Sharon Donnery (Deputy Governor, Central Bank of Ireland) speech on macroprudential policy

The Department of Economics, Finance & Accounting at Maynooth University welcomes Sharon Donnery, Deputy Governor of the Central Bank of Ireland, who will deliver a talk on “Building resilience in the face of uncertainty – what role for policy?”, followed by a panel discussion, chaired by Bridget McNally (Maynooth University) with panelists Robert Kelly (Central Bank, Head of Macro-Finance Division), Dermot O’Leary (Chief Economist at Goodbody Stockbrokers), and Gregory Connor (Maynooth University), on Thursday 31st May 2018,  at 11am – 12:15 pm, Renehan Hall, Maynooth University. R.S.V.P. For further information tel: 01-7083728 / 7083681

Independent Ireland in Comparative Perspective

I gave the economics lecture at the recent national conference at NUIG commemorating the centenary of the Easter Rising. I had three main messages. First, the economic history of post-independence Ireland was not particularly unusual. Very often, things that were happening in Ireland were happening elsewhere as well. Second, for a long time we were hampered by an excessive dependence on a poorly performing UK economy. And third, EC membership in 1973, and the Single Market programme of the late 1980s and early 1990s, were absolutely crucial for us. Irish independence and EU membership have complemented each other, rather than being in conflict: each was required to give full effect to the other. Irish independence would not have worked as well for us as it did without the EU; and the EU would not have worked as well for us as it did without political independence.

There is a podcast available here. Since only audio is available, here is a link to my slides. I’m working on a paper version of the talk and will post a link to this as soon as possible.

‘Taking back control’? Britain after Brexit

A fortnight after the British referendum on EU membership, Britain is still in turmoil. Some of the negative lessons are all too clear: don’t try to solve party political problems by invoking existential issues; referendums are volatile and uncertain; if you must have one, get a crack team together first. But, as weary politicians are fond of saying, we are where we are.
So what is likely to happen now?
There are different views about what course of action the referendum requires; but there are also very different views about what it might mean to ‘take back control’, which was the core theme of the campaign.

Continue reading “‘Taking back control’? Britain after Brexit”

Cameron’s Referendum Gamble

This is Colm McCarthy’s latest column for the Farmer’s Journal. They’ve very kindly let us repost it here:


The decision last Thursday to detach the United Kingdom from the European Union was taken by referendum, a procedure familiar in this country but a constitutional novelty in the UK. Ireland has a written constitution and one of its provisions is that it can be modified only by popular vote. If the Irish government wished to scrap EU membership it would have to seek deletion, by referendum, of the article inserted on entry in 1972. There are other countries with written constitutions which can be modified without a popular vote, usually by some kind of parliamentary supermajority.

Britain is completely different. There is no written constitution at all and parliament is completely sovereign. The UK joined the European Economic Community without a popular vote, could leave without a popular vote, could abolish the monarchy, invade France, expel Scotland or opt for a decimal calendar. Constitutionally a referendum in the UK is always a war of choice, never a war of necessity. The referendum last week was only the third such national poll in British history and the first to go against the incumbent prime minister.

Britain’s first-ever national plebiscite was called by Harold Wilson, the Labour premier, in 1975, not to approve British entry to the EEC but to confirm the entry decision already taken and implemented by simple majority of the sovereign parliament. Wilson called a referendum to heal a rift on Europe in his party, as did David Cameron this time round. Wilson won a comfortable 2 to 1 majority with all main political leaders, including Margaret Thatcher, campaigning in favour. He was widely criticised for this unprecedented constitutional adventure but it was low-risk – there was little likelihood that the electorate would vote for exit. The cost of the ‘wrong’ result was also low – Britain had been in the EEC only a few years, it was a much more limited organisation than the EU has since become and exit would have been a major nuisance rather than a major crisis.

The second also produced a vote against change. When the Conservatives formed a coalition with the Liberal Democrats in 2010 they promised their partners a referendum on the voting system. It was opposed by both Conservatives and Labour and duly defeated 2 to 1. The ‘wrong’ result would again have been no big deal, a limited move towards proportional representation.  Britain’s first two national referenda thus shared some key features. The Prime Minister who initiated each had good reasons to expect a win, and the stakes were not too high. Defeat would hardly have ended their political careers.

