Tuesday’s FT has a long piece on the Spanish banking system: you can read it here. An interesting difference relative to Ireland is that the Bank of Spain insisted on banks building up reserves against general future risks. However, these provisions are not formally counted as part of its capital base and the general push towards higher measured capital ratios means that the Spanish banks are also looking to raise capital. This may reduce the chances of these banks getting involved in acquisitions in Ireland, at least in the near term.
Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.
So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.
The latest round of international negotiations under the United Nations Framework Convention on Climate Change in Poznan reached its conclusion last week. The parties to this convention meet twice a year. The latest talks were a preparation for the Copenhagen negotiations scheduled for late 2009. Nothing much happened in Poznan. These were talks about talks. Should one pity the civil servant who attends these boring meetings, or envy her for all the foreign travel at the taxpayers’ expense?
By the way, the Irish taxpayer need not worry about such expense: The Irish delegation to the climate negotiations travels on account of official development aid. Poor foreigners foot the bill.
The irrelevance of Poznan is best illustrated with the fact that the European Council met during the “crucial” end-phase of the Poznan conference — and made decisions about European climate policy. The decisions are bizarre from an economic viewpoint.
The main target of European climate policy was unchanged. We will reduce greenhouse gas emissions in 2020 to 20% below their 2005 levels. A number of countries expressed concern about the costs of meeting such a strict target. These worries were placated by grandparenting more emission permits, and auctioning fewer. This is exactly wrong. Cap-and-trade with grandparented emission permits is roughly equivalent to a carbon tax with lump-sum recycling. Cap-and-trade with auctioned permits allows for a smarter recycling of revenue. In fact, almost any recycling scheme is smarter than lump-sum. In this particular case, the revenue is essentially a capital subsidy to energy-intensive industries (but long after credit will be uncrunched), although it can also be interpreted as a windfall profit. The agreed compromise is not bad for the environment as some environmentalists have claimed because emission targets are the same. The agreed compromise is not good for the economy either, contrary to the claims of the politicians involved. It is bad for the economy, but good for shareholders in energy-intensive industries.
The government has announced the launch of its recapitalisation process. The official statement is here.
It is up to each bank to decide its recap strategy. It will be interesting to observe the extent to which the major shareholders of each bank become actively involved, relative to leaving it to the management teams to develop these strategies.
Another instalment of miserable analysis to help maintain the festive spirit! This time, on cross-border shopping, patriotism and the real exchange rate.
Also, a paper by Olivier Blanchard on Portugal that got me thinking along these lines:
It all suggests that, as far as public sector pay is concerned, the commentariat is focused on quite the wrong question. It’s not whether there should be a public sector pay freeze, it’s how big the pay cut should be.
Responding to Labour leader Eamon Gilmore’s suggestion of a fiscal stimulus at his party’s recent conference in Kilkenny, Jim O’Leary argued in yesterday’s Irish Times that the option is unattractive. I would like to expand on some of Jim’s points and offer a few more.
The first is that the Government’s fiscal targets for 2008-2011 will in all likelihood be over-shot significantly in 2008 and 2009, and will be hard to hit in the terminal year of 2011. The targets are (as per the Budget Stability Update), GGB deficits for the years 2008 to 2011 at 5.5%, 6.5%, 4.7% and 2.9%. The gross debt grows from 36% through 43.4%, 47.5% to 47.8%, while net debt starts at 25% and grows through 31% to stabilise at 34% for both 2010 and 2011.
To begin with, the out-turn for 2008 will be a GGB deficit of maybe 6.5%: the NPRF vauation was 10% of GDP at end-June, but can only be 9% at best now; and GDP for 2008 will probably come in under the figure assumed in this table. At end 2008, gross and net debt ratios will likely be 2 to 3 points higher for these reasons. But borrowing in 2009 could be in the 8 to 9% zone, rather than the 6.5% target, and the assumed growth in NPRF value in 2009 may not happen. There could be bank bail-out costs not included in the budgetary arithmetic. At end 2009, gross debt will likely breach 50% (of nominal GDP below the 2008 outcome), and the net debt ratio could approach 40%. These would be the numbers before the fiscal consolidation begins!
There is a casual assumption being made by some commentators, and possibly some Governments, that the sovereign debt markets will pony up whatever is required, at least for developed countries and certainly for Eurozone members. But Germany struggled with a bond issue during the week, secondary markets are illiquid, spreads have widened and the weakest Eurozone member (Greece) trades 1.65% above bunds at ten years. The second-weakest is Ireland at 1.35%, and some Eurozone countries with worse debt ratios are trading on narrower spreads than us.
