Call for abstracts for a conference panel session on “Trust in Economics”

UCD Philosophy Prof Maria Baghramian is organizing a conference on “Trust, Expert Opinion and Policy” at the end of the Summer in Dublin and there’s to be a panel on “Trust in Economics”. She has asked me to post this call for abstracts. Should be an interesting event.

Place: University College Dublin
Time: August 31-September 2, 2017

Carlo Martini (University of Helsinki) and Don Ross (University College Cork and University of Cape Town) are organising a special session on

Trust in Economics

embedded in the international conference on Trust, Expert Opinion and Policy  (a multidisciplinary conference investigating questions of trust in and the trustworthiness of expert opinion).

The conference is organised by Professor Maria Baghramian (School of Philosophy, University College Dublin) and Professor Luke Drury (School of Cosmic Physics, Dublin Institute for Advanced Studies) as part of their Irish Research Council Project “When Experts Disagree” in collaboration with the project: “The Trinity of Policy-Making: Evidence, Causation, Argumentation”

Keynote speakers at the conference:
Onora O’Neill (University of Cambridge, Philosophy)
Patrick Honohan (Trinity College Dublin, Economics)

Call for Abstracts for the special panel on Trust in Economics

Description of the panel’s topics: What factors influence the extent of public trust in economists? Research and media outlets have recently reported a severe crisis of confidence affecting science, and economics in particular. But available surveys mainly focus on natural and medical sciences. What do we know, based on rigorous and objective surveys, about the attitudes of various publics toward economics? Past and current economic crises and turmoil are often cited to cast doubt on the expertise of economic policy advisors and commentators, but to what extent is this a problem for economics as a science? To what extent does it stem from failures in communication? Are some of the current negative judgments on economics and economists due to lack of adequate effort by economists in building a relation of trust between their science and its public?

We will be selecting a small number of contributed papers addressing, among others, the following questions:

Is there currently a crisis of public trust in economic science?
Do economists value trust in public communication of their science?
Are economists effective in communicating trust?
How should we conceptualize trust in economic expertise?
How can public trust in economics best be empirically studied and measured in surveys?
How can we most effectively build greater public trust in economic expertise?

We invite short abstracts (max 500 words) to be submitted to by July 15 2017. Notifications of accepted papers will be sent out shortly after the deadline.

Deadline for submission of abstracts: July 15 2017

The Irish National Accounts: Towards some do’s and don’ts

The statistical distortions created by the impact on the Irish National Accounts of the global assets and activities of a handful of large multinational corporations have now become so large as to make a mockery of conventional uses of Irish GDP. I suggest four preliminary remarks to help overcome some of the challenges facing observers of the Irish macroeconomy.

  1. GNP is now almost as unhelpful an aggregate economic measure for Ireland as GDP. (This is due to a change in the way in which some globalized countries are managing their affairs, with some significant global headquarters now being located to Ireland)

  2. Ratios to GDP are now almost meaningless for Ireland in most contexts. They need to be supplemented by alternative purpose-constructed ratios for specific uses, as the Irish Fiscal Advisory Council already proposed a few years ago with its weighted average of GDP and GNP for assessing fiscal sustainability – though that particular solution will no longer work well for the reason mentioned in point 1.

  3. International statistical conventions should be revisited to help the interpretation of the data in a world where huge MNCs, legally controlled from small jurisdictions are moving assets around on this scale.

One natural approach is to apply the thinking underlying the current statistical treatment of financial intermediaries to this kind of MNC.

(One aircraft leasing firm that publishes its accounts has just 164 employees in Ireland – and just 221 elsewhere – but a balance sheet total of $44 billion, the bulk in the form of aircraft that are operated by other firms. I do not know how the statisticians classify it, but in economic terms it looks much more like a financial firm than a non-financial firm).

Failing international convention changes, it may be necessary to envisage a parallel set of accounts being also prepared for the Irish economy.

  1. Some of the big aggregates of the national accounts are largely unaffected by the distortions. For instance, the figures for personal expenditure on consumer goods and services and for government expenditure on goods and services. These two series can still be used to get a more realistic picture of the recovery as it is felt in public and private consumption. But they should not be expressed as a percentage of GDP, but instead in real constant price terms, seasonally adjusted.

Thus, by the first quarter of 2016, personal expenditure was still just below its quarterly peak of eight years ago; it has been growing for twelve quarters since the trough at an annual average rate of 3.5%.

Government spending on goods and services (i.e. not including transfer payments) in the first quarter of 2016 was still six per cent below peak but has grown by 4.0% per annum on average in those twelve quarters.