The third referendum shared none of these features. David Cameron’s decision was announced in January 2013 at a time when his party trailed Labour in the polls and faced vote leakage to the Eurosceptic UK Independence Party of Nigel Farage. Both his Liberal Democrat partners and the Labour party favoured continuing in the EU and opposed the holding of a referendum. At the time a YouGov opinion poll showed that 40% would vote to stay in the EU with 34% voting to quit and 26% undecided. Cameron promised to hold the referendum should he win a Conservative majority at the election in 2015 which he duly did. It was never likely to be anything but close.

Moreover the European Union had become far more than a free trade zone, with extensive and detailed common policies covering energy, transport, environment, worker protection and a single market in financial services. The international economy had not recovered from the worst downturn since the Second World War. The consequences of withdrawal from the EU by a key member were unlikely to be minor, never mind predictable or easily managed. Cameron’s decision in January 2013 has been described, accurately, as a roll-of-the-dice, a high-stakes gamble driven by concerns about internal party management. His decision to resign was the correct one: he has landed Britain, Europe and indeed the world economy in an unholy mess at the worst possible time.

He is not the first of Europe’s leaders to place domestic political concerns ahead of economic prudence. The faulty design and subsequent mismanagement of the Eurozone owes much to short-sightedness in Germany. The next domino to drop could be in Italy, for long the least successful of the major Eurozone economies. The government plans a referendum in October on constitutional reforms supported by mainstream opinion. But it may be lost. It provides an opportunity to disgruntled voters to give the establishment another kicking in an over-indebted country with a dodgy banking system and could end the political career of Prime Minister Matteo Renzi. More importantly for Ireland, it could spark a terminal crisis for the common currency. The anger of European leaders with the United Kingdom’s referendum gamble is entirely understandable.

Markets and states are complements

The main point of my 1999 book with Jeff Williamson was that globalisation produces both winners and losers, and that this can lead to an anti-globalisation backlash. We argued this based on late 19th century evidence, but opinion poll evidence (citations here) suggested that something similar was at work in the late 20th century as well, a hunch confirmed in the early 21st century by the 2005 and 2008 French and Irish referenda.

What was missing from all this was an analysis of what, if anything, governments can do about this. Which is where Dani Rodrik’s finding that more open states had bigger governments in the late 20th century comes in. Dani’s interpretation is that markets expose workers to risk, and that government expenditure of various sorts can help protect them from those risks. In a series of articles, and an important book, Michael Huberman showed that this correlation between states and markets was present before 1914 as well: countries with more liberal trade policies tended to have more advanced social protections of various sorts, and this helped maintain political support for openness.

Anti-immigration sentiment was clearly crucial in delivering an anti-EU vote in England. And if you talk to ordinary people, it seems clear that competition for scarce public housing and other public services was one important factor behind this. If the Tories had really wanted to maintain support for the EU, investment in public services and public housing would have been the way to do it: if these had been elastically supplied, that would have muted the impression that there was a zero-sum competition between natives and immigrants. It wouldn’t have satisfied the xenophobes, but not all anti-immigrant voters are xenophobes. But of course the Tories were never going to do that, at least not with Osborne at the helm.

If the English want continued Single Market access, they will have to swallow continued labor mobility. There are complementary domestic policies that could help in making that politically feasible. We will have to wait and see what the English decide. But there are also lessons for the 27 remaining EU states. Too much market and too little state invites a backlash. Take the politics into account, and it becomes clear (as Dani has often argued) that markets and states are complements, not substitutes.


Britain and the EU

Though Ireland and the UK joined at the same time, the UK always remained semi-detached from the EU. Brussels affairs received barely a mention in the Blair-era diaries of British government ministers and advisors. That this was not even noticed by British reviewers is telling. London regarded itself as more significant on the world stage than Brussels. And, strange as this might sound to Irish ears, until German reunification it had perhaps good reason to do so.