Martin Wolf argued in the FT during the week that a weaker Eurozone member could, in principle, default. There cannot be a currency crisis, but there can be a credit crisis instead. Greece is the current bookie’s favourite, but Wolf described Ireland as ‘…a dramatic case’, noting the speed of the fiscal deterioration and the over-leveraged private sector. The system as a whole needs to de-leverage, and there is no point offsetting a necessary balance-sheet improvement in the private sector with a public borrowing explosion. Indeed, de-leveraging the public sector through liquidation of the NPRF at some stage, and crystalising the painful losses, will need to be addressed. If you can’t easily sell debt, you may have to sell equities, as many hedge fund managers have discovered.
Any attempt by Government to stimulate will run up against Ricardian Equivalence anyway, even more so in the UK version, where the tax reductions are accompanied by specific commitments to increase taxes later. If the private sector is determined to improve its balance sheet through cutting consumption and investment spending, fiscal easing will either fail, in which case it is pointless, or ‘succeed’ at the cost of frustrating the unavoidable private sector adjustment.
Finally, Mr. Gilmore proposed specific capital spending initiatives, such as school building. These may be better projects than some other components of the capital programme, but it is notoriously difficult to fine-tune with capital spending.
Sheltering under the Irish Government’s guarantee, the Irish banks have survived massive falls in their share prices.
In each case the current market price is less than 10 per cent of its peak — 2 per cent in the case of Anglo Irish Bank. Value to book ratio (using the last annual accounts) varies between one fifth and one sixteenth.
Time to recapitalize, then, I would guess. When the regulator finally decides to require them to increase their capital (not least to reflect the large foreseen losses of the “incurred but not reported” type), the Government will have to be ready to participate. But how?
For some ideas and a cautionary comment by an academic scribbler, see today’s Irish Times: http://www.irishtimes.com/newspaper/opinion/2008/1211/1228864660643.html
The European Commission have just released a new working paper by Lars Jonung, Jaakko Kiander and Pentti Vartia that examines the boom-bust-recovery cycle in Finland and Sweden.
The paper is available here: The great financial crisis in Finland and Sweden – The dynamics of boom, bust and recovery, 1985-2000
The CSO last week released its index of employment in the construction sector. This index has 2000 as its base year, with 100 the average value of the index in 2000. The index peaked in September 2006 at 113.8 and the October 2008 value is 83.6: this represents an 18.1 percent decline since October 2007 and a 26.5 percent decline from its peak.
Ireland is not the only country undergoing a sharp contraction in housing and it is interesting to learn about the policy debate in other countries (especially fellow members of the euro area). This new article on VoxEU gives a good overview of the current debate in Spain:
This website got a plug today in Alan Ahearne’s “Short View” column in the Sunday Independent. The article asked whether the Government should heed calls for a fiscal stimulus plan for this country. Ahearne concludes that the answer is an unambiguous no.
Cuts in VAT rates, along the lines introduced in the UK, would do little to bolster economic activity in this country. Part of the tax cut may not be passed on to consumers. Moreover, a substantial chunk of Irish households’ spending is on imported goods. Increased spending on imports provides only limited support to our economy. The bang for the buck from a VAT cut is small in an open economy like ours because much of the impulse leaks out through higher imports.
A stimulus proposal might be effective at boosting transactions if it were huge. But the country can’t afford such a plan. Claims that a VAT cut could be self-financing are baseless. The Dept. of Finance estimate that the 0.5 percentage point hike in the standard VAT rate in Budget 2009 will raise €220 million. A crude extrapolation would suggest that slashing VAT to the UK rate of 15 per cent would add another €3 billion to the State’s already enormous borrowing requirement. As argued previously on this website under the post “On Deficits and Debts” (3 December), there’s a limit as to how much the Government can comfortably borrow on international markets.
A cut in VAT would also likely do little to stem the flow of shoppers across the border with Northern Ireland. Price differentials between the Republic and the North largely reflect the weakness of sterling and differences in business costs. A fiscal stimulus won’t solve these problems. A focus on improved competitiveness and realistic wage-setting would be much more valuable. Meanwhile, budgetary policy should aim at avoiding national bankruptcy.