Personal disposable income (a much under-used series; up to date figures not available yet); other elements of the government finances; building and construction investment are other series that remain valid and usable for understanding the relevant parts of the economy.

How do these recent growth rates in consumer and government spending compare with those registered in the decade before the bust? Much lower of course: consumer spending rose by an average of 5.6% per annum 1998-2008, and government spending by 4.9%. Recovery yes: boom no.


An Bord Snip: Structural and Strategic Issues

In addition to the Department-by-Department blow-by-blow recommendations, An Bord Snip Nua has offered general comments and recommendations in Chapter 2 of its Volume 1. Among other things, it speaks about:

– Outsourcing and economies through shared ICT.
– Rationalization of Departmental structures and agencies including for the delivery of services at local level;
– Improvements in procedures for public procurement and property management.
– Value for money and performance appraisals.

I would welcome specific comments on these structural and strategic aspects in this thread.

An Bord Snip: Specific Savings

How about some specialized discussion on proposed cuts?

I haven’t yet counted the recommendations in Volume 2 of An Bord Snip’s report, but there is much detail on which specific expert comment would be valuable and could begin here.

Three-quarters of the potential savings identified by An Bord Snip nua are (unsurprisingly) in the three biggest spending areas: Health, Social Welfare and Education. I’m opening a separate thread for each of those three: keep this thread for the rest.

Please no general waffle on this thread please!

An Bord Snip: Education

I’m opening this strand to facilitate more specialized discussion on the cuts in Education proposed by An Bord Snip, which total €0.7 bn or 8% of the €9 billion currently spent in this area.

The proposed cuts include:

Structural efficiencies (e.g. amalgamation of some ITs and VECs).

Staffing reductions and productivity improvements
(e.g. in the area of sick leave arrangements, special needs assistants, pupil-teacher ratios, and more teaching hours)

Programme adjustments (mainstreaming of traveller education, costbrecovery of school transport, PRTLI)

An Bord Snip: Health

I’m opening this strand to facilitate more specialized discussion on the cuts in Health proposed by An Bord Snip, which total over €1.2 bn or 8% of the €15 billion currently spent through the HSE.

Cuts here include: staffing roll-back of over 6000; a tightening of the eligibility requirements for medical cards; increased co-payments for prescriptions and walk-ins to A&E; and some rationalization of agencies.

An Bord Snip: Social Welfare

I’m opening this strand to facilitate more specialized discussion on the cuts in Social Welfare proposed by An Bord Snip, which amount to €1.8 bn or 9% of the €18 billion currently spent in this area.

Among the proposed cuts are an overall roll-back in rates of 3% or 5% nominal; a 20% reduction in Child Benefit; and some changes in eligibility (double payments).

An Bord Snip Nua report

The two volumes can be found here: Vol. 1 and Vol. 2.

An initial glance through suggests that it’s all meat and little padding. It will be for others to frame the wider implications of what is being proposed.

There can be no doubt that the decisions that will be taken on public spending in the coming months will shape our society for a long time to come. Let the debate begin. And let’s get the balance of analysis and polemic right!

Update: OK, enough is enough. The volume of disparate comments — over a hundred now on this strand — tells me that some specialization is needed here, so I am opening five new strands to facilitate a more coherent discussion of sub-issues.

One strand, then, on each on the three biggest areas by spend (Social Welfare, Health, and Education) one on specific issues in the remainder and one on the strategic and structural aspects.

No doubt some contributors will also be drafting substantive posts on particular aspects, and on the overall implications of the report and reaction to it.

Another lap for hare

ESRI forecasts for 2010 allow me to update the internal/external balance plot first used  by Brendan Walsh and myself to describe the lengthy cycle 1975-2001. 

The first chart, with data up to 2006, shows the previous big counterclockwise cycle: first the balance of payments goes into deficit (1975-1979); then the correction begins and unemployment rises (1980-85), the balance of payments deficit contracts (1981-87) and moves into surplus (1991-93); finally unemployment comes down again (1993-2000).

Looks like the Irish hare is taking a shorter and sharper curve this time.  The balance of payments blow-out (2003-2008) has been much smaller in amplitude and shorter in duration than in the 1970s and 1980s.  The rise in unemployment (2007-2010) is much faster than in 1981-86.  Sooner or later we’ll get back to the bottom centre of the graph with low unemployment and zero balance of payments. 

The first chart shows data up to 2006, the second one joins the dots for 2007-2010 according the the ESRI forecasts published this morning.