The “supra-national” nature of the EU was designed by France to limit German post-war independence. As Ernest Bevin, Britain’s post-war Labour Foreign Secretary, commented: “when you open that Pandora’s box you’ll find it full of Trojan horses”. Britain felt neither the need nor the desire to have its independence limited in this way. For centuries it had stood secure in its island fortress, holding the balance of power between competing continental states. In the immediate post-war period it looked as much to the US and the Commonwealth as to Europe. The US was of much greater military importance. And as the world’s first industrial nation Britain had long pursued a ‘cheap food’ policy: the agricultural protectionism of the Common Market held little appeal.

Britain’s interest in Europe is as a free trade area. It viewed the creation of the single currency as a federalist step “far too far”, a position with which very many economists agreed.

Post-referendum Britain is not the only polity in existential crisis. The EU itself is clearly in the same position. The eurozone crisis side-lined the European Commission as member states looked to their own interests first. As a leading academic wrote recently, “supranational agents’ ability to take autonomous decisions can only be sustained in matters where the extent of disagreement among national governments over policy outcomes is relatively low”. The European elite thinks that the only way forward is through further integration: “more Europe”. But there is almost zero support across the European electorate for this.

The reaction to the referendum outcome has thrown a sharp light on clashing cultures. British political culture has always been suspicious of grandiose schemes and popular culture has always been irritated by layers upon layers of bureaucracy. (Ireland bears some responsibility for the latter, in that “a Commissioner from every member state” was given to us as a concession after one of our ‘no’ votes. Every commissioner views as their legacy the amount of legislation that they leave behind on the statute books.) The other side of the culture clash is reflected in the furious reaction of the European elite to the British vote, and the apparent desire to get the British out the door as quickly as possible. Twice the Irish voted no, and twice we were asked to vote again. Why did Europe react so differently to us, when there was so much less at stake?

The British vote is also clearly an inchoate reaction to globalisation, or perhaps more accurately to its “collateral damage”. In this it seems as one with the political support for the Trump campaign in the US.

Surely European leaders would be better advised to take a long hard look at how such widespread concerns might be addressed rather than rush to accept a British withdrawal? The latter may well lead to the break-up not just of the UK but to the withdrawal of other EU member states over time. It will entail years of negotiation on future relationships – at the bare minimum between the UK and Europe, and between the UK and Ireland. More worrying perhaps – given the class, age and geographic fault lines reflected in the referendum vote – is the legacy of bitterness and, quite possibly, civil strife that it will bequeath to Britain.

There is no need to rush Britain to withdraw, other than as a threat to other potential waverers. But this is hardly what the European project was supposed to be about. A year or two of uncertainty, particularly given the fragility of the global economy, is clearly undesirable. But the next general election in Britain is likely to offer the electorate an opportunity to visit the issue anew. Europe can use the hiatus to consider how the concerns of so many of its electorates can be addressed. A substantial electorate has spoken. Is Europe prepared to listen?

Ireland’s Negotiation Game Strategy for Brexit

Ireland needs to play its hand deftly and aggressively during the EU-wide Brexit negotiations. Irish interests in the Brexit process, post-vote, differ from those of other EU states. For EU enthusiasts in states with limited UK trade, a tempting strategy for preventing a NEXT-IT (Netherlands, Austria, Denmark, etc.) is to punish the UK via a spiteful exit deal. That would be a disaster for Ireland due to spillovers. Ireland needs to fight hard to let the UK be allowed a smooth and minimally-disruptive exit, not face a mini trade war. Ireland would be hit very badly in the crossfire.

Some thoughts on Brexit

Although I was a member of the Centre for European Reform’s Commission on the UK and the Single Market, I declined to sign a resultant letter to the newspapers on what the UK ought to do, as well as similar subsequent efforts. There were two reasons for this. First, I’m not British, and I know how irritating it is to have foreigners tell you what to do at times like this. Second, it wasn’t at all clear to me that economists’ letters were particularly helpful. On that score at least, I think I was right.  But Thursday’s vote is going to have implications for all of us, and especially for Ireland, so we all need to start thinking about what happens next.

Oxford vote 70% to 30% in favour of remaining in the EU, and I have lots of colleague who are absolutely devastated this weekend. It’s hard for people outside Britain to understand just how sad so many people are at what has happened. This isn’t just about economics, or even mainly about economics: it’s about identity, and a great many English people feel, profoundly and sincerely, that they are both European and British. Both identities are under threat today.