Nice article in the Irish Times today by Jim O’Leary. I particularly liked the following unusually honest section:
The case for borrowing more to fund an attempted stimulus package would be more difficult to rebut if there was a high probability of it being successful, but fiscal stimulus is notoriously difficult to effect in a very open economy like Ireland. The reason is that a high proportion of any increase in demand leaks out through imports.
From our point of view, the best sort of stimulus package are those put in place by our trading partners since these boost demand for our exports without costing us anything. And here, the good news is that most of our main trading partners have announced reflationary fiscal measures of one sort or another in recent weeks/months. What we need to do is ensure that we are well-positioned to avail of the opportunities that will flow from these and what that means, first and foremost, is reducing our production costs to competitive levels.
It is hard to disagree with the logic. If the amazingly profligate government we have had over the past decade had listened to people like JOL on issues like benchmarking, then we might have tried to pull our weight as part of a Europe-wide reflationary package, but as things stand, we are going to have try to free ride. Not very glorious (and rebalancing the books will obviously make a bad recession worse) but there you are.
But let’s hope that too many others don’t also take a similar view! The thing about free riding is that what is individually rational can be collectively disastrous. Dani Rodrik is gloomy here.
The Central Statistics Office, Financial Accounts Division, National Accounts has released “Institutional Sector Accounts: Financial 2001 – 2007 (Revised)”.
An e-copy of the release is available on the CSO Website.
An Excel version of the tables from the release is also available on the CSO Website.
In case you can’t wait for blogger PH’s rivetting radio lecture: “The Financial Crisis: Ireland and The World” (recorded yesterday before a live audience but not being transmitted until St Stephens Day), you can get the text here.
It’s mostly an interpretation of the causes of — and policy reaction to — the global crisis, and corrects several common fallacies or half-truths.
The Ireland-relevant take-away: Our banking problems were caused by globalization…but not in the way you may think.
It was the fall in interest rates on euro adoption that triggered much of the bubble; easy access to international funding that fuelled it.
(Irish banks’ net foreign borrowing 2003-7 amounted to 50 per cent of GDP; Icelandic banks didn’t do any net foreign borrowing!).
Colm McCarthy provides an interesting analysis in the Irish Times today (December 3rd 2008) about the poor November tax returns. A key issue raised by Colm is the market’s appetite for sovereign bonds, in view of the projected rapid increase in issuance across the advanced economies. Since there is a general increase in risk aversion, it will be important to ensure that Ireland is perceived as a low-risk sovereign. To this end, it is important for the government to establish a new multi-year fiscal programme that shows how the growth in public debt will be managed, with a clear plan to return the debt to a sustainable path once economic recovery takes hold.
The general budget balance for Ireland has sharply declined, with a surplus in 2007 being transformed into a deficit of at least 5.5 percent of GDP in 2008 and a target deficit of 6.5 percent of GDP in 2009.
The appropriate fiscal balance for Ireland was the subject of a panel discussion at the ESRI Budget Perspectives 2009 Seminar in October 2008. Papers and/or presentations by Ray Barrell, Joe Durkan, Patrick Honohan and Philip Lane are available here.
There is also a relevant paper by Philip Lane from the ESRI Budget Perspectives 2008 Seminar, held in October 2007: ”Fiscal Policy for a Slowing Economy” .
More generally, the appropriate fiscal policy for a small open economy that is a member of EMU is the subject of an IRCHSS-funded research project that is led by Philip Lane. You can learn more about this project here.
The Wall Street Journal (December 1st 2008) has an interesting article on how Latvia is dealing with pessimistic economic commentators. Click here for the article.
How to Combat a Banking Crisis: First, Round Up the Pessimists
Latvian Agents Detain a Gloomy Economist; ‘It Is a Form of Deterrence’
RIGA, Latvia — Hammered by economic woe, this former Soviet republic recently took a novel step to contain the crisis. Its counterespionage agency busted an economist for being too downbeat.
“All I did was say what everyone knows,” says Dmitrijs Smirnovs, a 32-year-old university lecturer detained by Latvia’s Security Police. The force is responsible for hunting down spies, terrorists and other threats to this Baltic nation of 2.3 million people and 26 banks.
Now free after two days of questioning, Mr. Smirnovs hasn’t been charged. But he is still under investigation for bad-mouthing the stability of Latvia’s banks and the national currency, the lat. Investigators suspect him of spreading “untruthful information.” They’ve ordered him not to leave the country and seized his computer.
This is a new initiative that has the goal of facilitating discussion of the Irish economy. Stay tuned for postings from a highly-qualified pool of contributing economists.
Thank you for visiting,