Internal and external balance to 2010

(PS: For those who like two-dimensional business cycle graphs, there is a very nice one (plotting rate of change of GDP against its level) for the US in a recent issue of the New York Times. Wish I had a copy of their animation software!)

Anglo Irish bank: dealing with risk investors

Anglo Irish Bank has announced losses that bring its measured shareholders’ funds down to about 0.1 per cent of total assets — effectively zero.  It has also announced a further €3.4 billion in expected loan losses, little of which would be offset by operating income over the next year or so.

From a strict contractual point of view, the next in line for absorbing these losses are the subordinated debt holders.  There has already been some discussion on this site of the issues involved here.

Now we are at a crunch point because a recapitalization of Anglo cannot be long-delayed. Indeed, to continue trading, the bank presumably needed the assurance that was provided by the Government today that needed capital would be forthcoming.

There is €2.8 billion of unguaranteed sub-debt on Anglo’s books.  I am assuming that part of the Strategic Plan promised by the bank this morning will have to involve risk-sharing by sub-debt holders.  This could take the form of of a deeply-discounted buy-back (as indeed is already suggested in the Government’s statement). It could also take the form of a debt-equity swap. (This would parallel current discussions in the US around debt-equity swaps to recapitalize some of the larger US banks following their stress-tests).

Obviously none of this is easy, and these bondholders may want to play chicken.  In a liquidation they would be wiped out, but — absent modern bank insolvency legislation here — a messy liquidation could also inflict severe taxpayer and economic costs.

I admit that I am not sure of the most effective way of accomplishing it. There are some obvious options. Perhaps readers will have some further ideas. I am sure that officials are pondering these issues.

But difficult does not mean impossible.  The stakes here are evidently high. 

Urgent work to modernize bank insolvency procedures (as recently enacted in the UK post Northern Rock) could strengthen the Government’s hand. 

It might be argued that losses incurred even by sub-debt holders of a bank could damage the credit of the Irish government.  I disagree. 

First, it is really immaterial that the bank is Government-owned: eveyone knows that situation has only arisen as a result of the disastrous performance of the bank. No new subordinated debt has been issued since the nationalization. Besides, in his statement in the Dail on January 20, during the debate on the nationalization bill, the Minister removed any doubt about whether nationalization entailed an expansion of the guarantee.

More generally, even though there might be an immediate knee-jerk reaction in market prices of debt, mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors.

Crisis Policy Conference programme, 20th May

Trinity College Dublin
(Department of Economics and IIIS)
and the
Dublin Economics Workshop



J.M. Synge Lecture Theatre (Room 2039), Arts Building,
Trinity College Dublin
Wednesday 20th May, 2009


Session 1: 1.30-3.30

Chair: Jim O’Brien, Second Secretary General, Department of Finance

John Fitz Gerald (ESRI) on Competitiveness
Karl Whelan (UCD) on Potential Output
Brian Nolan (UCD) on Inequality

Session 2: 4:00-6:00

Chair: John McHale, Queens University, Canada & NUIG

Colm McCarthy (UCD) on Pensions
Philip R. Lane (Trinity College Dublin) on Fiscal Policy
Patrick Honohan (Trinity College Dublin) on Banks
Continue reading “Crisis Policy Conference programme, 20th May”

Shifting ownership of Irish banks

Given the current interest in ownership of the Irish banks, I thought readers might be interested to read about the size distribution of shareholders.

AIB provides the most interesting data, reported in their recently published Annual Report and relating to end-December 2008.

There have been some interesting shifts in the past year.  First of all, shareholders in the Republic (including pension funds etc.) now hold 41 per cent of the shares, up from 37 per cent last year.

Second, in the face of dramatic declines in price and increase in volatility, the number of AIB shareholders has increased by over 10 per cent or 10,000 persons.  Almost all of the increase relates to the Republic, and almost all hold less than 5000 shares.  (Today, the shares closed at €0.81).  This confirms what was known anecdotally, namely that lots of middle income people thought it worth taking a flutter on bank shares given the novelty that they were only worth cents.  They have bought these shares from foreign institutions.

For, although there over 90,000 AIB shareholders in total, of whom 76,000 in the Republic, fewer than 5000 shareholders hold more than 10,000 shares, and just 384 hold more than 100,000 shares.

Bank of Ireland had about 80,000 shareholders when it last reported the number, about a year ago.  (We’ll likely see a similar pattern to the changes when the March 2009 figures are published.)