Of course, a healthy majority of English people are happy with the outcome, including some friends of mine, and I’m pleased for them. And presumably we all wish England well. But it’s also true that the English voted without paying the slightest heed to what was in the interests of Ireland, including that part of the island which remains part of the United Kingdom.  It was ever thus, for perfectly understandable reasons having to do with the relative sizes of the two countries, which is why Irish independence was always both inevitable and desirable. But that is another matter.

One of the truly extraordinary features of the British political landscape today is that neither the Leave campaign, nor apparently the British government, knows what it wants to happen next. But it is perfectly obvious what we in Ireland should want to happen next. England and Wales have voted to leave the European Union, and hence the Single Market. The reality therefore is that, as things stand, the UK is headed out of the Single Market that it was always such a keen supporter of. And that would be bad for Ireland in a whole host of ways that are by now well understood.

Of course, the British may decide to reapply for Single Market membership, as part of the process of negotiation which now has to take place on the terms of their exit from the European Union. They are perfectly entitled to do so.  If they do reapply, they should be granted membership of the European Economic Area on the usual terms: Ireland, and Britain’s many other friends in the European Union, should insist on this, and indeed it would be in everyone’s best interests. But only the British can decide if this is what they want. Given that labour mobility will be part of the deal, I would have thought that such a decision would require another referendum on both moral and political grounds. I don’t view that as an insuperable obstacle, since I don’t see why such a referendum could not be won — especially since this may well be the key to avoiding a hard border with Scotland. And if the English don’t want to join the EEA, we need to know that too.

The rest of Europe should resist the temptation of a “fuite en avant”, attempting to move full speed ahead towards a fiscal and political union that nobody wants. (Yes, that has implications for the survival of the euro, at least in the long run. So what? The single currency was always a terrible idea.) Far better to accept the reality of a multispeed Europe, which better reflects the diverse opinions of its many citizens.  If the United Kingdom, or England and Wales, were to become firmly embedded in the European Economic Area, while remaining outside the European Union, not only would economic disruption be kept to a minimum, and Ireland’s best interests be protected; this would be an important move towards a looser and more shock-resistant economic architecture for Europe as a whole. And there would actually be a certain upside to that.  Too much rigidity, and the entire European project risks implosion. This is not so much a case of “reculer pour mieux avancer”. It is a case of “reculer pour survivre.”


“No recovery here”

One of the really interesting outcomes of the last election was the rejection by voters of the Fine Gael strap line: let’s keep the recovery going. As measured by GDP growth, Ireland was rebounding from its period of austerity very strongly, with the fastest GDP growth in Europe.

A household sector which had just received an income tax cut, child benefit increases, pension increases, social welfare increases, public sector pay increases (or restorations, whatever), threw the main party’s ‘recovery’ line back in its face at the doorsteps–what recovery, they asked. No recovery here.

This was taken to mean that there was no recovery outside of Dublin. Dan O’Brien’s series of columns have dispelled that myth. There is a recovery in rural Ireland, it’s just not happening as quickly as in the capital, where employment levels are now 96% of their 2008 peak. In the Mid-West employment levels are at 88% of their peak.


Then a long and rambling discussion on the corporate tax element of Ireland’s apparent rebound took place, largely on twitter. The volatility of the corporate tax take in Ireland is exceptional.

Yet another strand of the argument is given by thinking about Ireland in relation to Europe. Philip Connolly of the times in Ireland showed me these data of GDP per capita in purchasing power parity adjusted euros compare it with an actual income for consumption measure. The graph below is from Eurostat and shows the difference in the two measures  with Ireland and Luxemburg showing a very large difference between these two measures of household welfare. Using the AIC measure, Irish households are closer to Italian than Danish levels of welfare.

Source: Eurostat
Source: Eurostat

This may give a clue as to why we see such large differences between official rhetoric and the popular reaction to that rhetoric.




Slow train wreck

Why is anyone shocked at the political news from France this morning? Everyone is saying that the FN got a boost from the November 13 atrocities, and perhaps they did, but there are far longer run forces at play here.

