Ireland and EMU

The Daily Telegraph gives prominence today to the recommendation by David McWilliams (made on RTE radio over the weekend) that Ireland should consider leaving the euro area: you can read the article here. The notion that Ireland or some other member country might leave the euro area is now a factor in the government bond market.

However, the adverse economic consequences of leaving the euro area are so large that this option should not be taken seriously. Barry Eichengreen has written a comprehensive paper on this topic, which you can download here.

The benign scenario described in the comments attributed to McWilliams in the Telegraph article envisages Ireland being able to use monetary independence to achieve real exchange rate depreciation in a stabilising fashion. However, a new Irish currency would be emphatically not trusted by the markets (a government that is willing to take the steps to exit the euro area is not a government that can be counted upon to keep its promises), such that either the new central bank would have to offer high interest rates or the government would have to impose capital controls. Neither is a recipe for a growth recovery.

Holding our nerve

At the time of writing, the Irish bank shares have fallen by about 50 per cent since last Friday’s closing price. The last time there was a one-day fall of comparable percentage size was at end-September, 2008 and it was immediately followed by the announcement of a blanket guarantee.

Let’s not have any knee-jerk reaction this time. The bank shares were already worth almost nothing, so there is scarcely any real impact of this price movement on the economy and on incentives.

Instead we need to have a process of confidence-building in the coherence and feasibility of the overall economic policy strategy for recovery. This must include a broad acceptance of the parameters of tax and spending policy, including on public sector pay. (Banking issues are only part of the equation and they will not be improved by sudden or half-baked initiatives.)

Previous posts have talked about public sector pay and restructuring the tax system. Getting a broad social consensus around an acceptable policy approach must surely be the priority. Here too, precipitate action will not be helpful. We need to know not only the government’s intentions; but that they will be seen as sufficiently effective and fair to elicit broad support rather than a general rejection and protest.

Thoughts at the Abbey

We went to see Roddy Doyle’s Playboy at the Abbey this weekend. I recommend it to anyone who hasn’t yet been.

It sparked two thoughts. The first was: boy, do we do theatre well in this country. I often leave the Abbey or Gate feeling this way, and my wife tells me I am getting boring on the subject. But it is nice, amid all the ‘world class’ blather we are subjected to, to go to something in Dublin that really is world class.

The second was this. Doyle’s reworking of the Playboy is very Celtic Tiger, not just because of the Nigerian Christy Mahon, but because of its underlying cultural assumptions. Synge has Mahon enter a typical Irish peasant community, and because they are a typical Irish peasant community, they look up to someone who has broken the law to the extent of having killed his father. I guess Doyle didn’t think that he could plausibly carry this off in a play set in modern Ireland, and so he has Mahon show up on the doorstep of a Dublin gangland family. In the context of an Ireland which has had its own state for 80 years, in which there are no post-colonial hangups about the law, and in which we no longer look up to people who cheat the system in various ways, since we are a Republic now, and are all in this together, this was a very clever move.

Interestingly, the Anglo-Irish Bank corporate logo was prominently displayed on the programme.

In Search of the Holy Grail

In case you haven’t come across it, there is a provocative (if sometimes repetitive) recent book on the Japanese slump by Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession (Wiley).   Koo places the blame squarely on balance sheet problems.    Interestingly, the balance sheet problems he emphasises are not in the financial sector but in the corporate (and broader) private sector.  

The following passages give a flavour of the argument:

If Japan’s fundamental problem was neither structural nor banking related, was it caused by monetary policy mistakes, as so many academics have claimed?  To answer this question, one must look at a peculiar monetary phenomenon of the Japanese economy that is not discussed in any economics textbook or business book.   Some readers may think this claim is exaggerated, but Japanese firms have spent the past dozen-odd years paying down debt when interest rates were at zero. (p. 11)

. . .

In summary, the private sector felt obliged to . . . to pay down debt . . ..  Disastrous consequences were avoided only because the government took the opposite course of action.   By administering fiscal stimulus . . . the government succeeded in preventing catastrophic decline in the nation’s standard of living despite the economic crisis.  (p. 25)

Of course, it would be a mistake to exaggerate the similarities between the Japanese and Irish economies.    For one thing, the Irish fiscal situation is already dire.   But, despite the appreciated efforts to put me straight, I continue to be surprised by how little attention is being given to domestic demand.   Improving competitiveness is critical and rightly the focus of much comment, but it will be a drawn out affair.   I fear many good enterprises will be destroyed along the way as expenditure switching is dominated by expenditure reduction.   How can we avoid an obscenely excessive property boom being followed by an obscenely excessive liquidation? 

Sunday Times Death Spiral Watch

Reading my Sunday newspapers for insights on the economic crisis, I came across the following from Damien Kiberd in the Sunday Times: “Two hundred economists gathered at UCD last week and all we heard from them were suggestions for more taxes: the reintroduction of domestic rates and third-level fees, taxes on child benefit, carbon taxes, taxes on social welfare, sucking the low-paid back into the tax net and higher excise duties. This is exactly what we did in the 1980s, when Ireland nearly went bankrupt.”

What a pity I missed that conference. Now I did attend an event on Monday at the Royal College of Physicians (organised by UCD and the Dublin Economics Workshop) and funnily enough that event had about two hundred people at it also. But there the similarities end. Participants at the conference I went to focused heavily on the need to cut public sector pay and of the range of tax measures mentioned by Kiberd, only one (reintroducing rates) was discussed. It’s rather strange of UCD to organise two different conferences on the same topic in the same week, but then that’s economists for you.

Let’s hope our new State-owned bank is not for forbearance

Two contradictory ideas about the consequences of possible failure at Anglo Irish Bank were going the rounds in the last few weeks.

The first idea — a strange one — was that any attempt to foreclose or restructure non-performing corporate creditors of Anglo Irish Bank would have an unfavorable “ripple effect” on the other banks, who also have lent to the same firms. (What kind of ripple? If it causes the other banks to wake-up and help restructure weak firms, that can only be good for everyone — except perhaps the controlling shareholders of the borrowing firms, who are currently living on borrowed times).

The second idea — not quite so strange — was that a bank being wound down would obviously do worse in recovering on the bad loans it had made. (That sort of thing has happened to China’s AMCs, but mainly where the AMC has decided to sit back and not pursue the recovery courses open to it).

Despite their doubtful validity, both arguments are now likely to be used to try to prevent the soon-to-be state-owned Anglo from pursuing delinquent debtors with vigour.

That would be a bad mistake both for the bank’s own recoveries, and for the economy as a whole.

State-owned banks around the world have tended to fall into the pattern of ending-up as lenders of last resort to large but barely viable companies with good political connections.

May I be permitted to repeat a paragraph from my conference paper of last week:

“Distressed firms need to be decisively restructured, and not kept alive on a drip-feed. The dangers here apply especially to property-based companies, but also to others. In other words, parallel to the financial restructuring of banks, there needs to be work ensuring that surviving non-financial firms are financially solid. This can be done largely by the market; the barriers to prompt action here are likely to come from banks that are in denial about the true financial condition of their biggest borrowers, and from political pressure.”

If nationalization means that previously cossetted Anglo borrowers are now going to be pursued energetically, it may prove to have been a good thing.