A look at Irish Life and Permanent‘s reports (giving shareholders at end March 2009) shows a similar, though smaller trend: they now have over 135,000 shareholders up about 1%.  All but 10,000 of them have fewer than 1000 shares each, but most of the newcomers seem to have between 1000 and 10000).

Anglo Irish Bank had far fewer shareholders — fewer than 20,000; just over 100 of them held 85% of the total shares between them.

Scope of NAMA

Much has been written about the pricing of the NAMA loan purchases and the consequences for shareholders (including by myself in tomorrow’s Sunday Business Post), but less on the scale and scope of the proposed purchases.

The announced plan is that

“The eligible land and development loans of each bank involved will be transferred – that is the eligible loans secured on development land and property under development. In addition, the largest property-backed exposures of all the banks in the scheme will be transferred.”

Ignoring, for a moment the undefined word “eligible” — which allows an attractive degree of flexibility — what about the two other distinctive features of this proposed scope of purchase:

First, it is not limited to non-performing or impaired or problem loans. Second, it excludes a large swathe of property-related and other loans, including problem loans.

Inclusion of performing loans
I can see that it is an attractive simplification for NAMA’s management to sweep in all of a clearly-defined category of loans, not least because that way you are sure of covering even those loans that have not gone bad yet.

I am less impressed by the argument that including performing loans is good for the taxpayer because they will be serviced. The inclusion of performing loans increases the gross scale of the NAMA operation, and with it the size of the National Debt. It may also, I suppose, complicate the operation inasmuch as both the banks and their non-delinquent borrowers may be very unhappy to be separated.

Exclusion of non-development-property loans
If the goal is to end up with unquestionably clean bank portfolio, should one not also be considering inclusion of other non-performing loans, given the deterioration in the overall economic prospects?

At this stage, I am not sure what to conclude, except that the scope of the purchased assets is an important issue. Clearly, that word “eligible” could come in very handy as the scheme moves towards statutory definition.

Meanwhile, another question worth considering is whether NAMA needs to wait until it has identified all of the loans to be purchased. Here the answer seems clear: best to go ahead with an initial purchase of the most problematic loans as soon as the agency is up and running (assuming, of course, all of the pricing & financial restructuring,  governance and transparency issues also sorted).

Getting the asset purchase scheme right

As we wait for today’s budget announcements, it is worth reflecting on the challenges of getting the right design and pricing for the asset purchase scheme now being trailed.

Some bloggers have made up their minds that the government will overpay for the assets. How can such an outcome be avoided? I have a slightly novel suggestion for this.

As in the United States, there will be a huge gap between what the banks claim the assets are worth and the value that the rest of the market would place on them.

Finding a mechanism that places a generally accepted price on the assets is as difficult here as it is in the US. Any asset purchase scheme will require a further detailed scrutiny and evaluation of the assets to be purchased.

It is to be hoped that the initial announcement of an asset purchase scheme will not lock the government into prematurely firm commitments on pricing and financial restructuring of the banks. The worst possible thing would be to crystallize the taxpayers’ costs at too high a level.

Buying the assets at inflated prices would surely be politically unacceptable. Indeed, Government sources have clearly trailed that they will not pay current book value for the assets.

Each country’s situation is slightly different. If we were to subtract now the present value of all prospective loan losses (taking recent analysts’ estimates), the main Irish banks would be severely undercapitalized. Removing the problem loans at anything close to the prices implied in the analysts’ estimates will require the banks to take immediate write-downs that have the same effect.

Therefore implementation of the asset purchase scheme at realistic asset prices will create the need for a further recapitalization of the banks.

Injection of more preference shares by the Government will not do the trick. If the banks are to move forward in a sound manner, and be accepted as financially self-sufficent, they must have sufficient equity capital. In quieter times there would be enthusiastic private sector buyers for equity in such cleaned-up banks. Failing that, the residual equity investor is likely to be the government. When you do the sums using the analysts’ estimated, this has to imply huge dilution of the existing shareholders. No wonder many commentators have concluded that full, albeit temporary, government ownership is on the cards.

Given this background, it might be better to do something just a little more complicated: let the asset management company pay even less than fair price for the bad loans, and in return give the existing shareholders of the banks an equity stake in the AMC. This has the advantage of making sure that the surviving bank really is clean, and neatly defuses shareholder objections that they are being expropriated. Of course they are even less likely to own much or any of the surviving bank, unless they choose to contribute to its recapitalization. Other existing risk capital providers, such as the holders of unguaranteed subordinated debt, could also be compensated for write-down by acquiring a stake in the AMC.

