007 and 2013. Its far more likely, of course, that house building will rise in the next few years.

That is not to say that the economy will not overheat eventually. All periods of economic growth (in every country) eventually lead to overheating as full employment becomes the norm, wage demands increase, inflation rises and competitiveness worsens. However, past experience shows that Ireland’s highly flexible enterprise-oriented economy is nowhere near that point at present and can sustain many years of high growth before overheating becomes a problem. The first long boom in Ireland lasted 24 years from 1958 to 1982. The second long boom in Ireland lasted 21 years from 1986 to 2007. Decades went by before the inevitable overheating took place. The current boom is only 2-3 years old and showing none of the signs that are common in the later stages of a long boom. Claiming that at this point in the economic cycle the economy is in danger of overheating is baloney.

The other claim being made by some commentators (e.g. Colm McCarthy’s article in the Sunday Independent) is that the current boom is simply the result of a string of lucky breaks, in particular the fall in the oil price and the fall in the euro. Well, lets look at the facts:

Y-O-Y growth in volume of GNP in Ireland:

Q3 2013: +8.4%
Q4 2013: +7.2%
Q1 2014: +4.3%
Q2 2014: +10.7%

So, the boom was firmly established with Celtic Tiger growth rates by 2013-2014:

exchange rate of Euro v Dollar:

Q3 2013: 1.32
Q4 2013: 1.36
Q1 2014: 1.37
Q2 2014: 1.37

since then falling to 1.11 in Q3 2015

exchange rate of Euro v Pound Sterling:

Q3 2013: 0.85
Q4 2013: 0.85
Q1 2014: 0.84
Q2 2015: 0.83:

since then falling to 0.71 in Q3 2015

So, the current boom was firmly established with Celtic Tiger growth rates a full year before the alleged causes of it (falling oil prices and falling Euro) actually occurred.

A question that must be posed, although this seldom happens, is whether the steps required to enable a member of the Eurozone withstand the heat in the euro kitchen are, in themselves, beneficial. The debate is rather about the supposed limitations on national sovereignty (as if that meant something other than retaining the ability of politicians to do the wrong thing).


Recitals 10 and 11 are particularly relevant.

The Irish economy is likely to go off the rails again for the reasons mentioned and, in particular, the unaffordable levels of spending on public services and social protection both in terms of the sums involved and the drag constituted by the uneconomic manner in which they are delivered.

Of course, all of this is pure economics!

What is good or bad for a small economy depends.

The Czech and Slovak republics had relatively smaller recession dips compared with the Baltic republics and Slovakian GDP will be up 18% on 2007 by end 2015 compared with 6% in the Czech republic.

Both are dependent on car production for foreign companies and Slovakia is in the Euro Area. Czechoslovakia was dissolved in 1992 and it’s interesting that both of the new countries in 2014 had a similar actual consumption per capita (AIC) levels, which were below Greece’s.

Finland is facing challenges in key sectors of the economy but because it was more prudent than Ireland during the boom period, it will have a -30% of GDP net debt by 2020.

We can see that in emerging economies foreign funds tend to flow out on bad news and this year will be the first since 1988 that net total flows for 30 countries will be negative.

It’s quite extraordinary that Enda Kenny has set up the election as a competition on tax and invoking the days of self-financing cuts, on Friday used the introduction of the 12.5% corporate rate as a cut that more than paid for itself.

It was a tax rise for exporting firms that did not have special deals!

Ireland remains a low tax country and is among the OECD countries with a low tax wedge — that seems news to the taoiseach.


The real threat to ‘democracy’ lay in citizens being saddled with the gambling debts of bankers and bond holders allied to political regimes now putting in place half baked laws which are allowing a reoccurrence of the same scenario….

re the extant remnants of the ‘fighting Irish’:

Quite simply brilliant Billy; and quite possibly the finest spell of amateur international Irish coaching ever.

@ MH

He was preaching to the faithful!




It is no accident that the countries that have maintained stable housing markets – Germany in particular – have come through the crisis best. The classic Irish mindset, shared by the three establishment parties, but not confined to politicians, is to view housing as an investment when it is best seen as a cost. They are finding out that a market approach only, based on excessive credit, the cost of which is beyond many families, does not work. The political cost will be high, especially for Labour.


Your link is irrelevant to the subject of the thread, which is effectively about whether or not the economy is close to overheating and, therefore, whether or not last week’s tax cuts were justified.