One is the corruption and sleaze that characterises Parisian politics. But there are also economic factors that are having a predictable impact on attitudes (and if they are predictable, then economists don’t have the right to ignore them). Globalisation creates losers as well as winners, for example, and if no-one really cares about the losers, and we just pay lip service to the problem, then it is predictable that there will be a backlash. The Euro has not only locked in a set of distorted real exchange rates, but a macroeconomic policy mix with a pronounced deflationary bias. If times remain tough enough for long enough, and politicians hear your pain but don’t actually do anything about it, some people will eventually respond by voting for candidates who reject existing constraints on policy making. “Europe” is increasingly experienced as a set of constraints preventing governments from doing what their people want them to do, rather than as a means of empowering governments to collectively solve problems.

So why would anyone be surprised that Mme Le Pen has done so well; and is it not likely at this stage (though 2017 is a long way away) that absent major policy shifts she will come first in the first round of the Presidential election? And let there be no mistake: if she actually won the second round, either then or in 2022, this would mean the end of the EU as we currently know it.

What is so frustrating about all this is that it has been so predictable. Here are some links dating back to 2010, a year that risks being viewed by future historians as a fateful one:

Adam Posen

And me, with apologies for the self-indulgence, writing for Eurointelligence.

I am pretty sure Martin Wolf was saying similar things back then, and that many others were too.

The good news is that, as recent Irish experience shows, the populist vote stops rising when the economy recovers. (The decline in the independent vote share is quite striking, and SF have clearly stopped rising. And no, I’m not saying that anyone is like the French National Front, but support for these parties is the closest Irish equivalent to the French anti-establishment protest vote that is benefiting the FN so much.) And 2017, and even more so 2022, are a long way away. But Eurozone monetary and fiscal policy, and social policy too I would think, need to start taking into account the fact that the entire European project, the good bits as well as the harmful bits, is now facing an existential threat.

Update: Paul Krugman weighs in here.

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.


Garret FitzGerald Lecture and Autumn School

UCD College of Social Sciences and Law will host the Garret FitzGerald Lecture and Autumn School on Monday 19th October, in the UCD Sutherland School of Law. The daytime School (from midday) will focus on the significance of the social sciences. The evening Lecture will be delivered by Professor Cass R Sunstein,Harvard Law School, on the theme ‘Is Behavioural Science Compatible with Democracy?’. More details and bookings here.

New York Times: A Migration Juggernaut is Headed for Europe

Eduardo Porter, one of the most highly respected economic analysts in the US media, has an interesting, thoughtful new article on European immigration pressures. He argues that European economies and societies need to prepare for large-scale immigration from Africa, the Middle East, and South Asia. These regions are close to Europe, are notably poor by world standards, and have a forecast population increase of three billion in coming decades, on top of the large increases which have already occurred in the recent past. Porter argues that attempts to stop completely this migration pressure will not succeed, and instead Europe should try to adjust to an inevitable large inflow.

Guest post by Marios Zachariadis: On the Greek Crisis and German Imbalances

Policies undertaken from a narrow national perspective that encourage systematic fiscal surpluses coupled with a national consensus on wage suppression between unions and industry facilitated by the state, impact negatively upon domestic spending while increasing national saving and may lead to mercantilist outcomes of systematic policy-induced positive trade balances with large financial flows going the other way. This mechanism in relation to export-dependent countries like Germany has been recognized for a while by leading American economists like Obstfeld (the IMF’s new chief economist succeeding Blanchard) or Bernanke, while many have also pointed out low domestic investment, consumption taxes, and rigidities in the service sector as additional policy-related reasons for this German systematic phenomenon. Continue reading “Guest post by Marios Zachariadis: On the Greek Crisis and German Imbalances”

McCarthy and Mody on what the Greek fiasco tells us about the ECB and IMF

Here, and here.

Three questions arise. Why would any non-European country be willing to accept another European IMF head? Would it not be better for the Europeans themselves if a non-European IMF head provided us with an “adult in the room” at times of crisis? And why would any European be happy living in a monetary union in which a politicized central bank cannot be relied upon to act as a lender of last resort, and in which their guns could be turned on any (sufficiently small) member state in a time of crisis?

Canada Day

Yesterday, the First of July, was Canada Day.

Discussing  the crisis in the Eurozone with some visiting Canadian relatives led to the question How stable is the Canadian currency union?