Let’s hope this week’s statements do not shut off possibilities such as this which can protect the taxpayer without destabilizing market confidence by allowing well-adapted financial contracts to bridge the gap between taxpayer and shareholder.

Although my idea may seem novel, specialists will recognize it as only an adaptation into our current circumstances of the most conventional form of bank resolution mechanism. It can work.

Hindsight on banking crises

While I would not claim to have been able to foresee the global financial meltdown, triggered by the unprecedented crisis of structured finance, a few of the national systemic crises in Europe, including our own, occurred more or less independently and had a more traditional character.

Could early warning packages, designed to alert regulators in developing countries to the possible emergence of a boom-bust systemic banking crisis, been of use in Europe? In particular could they have provided ammunition for those who were warning about property bubble excesses in Ireland? To explore this, I revisited some old work of my own.

In a 1997 paper, published before the East Asia crisis broke and based on a statistical analysis of worldwide banking crises before 1995, I suggested two simple and readily available systemic indicators as warning flags of a possibly unsustainable banking boom. These are: the loan aggregate-to-deposit ratio and the real growth in private credit. Reluctant to claim too much, I cautioned that these flags should only be thought of as crude preliminary indicators that might generate many false positives.

In a 2000 paper, I showed that these two indicators had both indeed been flashing simultaneously during 1994-96 for all five of the countries most affected by the East Asia crisis of 1997-98. Furthermore, on that occasion there were few false positives: the flags were both raised for only five other (non-crisis) countries out of 139 countries for which data was available.

Now, revisiting this simple two-flag approach using 2004-2006 data on thirty European and selected other high income countries, I find a striking confirmation of its apparent usefulness.

Indeed, of these 30 countries the banking systems of only three countries, namely Iceland, Ireland and Latvia, registered above average values for both flags. Of course these are the three countries which have subsequently experienced the most severe bank-related collapses in Europe.

The two indicators are plotted in the Figure — the straight lines are the mean of each variable. Note how only the three countries referred to are in the top right quadrant.

Iceland, whose banking system collapsed in spectacular manner in October 2008, is the clear outlier, followed by Latvia which is also struggling — with IMF assistance — since last December, to emerge from a bank-led collapse.

Ireland was firmly in the danger zone too on this 2004-2006 data. Maybe I should have taken my crude early-warning system more seriously!

The countries included are: Austria, Belgium, Bulgaria, Canada, Chile, Croatia, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Latvia, Lithuania, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Romania, Slovak Republic, Spain, Sweden, Switzerland and the United Kingdom. These represent all of the smaller EEA countries for which full data is available in IFS (Cyprus, Estonia, Malta, Poland and Slovenia missing), plus Canada, Israel and New Zealand.

Another crisis conference — mark your diaries

Since the very timely and successful event organized by Colm McCarthy on January 12, the economic crisis in Ireland have evolved significantly. We’ve had the nationalization of Anglo Irish Bank, the break-down (and relaunch) of the partnership talks, the pension levy, the announcement of next week’s supplementary budget and a steady stream of deteriorating macroeconomic statistics.

No wonder Philip Lane and I feel a follow-up conference coming on.

We’re planning to cover not only the evolving medium term fiscal and growth prospects, but also the impact of the recession on inequality. We’ll also catch up on banking developments since January.

In addition to the organizers, confirmed speakers include John FitzGerald, Brian Nolan and Karl Whelan.

In order to give the budget time to be digested, we’re scheduling the event for the afternoon of Wednesday, May 20th. TCD will host. So mark your diaries now.

As with Colm’s event, it will be under the auspices of the Dublin Economics Workshop, free and open to all, but registration will be required. Send an email to to book your place.

The evanescent taxes still the main source of revenue collapse

Another picture, using the latest Exchequer returns, to illustrate the extent to which the tax collapse is disproportionately concentrated in just three taxes: Corporation Tax, Capital Gains Tax and Stamps. These fell by 56.5% in the first quarter of 2009 relative to the same quarter of 2008. The percentage fall in the remaining taxes was “only” 16.6%. This figure is in nominal terms–no deflation.

For a longer perspective, scaled by GDP, and showing just how systematically reliance switched to these boomtime taxes over the years — and away from the baseload taxes, take a look at the following:

(NB: recall that, because based on Exchequer returns, these do not include PRSI, etc).

Credit card sales

Among the many interesting bits of data in today’s release of the Central Bank’s monthly statistics are the February 2009 data for credit card spending. I haven’t paid too much attention to these before, but they seem like a useful early indicator of retail sales, and they may include cross-border purchases.

