The first-order policy challenge the new government faces is to restore the creditworthiness of the State and the banks. Without market access, Ireland becomes effectively a permanent ward of the international community, continuously vulnerable to withdrawal of support, and thus in a persistent state of insecurity that undermines recovery.
To say that Ireland is not creditworthy is really just to say that markets put a high probability on an Irish default. At the moment, the cost-benefit analysis does not look favourable to a pre-emptive unilateral default, not least because of the likely backlash by official creditors including the ECB. But the high probability markets are placing on an Irish default means that the markets believe the cost-benefit calculation will shift. This could be because the perceived benefits of a future default are relatively high (say because of the high marginal cost of austerity measures), or that the costs of future default are relatively low (say because the official funders will condone and even facilitate future debt restructurings).
This places us in a bind. If it turns out that we do later have to default, it is best that it comes with as low a cost as possible. But the potential for a low-cost future default makes it impossible to raise longer-term funding now, effectively trapping us outside the markets.
Suppose, however, we could somehow raise the social costs of default (say by offering collateral on any new borrowing). This would be a double-edged sword. It would help us to credibly commit to avoid default and thus lower the market risk premium. But it would leave us facing a worse outcome in the event the benefits of default turn out to be high and the default decision is the sensible course.
But now suppose we introduce a political cost of default – costs that fall specifically on the politicians who make the default decision. This allows for a more credible commitment to avoid default while not imposing unnecessary additional social costs in the case where default actually occurs. For reasons similar to those for appointing an “inflation nut” to head a central bank, it could make sense to appoint a “default nut” as finance minister — someone who sees massive political (or even personal) cost in defaulting. The credibility of the anti-default stance could be enhanced by a promise to resign in the event default occurs – or even better to join a monastery/convent should the terrible event ever come to pass! (For this to work there would also have to be political costs to getting rid of a finance minister that refused to default, or broader political costs to the government as a whole.) One drawback of putting a “default nut” in charge of finance is that default might be or excessively delayed or avoided altogether when it is the right course. However, given how the perception of a soft restructuring down the road can trap a country outside the markets, this risk of an excessive ex post default aversion could well be a price worth paying.
The candidates for minister for finance should be falling over one another to signal to Mr. Kenny and Mr. Gilmore that default is anathema to their very being.