At first sight it seems to be much more stable than its European counterpart. The Canadian banking system is renowned for its solidness. It is dominated by five national banks that operate coast to coast, supervised by the much-admired Bank of Canada.  There is a large national budget that includes important elements of inter-provincial fiscal equalization. Internal labour mobility is relatively high.

But on the other hand the provincial governments are not constrained in their borrowing, there are enormous differences between the economic structures of the provinces, and there is always the Quebec question.

In fact, to a surprising extent, the stability of the Canadian union appears to depend on the fact that, as the author of this article puts it,”there are no Greeces here”.  He draws attention to flaws in the design of the Canadian currency union that could come home to roost some day.

Sinking, fast and slow

For well over a year now some of us have been pointing out that the Eurozone crisis was entering a very dangerous phase, in which slowly increasing unemployment would eat away at the foundations of Europe’s societies, while short-sighted politicians and excitable journalists proclaimed that the Euro was saved. The invaluable Eurointelligence has been doing a great job recently tracking the apparently inexorable deterioration in the economic fundamentals of the Eurozone, with Germany itself now apparently affected. But for both political and personal reasons I find myself worrying most about France.

Twiddling their thumbs and hoping that something (the economy) will turn up, flawed macroeconomic policy notwithstanding, seems to have been the French government’s master plan up till now. As a result it is hard to see Francois “Say” Hollande, or any other Socialist for that matter, getting through to the second round in 2017.

You may think that Paul Krugman is being too alarmist when he raises the possibility of President Le Pen, and I hope you are right. But Sarokozy’s apparent return to the political fray does worry me. Of course, you may think that if he wins the UMP nomination, the Left will rally round and vote for him when it comes to the second round.

How confident are you about that?

Symposium at NUI Maynooth: “Can Social Investment Save Social Europe?”

On Thurs., 29th of May, a special seminar on Social Investment in Europe will be hosted by the Department of Sociology/ NIRSA, Political Economy and Work Cluster and the New Deals in the New Economy project. The seminar will run from 9.30 to 1.30 and will be followed by the launch of a new MA in Sociology (Work, Labour Markets and Employment) by Minister Joan Burton.

‘Social Investment’ focuses on investing in people’s skills and capacities and supporting them to participate fully in employment and social life (EU Commission). Does ‘social investment’ lead to a renewal or an erosion of the welfare state? Will ‘social investment’ support economic and social recovery?

The event will start at 9.30 with registration and coffee followed by the seminar at 10.00 in the Phoenix building on the North Campus in NUIM keynoted by Prof Anton Hemerijck, VU University Amsterdam and Prof Brian Nolan, UCD, and chaired by Prof. Seán Ó Riain.

Following a break for coffee there will be a roundtable discussion with: Rossella Ciccia (NUIM), Tom Healy (NERI) and Rory O’Donnell (NESC), chaired by Mary Murphy (NUIM).

See more at:

Please register for seminar by emailing before May 26th, 2014

Problematic Calibration of the EU Banking Sector Stress Test for Ireland

The details for the calibration of the EU-wide bank stress test are now available. Looking only at Ireland, and only at one of the key variables in the stress test, the calibration looks problematic. It may be coincidental that the Irish adverse scenario has been badly chosen; it might be that all the other member countries have reasonable calibrations.  If the others are as problematic as in the Irish case, this is not a reliable EU banking sector stress test.

Under the adverse scenario, Irish property prices are assumed to suffer a cumulative three-year drop of 3.03%; equivalent to a decline of 1.02% each year for three years in a row. Over the period covered by CSO data, 2005-2013, Irish residential property prices had an annual sample volatility of 11.7%. This in turn implies (under reasonable assumptions) a three-year volatility of 20.27%. In risk analysis it is conventional analytical shorthand to measure adverse outcomes in “x-sigma” units defined as the outcome as a multiple of the standard deviation. For an adverse scenario calibration, the assumed outcome is usually roughly a two-sigma or three-sigma event. Using a four-sigma shock would not be unusual (due to fat tails in some probability distributions). The EBA has calibrated the adverse price shock as a 0.1492-sigma event. That is not credible as an adverse scenario in a stress test.

