Vincent O’Sullivan and I write on this topic, applied to the case of the Capital Requirements Directive IV, on the Harvard Law School Forum on Corporate Governance and Financial Regulation here. A related talk I gave at the IIEA is here.
It can be hard to get an intuitive sense of potential evolution of Ireland’s budgetary situation post-2015. With this in mind, readers might be interested in seeing a hypothetical scenario for the period 2016-2020. I hasten to add that this is neither a forecast nor a recommendation.
The scenario begins with the Government’s projections out to 2015 as recently published in the Stability Programme Update. To limit the number of assumptions, I focus on the actual budget balance rather than the structural budget balance. The post-2015 scenario assumes: (1) an annual nominal GDP growth rate of 3.5 percent (which, for reference, compares to a forecast in the SPU of 4.5 percent nominal growth in 2015); (2) an average interest rate on outstanding debt of 4.9 percent for 2015-2020 (equal the projected interest rate for 2015 in the SPU); (3) total General Government Revenue grows at the same rate as nominal GDP; and (4) non-interest (or primary) General Government Expenditure grows at half the rate of nominal GDP. Of course, a faster rate of primary expenditure growth would be possible for the same evolution of the budget balance with the tax system not fully indexed to nominal GDP.
The evolution of the key aggregates (measured in millions of euro) are shown here; these aggregates as a share of GDP are shown here. The debt to GDP ratio is shown here.
Under this scenario, the actual deficit as a share of GDP would fall from the projected 2.8 percent of GDP in 2015 to -0.4 percent of GDP in 2020, a change of 3.2 percent points of GDP. (The improvement in the underlying structural deficit should be broadly similar, starting from a projected 3.5 percent of GDP in 2015. The rate of improvement is above the minimum required rate of improvement in the structural deficit of 0.5 percentage points of GDP per year along the adjustment path to structural balance.) The debt to GDP ratio would be falling at a rate of 3.5 percentage points of GDP in 2019 and 4 percentage points in 2020, within the requirements of the one-twentieth rule, which comes into force after 2018.
In Saturday’s Irish Times, Alan Ahearne does a good job laying out the dangers of unfolding events in Greece (see here). Political support for the adjustment programme has been lost, with the Greek population understandably perhaps blaming much of their disastrous economic performance on the conditions of the programme. While the austerity measures have certainly played a role in the growth performance, they are just one component, with the confidence-sapping effect of the fear of a melt-down situation itself playing a major role. The correlation between austerity and weak growth is now deeply established in the minds of many Greek voters – whatever the actual contribution of the austerity measures. A rejection of the programme in the elections is a real possibility. So too is a tough response from official creditors to an unwillingness to meet the programme conditions.
A Greek exit from the euro zone could be containable with sufficient will. However, there is a likelihood that moral hazard concerns could lead the response might be too halting, leading the crisis to easily spin out of control. As Alan argues, even with a successful containment, the precedent of a country leaving the euro would fundamentally change the stability of the monetary union, making it more prone to the runs that plague fixed-exchange rate regimes. (See also Martin Wolf here.)
Is there room to give Greece more time, providing at least some political counterweight to the massive anger at the programme? The stronger euro zone countries are understandably concerned about the moral hazard problems of any backtracking on the conditionality being applied to Greece.
This is where the weaker countries could play an important role. They could do so by making it clear that they see no interest in seeking relief through default or in a relaxation of formal/informal commitments, regardless of any additional accommodations for Greece. This need not include measures currently under discussion for strengthening the overall crisis management, including the lengthening of the maturity of the promissory notes, direct injections from the ESM into undercapitalised banking systems, or relaxing the aggregate stance of the Excessive Deficit procedure (especially for countries with fiscal space). I think this goes with the grain with the approach of governments in Ireland, Italy, Portugal and Spain. (Indeed, in the case of Spain, their unwillingness to accept a one-year extension for reaching the 3 percent target under their Excessive Deficit Procedure (EDP) may show excessive unwillingness to accept the easing of conditions, given that it can be viewed as part of broader easing of the aggregate stance of the EDP on the basis of the aggregate euro zone considerations.)
I don’t want to exaggerate the impact of leadership of the weaker countries on this issue, but it could help tilt the steering wheel from what looks now like a very dangerous course. Greece has got itself into a mess, much of it of its own making. Greece has no choice but to make tough adjustments, but giving more time may be the only way to prevent political rejection. Solidarity – but most of all self interest – should lead all euro zone countries to work hard at finding a workable way out.
Six months ago on this blog I made a quasi-prediction that the number of new residential mortgages in Ireland might shrink to zero-plus-noise. Arguably this has now happened. I claim no great insight and concede that it might have been dumb luck. My quasi-prediction was based on some informal liquidity-risk analysis of the Irish banks. The banks are in a corner solution with respect to long-term illiquid assets. There is little good reason for an Irish-domiciled bank to issue a new residential mortgage, rather, they might be keen to sell any of their existing long-term illiquid assets at a loss. This has only second-order policy importance relative to Greece, etc., but is worth documenting.