I’ve said emphatically that it isn’t even close to overheating (my reasons listed above) and that, consequently, the tax cuts were totally justified.

David McWilliams seems to share my opinion on this matter.


I believe the following recollection is accurate – Colm McCarthy at the height of the Tiger recommended that sites like Clontarf Bus Station and St.Annes estate be zoned for housing, making his planning/zoning point. Presumably, similar opportunities existed south side.
Post collapse that recommendation lost credibility, is he now reviving his original view?
As regards a view that the economy is on the verge of ‘overheating’ – those who believe that should visit rural towns and villages – at best some are just about surviving, most are struggling economically, despite a lot of local voluntary efforts.
One potential employment stimulus for rural Ireland – HIGH SPEED BROADBAND wherever you are located.
Oops – not good – economy overheating – enough ‘ fuel’ has been injected!


I was referring to your first post (with the German link) in my reply above.

I hadn’t seen your second post (with the Colm McCarthy link) at the time.

I agree with the sentiments expressed by Colm McCarthy in that article. Its very sensible. I’ve said similar many times here in the past. But, its sensible only because the frequently-made (until recently) and politically-motivated claim of 350k empty houses left behind by FF has turned out be totally false. If there actually were 350k empty houses, there would be no need to build houses or zone land for building for at least a decade. But, there aren’t.


If David McWilliams agrees with you, or you agree with him, I suggest that you need to worry.

FYI the press release by the MOF on the appointment of Philip Lane as governor of the ICB.


N.B. This extract.

“I would like to congratulate Professor Lane on his nomination to this prestigious national and European position. Professor Lane’s outstanding economic, financial and policy making record ideally position him to lead the Central Bank in the coming years. Also, his appointment by ECB President Draghi to chair the Advisory Scientific Committee of the European Systemic Risk Board demonstrate the standing he is held in at European level.”

Why the second sentence?

@ Vinny

Your comment about the absence of any sign in rural Ireland of overheating is well judged. But it is not the economy. The electorate may not, unfortunately for the government, be aware of this.

Speaking of ‘threat to European Democracy’ …

Anibal Cavaco Silva, Portugal’s constitutional president, has refused to appoint a Left-wing coalition government even though it secured an absolute majority in the Portuguese parliament and won a mandate to smash the austerity regime bequeathed by the EU-IMF Troika.

He deemed it too risky to let the Left Bloc or the Communists come close to power, insisting that conservatives should soldier on as a minority in order to satisfy Brussels and appease foreign financial markets.

Democracy must take second place to the higher imperative of euro rules and membership.
This foolish treaty law obliges Portugal to cut its debt to 60pc of GDP over the next 20 years in a permanent austerity trap, and to do it just as the rest of southern Europe is trying to do the same thing, and all against a backdrop of powerful deflationary forces worldwide.
The strategy of chipping away at the country’s massive debt burden by permanent belt-tightening is largely self-defeating, since the denominator effect of stagnant nominal GDP aggravates debt dynamics.

Europe’s socialists face a dilemma. They are at last waking up to the unpleasant truth that monetary union is an authoritarian Right-wing enterprise that has slipped its democratic leash, yet if they act on this insight in any way they risk being prevented from taking power.


Threat to democracy; QED!


I found this in my files. I think it was FT and Martin Wolf but I cant find the link online.

“>Martin. At what point do you think the political consensus supporting economic orthodoxy at the centre starts to fracture and voices from the left or populist right get really substantial electoral support saying its time to “renegotiate” existing agreements because the younger generations futures are being sacrificed to foreign financiers?

>I keep thinking of 1930s France when the Laval administration followed the sort of deflationary policies now pursued in the Euro-zone periphery and in the end the voters kicked them out and put in the Popular Front (another disaster). How long do you think these Euro austerity policies have got to promise but fail to deliver some light at the end of the tunnel before the voting patterns change?”

I think getting Portugal down to 60% is incoherent when the ECB is hoovering up bonds , transferring them from private to public sector.

The Germans go on and on about moral hazard because in their sound money monetary fetish world fiscal policy is evil but there is a far bigger moral hazard play happening in the financial sector with all of the mispriced assets on so many balance sheets because of ZIRP. Incoherence is very much part of the Zeitgeist.
And look at how much good following economic orthodoxy did Finland.

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