Category: EMU

Divide and conquer

A friend of mine has just sent me this link, in which Sarkozy is saying that it is unreasonable for us to maintain our low corporate tax rates while seeking financial aid from Europe:

“I deeply respect the independence of our Irish friends and we have done everything to help them. But they cannot continue to ask us to come and help them while keeping a tax on company profits that is half (what other countries have),” he said.

For a more inflammatory version of the same argument, by an influential French economist, click here. And I was struck on my last trip to France by how ordinary people there are making the link between the Irish bailout and our ‘dumping fiscal’.

There are lots of obvious counters to all this, but I think the more important point is that such responses are inevitable, given the European response to the crisis to date. As two recent articles point out (here and here), the real cleavage in Europe is between European taxpayers and bank creditors (with the ECB being a third interested party, as another body which could help to fill the holes which have emerged in the European banking system). But since the powers that be are ruling out bondholder haircuts and quantitative easing, the only cleavage we are left with in practice is the one between core and periphery taxpayers.

Of course ordinary French and German taxpayers are going to be angry at lending their money to an insolvent state with lower tax rates than their own. Why wouldn’t they be? Of course ordinary Irish taxpayers are going to be angry at having to pay for high interest loans designed to bail out foreign banks. Why wouldn’t they be?

And while ordinary Europeans get angry with each other, with unpredictable political consequences, capital walks away scot free.

Baltic Meltdown Avoided?

Just arrived in my inbox, a link to this IMF article, containing the following paragraph:

Meltdown avoided

It is too early to pass final judgment on the success of the Baltic strategy. Adjustment is still far from complete, and the current problems in the eurozone may yet complicate recovery. What is clear, however, is that the most dire predictions have not come true. Despite an unprecedented economic downturn―cumulatively, GDP has shrunk by about a quarter―devaluation and banking crises have been avoided.

So they’ve lost quarter of their GDP but a meltdown was avoided? I guess this shows that the definition of a meltdown is in the eye of the beholder.

Buiter et al. on the eurozone debt crisis

The report by Willem Buiter and colleagues on the eurozone debt crisis is available here.

EU Commission Document on Bank Resolution Framework

The European Commission has released a “working document” that “seeks views on the technical details of a possible EU framework for the management of failing credit institutions and an appropriate class of investment firms.” There’s a press release here and an FAQ here.

The document contains a lot of sensible proposals that would lead to a common future European approach to dealing with failing banks, in contrast to the chaotic and disorganised approach that was seen during 2008-2009.

There’s plenty in the document worth discussing but, given the particular focus of this blog, it is clear that the most interesting aspect of the document is the annex starting on page 86 titled “Debt writedown as an additional resolution tool”.  It’s worth reading in whole but here’s the basic idea:

Thus, to provide additional flexibility and to ensure that any write down power is sufficient to deliver the policy objectives, this consultation outlines two possible models for additional write down powers. Building on the minimum powers above, the first ‘comprehensive’ approach aims to make a broad range of senior creditors face the real risk associated with bank failure. The second ‘targeted’ approach aims to create a more focused tool for resolving in particular, institutions which have been assessed as likely to prove difficult to resolve with traditional resolution tools at a time of fast moving idiosyncratic or systemic crisis.

Resolution authorities could be given a statutory power, exercisable when an institution meets the trigger conditions for entry into resolution, to write off all equity, and either write off subordinated debt or convert it into an equity claim. However, in some cases this will not be sufficient to ensure that an institution in difficulty returns to viability so as to maintain market and creditor confidence when the markets next open. (For example, RBS’ balance sheet at the end of 2007 contained £38bn in subordinated liabilities, while losses before tax in 2008 amd 2009 amounted to around £43bn.

As is de rigeur these days the Commission argues that “Such a power would only apply to new debt issued (or existing debt contracts renewed or rolled over) after entry into force of the power.”  In other words, existing European senior bank debt cannot take a haircut in this way.

However, the problem with this argument, as well its sovereign cousin (the idea that only post-2013 sovereign debt will be open to restructuring) is that it is subject to what economists call time inconsistency. As described by Wikipedia, “time inconsistency describes a situation where a decision-maker’s preferences change over time in such a way that what is preferred at one point in time is inconsistent with what is preferred at another point in time.”

Today, Europe has lots of troubled banks and some troubled sovereigns. Ideally, the powers that  be would like financial markets to not worry about being defaulted on and to keep lending to these banks and sovereigns. No agreed EU resolution regime for banks or sovereigns is in place, so the authorities would like to reassure current lenders that they will be safe when such a regime is put in place and that it is future lenders who will take the hit.

However, when the future arrives, it becomes the present and future senior bank bond investors will consider a regime in which only they are subject to a resolution regime involving selective haircuts as totally unacceptable.

The time-inconsistency of the current sovereign debt proposals are clearly recognised by sovereign bond markets, which are pricing current Irish and Greek government bonds at yields that clearly indicate the likelihood of default. For banks that are already in trouble, it seems unlikely that these proposals will really comfort bond investors that they are genuinely safe from getting haircut by a future resolution regime.

It wasn’t just Americans who were skeptical!

Paul Krugman had a post the other day which pointed out that a lot of US-based economists were skepical about the euro project back in the 1990s, and that their meat-and-potatoes-style analysis actually turned out to have had a lot of useful things to say on the subject.

Patriotism is the last refuge of a scoundrel, and over here there are plenty of people who suggest that it was ignorant outsiders who were skeptical about the euro project. Krugman links to this article which is bound to become a standard undergraduate reference, but I find the recent references by Klaus Regling to ‘outside “experts”, who always seem to know what is good for Europe’ to be more telling given their provenance.

So it seems fair to point out that Irish academic economists also expressed skepticism regarding the euro project during the 1990s, most notably Peter Neary and Rodney Thom. I’m sure Rodney won’t mind if I point out that Peter was not just anybody in the context of the Irish profession, but its most prominent member by far, and someone who went on to become President of the European Economics Association. Here is an article by Neary and Thom, and here is another article by Peter writing on his own.

Nor were Peter and Rodney alone in worrying about the consequences of euro membership for Ireland. Here is an entertaining newspaper column by Jim O’Leary. Indeed, to quote Peter writing at the time,

to my knowledge every university economist who has commented on the matter has expressed grave reservations about our joining EMU if sterling does not.

The key word here is obviously ‘university’, since the pro-EMU Baker, Fitzgerald and Honohan report written for the Department of Finance was an ESRI production. But the point remains that the Neary-Thom view was by no means an uncommon one at the time.

Finally: I don’t think anyone has linked yet to Colm’s Stephen’s Day piece on Estonia and EMU, which shows that even economists are capable of enjoying the holiday season. So here it is.