Not surprisingly, the February figures are very weak — indeed it seems that January and February 2009 are about the same as the same months in 2006. And these are in nominal euros — not inflation adjusted.

I thought readers might like to see this seven year chart which I have drawn. Of course February is generally the lowest month of the year (though it wasn’t in 2008), but the drop is very striking.

Update: OK, so I’d better deflate this by the CPI as below (Average in 2002=100). I leave it to someone else to seasonally adjust.

Income tax exemption limit

In my post on income tax of a few days ago, the sample structure that I presented went part of the way back to the rates and bands in effect in 1996, a good year.

One feature of the mid-1990s income tax structure was the much lower exemption levels effectively achieved nowadays through tax credits. Should this trend be reversed?

Two comments on my earlier post point to problems in lowering the effective threshold. Colm McCarthy worries about incentive effects given the interaction with social welfare. Aedin Doris finds it difficult to justify taxing a low income single mother with two kids.

I have sympathy with both views, and this is not a make or break issue for revenue (though there is some revenue potential even at the low end).

I also note counterpoints. The more revenue we seek from the system as a whole, the more a high exemption threshold/general tax credit pushes other workers into higher marginal tax rates; bad for incentives. And, depending on their family/household circumstances, not all low income part-timers have low consumption.

Then there is the political/ideological view that as wide a range of citizens should feel involved in the national housekeeping by paying some income tax (though all pay expenditure taxes anyway).

The impact of a lower exemption threshold on low income tax payers could be considerably eased, as has been suggested, by re-introduction of a third low income tax rate.

My guess is that, for a Minister of Finance, lowering the effective threshold (by lowering personal tax credits) offers too big a hostage to fortune to be worth the revenue it would raise.

What do others think?

(Update: the first version of this posting used misleading language about thresholds, I have modified it without changing the intended sense).

Both tax and spending need attention

Now that we all recognize the way in which the tax system has gone wrong and the need for adjustment so that it collects more revenue, it’s time to have a look at the balance between tax and spending adjustments needed to get back to the kind of reasonable budgetary structure that we had in the late 1990s.

To this end, I thought it would be useful to post charts showing total government expenditure and total government taxation as (i) % of GDP; (ii) Real terms.

I’ve used the latest NIE and the data in the October 2008 budget book, together with the ESRI’s latest GDP forecast. So this is all a little out of date.

Both charts reveal both the sudden collapse in taxation.

They also show the way in which real spending had a strong upward momentum which ran ahead of economic growth, especially as soon as this started to slow in 2007. (Some of this is the operation of automatic stabilizers, so important not to overcorrect.)

Pretty clear then that, if we’re to get back to the comfortable zone we were in in the late 1990s, it’s not just a tax adjustment that’s needed,  but also a reining in and rollback of spending.

Bringing the income tax structure back into sustainable shape

In a previous post I pointed out how growing reliance on cyclically-sensitive taxes had left Ireland’s tax revenue exceptionally vulnerable to a downturn. In effect we were running a sizable structural deficit without noticing.

So clearly we now have to ramp up the more reliable and less cyclically sensitive taxes again.

Rates and bases of lots of taxes need to be changed. The most complicated one is income tax. In 1996, before Charlie McCreevy’s first budget, standard and higher rate income taxes were 27 and 48 per cent. Yet we were happy, growing rapidly and in effect “Europe’s Shining Light”. Such an income tax schedule did not destroy the economy.

Now the tax rates are 20 and 41, plus the new income levies of between 1 and 3 per cent. (I’m going to ignore the health levy, the public sector pension levy and PRSI in this). Even more important, the standard rate band has been about doubled in real terms and the exemption limit increased by an even larger margin.

I thought readers might be interested to compare the average income tax rates (including the 1,2,3% levy) paid under the current tax schedule with what would be implied by the 1996 tax schedule adjusted for CPI inflation since 1996. This is shown in the following charts.

Wow, what a sizable reduction there has been. Average income tax rates in 1996 were 6-15 per cent higher than today. And interesting to see that the changes have not been uniform. That means it would be quite politically contentious to go back to 1996.

But we do have to go some way if sufficient tax revenue is to be generated. And it may take a few years to get there.

Here’s a first shot at a tax schedule that, starting from the current situation, gives a roughly proportionate increase in average tax rates from where they are at present. It’s just a first shot and illustrative of the sorts of decision that need to be taken.

The parameters are: 22% basic rate and 48% top rate (to include the 1,2,3% levies); Tax credit lifted from €1.8K to €2.5K; standard rate band reduced from €36.4K to €25K. This is a lower schedule than in 1996, especially for the lower paid, but still a sizable increase from the present. My guess is that this should yield upwards of €2.5 billion in additional income tax revenue–though depending on savings response there would be a negative impact on expenditure tax receipts.