Keep in mind that the stress test is meant to reassure market participants that even in an adverse scenario the Irish banks are sound. This test reassures us that if property prices fall by as much as one percent a year over the next three years, the banks have enough capital. In the case of a two-percent fall, there are no promises.

As a caveat, this does not mean that the Irish banks need equity capital. They have already had a credible stress test (in 2011) and a big capital injection. Also, the Irish property market although very volatile has a maximum likelihood price change which is positive over the next three years. However the asset class also has considerable “downside” potential and continued high volatility. Conventionally, at least in the case of portfolio risk analysis, the unconditional mean of a stressed variable is set equal to zero for risk analysis purposes. The EBA has chosen to build in a big positive benchmark price rise for Irish property assets, and this is part of the reason that the adverse scenario is unacceptably mild. In any case, this calibration is extremely mild as an adverse scenario and not reassuring for the EU-wide test.

EC Autumn Forecast 2013

All the documents can be accessed from here.

The main figures for Ireland (“rebalancing on track”) are:

Among Euroarea countries six are expected to face a BoP current account deficit in 2014: Estonia, Greece, France, Cyprus, Latvia and Finland.  The largest deficit is expected to be in Estonia at 2.2% of GDP.  On the other side Germany, Luxembourg, the Netherlands and Slovenia will have a current account surplus of more than 6% of GDP.  The first three will have three-year averages greater than the 6% of GDP threshold set out in the Macroeconomic Imbalance Procedure.  In aggregate the euroarea is projected to have a current acount surplus of around 3% of GDP for the next two years.

The Spanish public deficit is forecast to increase to 6.5% of GDP in 2015 with France, Cyprus, Malta, Slovenia and Slovakia also projected to have deficits in 2015 over the 3% of GDP threshold for the Excessive Deficit Procedure.  In aggregate the Euroarea is expected to run a public deficit of around 2.5% of GDP for the next two years with public debt steady at around 95% of GDP.

Economic policy: voters versus men in white coats

Eurointelligence’s news briefing this morning (the professional edition) had a really excellent comment regarding the news that Jeroen Dijsselbloem is proposing that the stability pact be reformed, so as to link flexibility on deficit correction to “economic reform”. The question is, of course, what constitutes “economic reform.” Says Eurointelligence:

We recall that the expression „economic reforms“ had the exact opposite meaning in the 1970s – a reduction in market liberalism, more regulation, more workers rights. Economic reforms is always a political process. Is Dijsselbloem saying that decision on labour market organisations, for example, should be done at central level, and if not, who decides what reforms are desirable, and what constitutes reform? Say, the Commission enters into a “contract” with a country on certain types of reforms, what would stop a newly elected parliament in that country from breaking such a contract? In German constitutional law, for example, the parliament’s sovereignty would always rank above such contracts. One of the lessons of the eurozone’s short history is that one should not put currently fashionable ideological positions into a treaty or a law.

It is one thing to say that monetary policy should be the preserve of technocrats. You can also make a case that the same should be true of governments’ overall fiscal stances (although as soon as you get into questions of taxation and expenditure, you are beginning to trespass on matters that should properly be dealt with by democratically elected parliaments; and there are also the questions of whether the beurocrats in charge know what they are doing, and whom they are listening to). But the balance between expenditure cuts and tax increases in a deficit reduction programme? The composition of taxes or expenditures in normal times? Microeconomic regulations influencing the balance of power between employers and workers? These are political matters, on which the right and the left have legitimate disagreements (and, besides, economists know a lot less about a lot of this stuff than they sometimes pretend). Sorting out these disagreements is a core function of any modern democracy.

If, as a technical matter, the Eurozone requires at least some degree of fiscal union, and if, as a political matter, a big obstacle to this is citizens’ distrust of “Europe”, then measures which can be seen as attempted power-grabs by the centre at the expense of voters would seem to be directly counter-productive. Not everything in the economic life of a nation is a purely technical matter; we should be trying to convince voters that the Euro, and the EU itself, are compatible with the principle that our votes count for something, and that we can change policies that we don’t like, no matter how “technically desirable” they are thought to be in 2013 by the OECD or IMF or EC or whoever it is. Make the electorate feel disenfranchised, and you play into the hands of the populists.