I know this can be improved upon, with only a modicum of additional work.

I presume/hope these kinds of calculations are being worked on in a much more precise way by the Commission on Taxation and/or in the Department of Finance and discussed with key politicians.

Update: There were some flaws in the original version which I have fixed now. Exemption in 2009 is now achieved only through the tax credit and thus is not tightened in the sample schedule (affects the comments by Colm and Aedin below)

Ireland’s borrowing capacity

I didn’t expect to be asking this question again (I thought about it a lot a quarter century ago), but how much Government debt do contributors believe the Irish economy can support? A lot more than it has at present, of course.

But I raise the point now because Morgan seems sure in his latest newspaper article (not as incendiary as the previous one). It’s OK, he says, if the Banks have “bad debt” of only €10-20 billion; not OK if this number goes up to €50-60 billion.

OK, by “bad debt” I presume he means prospective loan losses. And I suppose he also may be ignoring the fact that the banks still have upwards of €20 billion of book equity capital to burn through before the Government starts taking the hit — but let’s ignore such details.

The interesting point is that the difference between his low figure and his high figure is only 22% of forecast GDP for 2009. Can we be so sure that one figure is affordable, and the other not?

Seems to me that the taxation collapse, and the resulting surge in the deficit on normal operations, is at least as big an issue in terms of a sustainable debt path as the prospective banking losses, large though these are.

Why do bank share prices fall when government buys preference shares?

The two main Irish bank shares fell back again today following the announcement of the details of the recapitalization — down 16 and 14 per cent respectively. There could be lots of reasons. To begin with there was the extraneous factor of the back-to-back deposits between Anglo and ILP mentioned in a previous post. ILP fell back 15 per cent as well.

Then there is the possibility that shareholders expected a more lenient deal? But how lenient could that have been? The interest rate on the preference shares is stiff enough, but not out of line with prevailing practice in other countries and anyway was well-flagged.

To all intents and purposes, however, the share prices are close to zero — down over 95 per cent on their peak.

My purpose in writing, though, is to point out that even though the preference shares are senior to equity, an injection sufficient to assure solvency going forward could nevertheless have been expected to lift ordinary share prices.

I suspect this is not a well-known effect. Permit me to present a very simple model.

Thus, suppose that there are just three periods. For convenience, assume our bank begins with zero capital.

In period 1, the government decides the amount S it will inject through purchase of preference shares.

In period 2 we discover the true state of the world, i.e. the size of the loan losses (H high in the bad state, L low in the good state). If the losses exceed the funds the government injected, then the bank is liquidated and the shareholders get nothing; If the losses are equal to or less than injection, then the bank continues in operation.

In period 3 the bank, if still in operation, earns franchise profits Z on the rest of its business. It is then wound up; the government receives its injection back if possible. Any surplus goes to the shareholders.

Clearly, if the values H and L are known and if the government injects any amount equal to or less than L, the market value of the shares at the end of period 1 is zero. (Of course, the analysis assumes rational market expectations.)

If the government injects more than that, the market value of the shares at the end of period 1 is p*max{0, (Z-L)}, where p is the probability of the good state. A longer expression gives the share value if the injection S is higher than H.

The point is that even an injection S that is only sufficient to ensure the bank’s survival in the good state will, when announced, increase the market value of the shares.

The Irish Government injection of yesterday was insufficient to do that.

No wonder it’s hard to interpret monetary statistics

Who would be a monetarist these days? Most monetary policy types are scrambling to re-estimate behavioural relationships.

And then there are the window-dressing operations, which are now revealed to have been exceptionally large in Ireland around the time the Government had to rescue the banks at end-September 2008.

No wonder it is hard to make sense of deposit and monetary movements at that time. In a footnote at my paper in the crisis conference I was reduced to hand-waving: “It is striking that these events have not left a very prominent track on the monetary aggregates. The evidence of a cash crunch at end-September is very muted…though of course we do not have day-by-day figures for the last week in September).”

Now we begin to know why.

Government buys some bank preference shares

Details of the much discussed recapitalization plan for the two main banks have finally been announced as approved by the Government.

In terms of financial restructuring the plan is modest enough. There is only modest dilution of shareholders; the government’s reluctance to take ownership is evident. And there is nothing yet on removing bad assets to be managed separately (though the government statement expresses interest in pursuing this line in light of international developments).

The bank’s books now imply that between them they will now have close to €20 billion in core Tier 1 capital. Out of the money options embedded in the scheme suggest that at least one side of the deal is anticipating a vigorous rebound in the banks’ ability to raise private capital.

Meanwhile Bank of Ireland have taken the opportunity to revise their estimates of prospective loan losses over the next two years by up to €2.2 billion — less than the injection of capital. Of course this is far less than the figures being bandied around by the more strident commentators, so we may look forward to seeing in due course who is right.

But negligible share price reactions so far this morning and over the past few days suggest that the market still assumes that the underlying value of the banks’ equity shareholders claims may not have moved out of the negative range.

An interesting feature is the way in which the Government is sourcing the funds. They could have just issued some new bonds and placed them in the banks’ portfolio, but they have gone for drawing on the NPRF. However, there’s a wrinkle: “€4 billion will come from the Fund’s current resources while €3 billion will be provided by means of a frontloading of the Exchequer contributions for 2009 and 2010.” I’m still trying to figure out what difference this wrinkle makes to the different measures of Government deficit/borrowing in 2009 and 2010.

A European solution to wide Irish spreads

Influential Belgian economist Paul de Grauwe argues in a Vox piece that ECB should be buying Irish and other high-yield eurozone sovereign bonds in the secondary market to correct what he describes as “panic” pricing. I think he’s got a point and it would certainly help stabilize expectations about fiscal prospects here and in those other countries.

It’s certainly no more radical than actions currently being taken by the Fed to stabilize their markets. A promising idea?

Foir Teoranta Nua?

A report in this morning’s Sunday Independent flies the kite for a new State Agency to invest equity in private companies. Inevitably, this will remind some of Foir Teoranta, a state agency which was officieally described as a lender-of-last-resort to private companies in the 1970s and 1980s.

Founded in 1972, Foir Teoranta’s stated objective was “to provide reconstruction finance for potentially viable industrial concerns which are unable to raise capital from the normal commercial sources.”

I’m not aware of a systematic analysis of Foir Teo’s effectiveness in that period. Maybe readers can remember more. But my impression is that, on its dissolution in 1991, it was not widely regarded as having been a brilliant success.

So what would make a new company of this type successful? The Indo’s article confirms that it would be well-managed, so that’s all right. But what else? The intended emphasis is said to be on equity, rather than debt (which was Foir’s main instrument). But is that a strength or a weakness in the current climate? How would it complement the European Investment Bank’s EIF, which seems to be in the same territory?

Would it be better to think in terms of a partial credit guarantee scheme instead? After all, if the banks are to receive huge injections of government capital, should one not be thinking of them as a natural source of finance to keep viable firms going? Partial credit guarantee schemes have been the policy instrument of choice for governments wishing to expand credit to small and medium enterprises, and there is an astonishing number of such schemes around the world. However here too there are severe risks; my recent review of these schemes emphasizes the drawbacks and the need for careful scheme design, if damage is to be avoided.

Irish bond spreads

I was idly looking for patterns in the daily evolution of eurozone government bond spreads (like you do) and thought I would share some findings. The spread of Irish Government bonds over the 10-year German benchmark have of course trended upward during the period since early September 2008 to last week:

If we compute principal components of the spreads of ten euro-currencies we can try to isolate the different factors: separating factors that affect all countries from those that affect Ireland in relative isolation.

Using daily changes in the spreads, the first three principal components explain 80% of the total variation in the ten series.

All ten bonds have roughly equal loadings on the first PC (which alone explains 62%). We can therefore think of PC1 as measuring fluctuations in general aversion to credit risk.

PC2 seems to measure a component which is irrelevant to Ireland — from the loadings this one looks like Club Med vs the North.

But PC3 is an almost Ireland-specific factor, much smaller loadings on the other countries. The big action in PC3 is on just three almost consecutive days in January: the 16th (Anglo nationalization), 19th and 21st.

To me this illustrates just how easily spooked this particular market is. Anglo nationalization was not even demonstrably bad news. When will it settle down to a realistic assessment of Irish risks?


The linear regression equation explaining changes in the Irish spread in terms of three principal components is (t-stats in parentheses):

ΔIreland = 0.020 + 0.015 PC1 + 0.042 PC3 + 0.024 PC4
(17.7) (32.7) (32.0) (15.6)
RSQ=0.958 DW=2.16

The constant term reflects the general upward trend in Ireland’s spread (which is not explainable by this method).

(Of course there are many methodological tricks one could explore, but it’s getting late and this seems enough for the present. Probably some readers do this stuff for a living!)