The Irish Economy

The Central Bank have released their annual report (press statements from Governor Honohan here and from Chairman of the Regulator Jim Farrell here).  The NTMA has also released its annual report here and its mid-year business review here.

The lead headline in the Irish Times today must have depressed many: “Economy to shrink 11% over the next 18 months, says Central Bank.”  Things feel bad now, how bad would they feel if output fell by another 11% over the next 18 months.  Well, this is not at all what was forecasted by the Central Bank and their forecast is actually not that gloomy at all.

First, the bank’s forecast is that the average level of GDP in 2009 will be 8.3% lower than the average level of GDP in 2008, and then that the average level of GDP in 2010 will be 3% lower than in 2009.  The Bank did not release a forecast about what will happen over the next 18 months.

Second, while the Bank (like the ESRI) do not release quarterly assumptions underlying their forecast, one can back out roughly what they might look like.  Seasonally adjusted real GDP in 2009:Q1 is already 5.8% below last year’s average level.  So, if GDP was flat for the remaining three quarters of the year, then the Bank’s figure for the year average over year average for 2009 would be -5.8%.  One way to get their figure of -8.3% is to assume a decline of  -1.8% over each of the last three quarters of the year.

However, if that were to occur, then even a flat level of GDP in 2010 would produce a year average over year average figure for 2010 of -2.7%.  So, in fact, rather than an 11% decline over the next 18 months, the banks figures are actually consistent with a decline in GDP from the end of June to December this year of 3.6%, followed by a very small decline in the first quarter of 2010 and flat GDP after. A more likely scenario that would produce the Central Bank’s forecasted outcome would see a larger fall in 2010:Q1 and perhaps 2010:Q2 followed by a recovery in the subsequent quarters.  In light of the severe fiscal contraction being inflicted on the economy over this period, this would not represent such a bad outcome.

Beyond the question of what the Central Bank forecast actually implies, there is the more general issue, which I have referred to before, of the difficulty in mapping forecasts based on year-average over year-average into commentary about what is actually happening now in the economy.

Rossa White of Davy’s has also written on this issue.  See here.

We are pleased to bring you this guest post by Dr Jonathan Westrup of the IMI and author of the 2002 TCD Policy Institute Studies in Public Policy No. 10 Financial Services Regulation in Ireland – the Accountability Dimension .

” Further to Karl Whelan’s post, the government has clearly decided to radically reorganise the present unwieldy structure that, for the past 6 years, incorporated the financial regulator within the Central Bank.

Two features of the proposed reform immediately stand out. First, the decision to put responsibility for stability and supervision into one organisational structure rather than to have them divided between the Bank and the Regulator. Second, the decision to set up a presumably stand alone Financial Services Consumer Agency with responsibility for consumer protection incorporating the existing consumer directorate of the Regulator and the Office of the Financial Services Ombudsman.

What is intriguing is the Taoiseach’s reference in his speech to “international best practices similar to the Canadian model”. A quick look at the Canadian regulatory system, as Karl mentions, shows that a distinguishing feature of the model is that the Central Bank has never had a responsibility for regulation. Instead, since 1987, the Office of the Superintendent of Financial Institutions (OSFI) has regulated both the banking and insurance sectors while Canada remains the only major country without a securities regulator, with responsibility devolved to the individual provinces. In terms of a consumer protection mandate, the provincial securities regulators all have a responsibility while, since 2001, the Canadian government established the Financial Consumer Agency of Canada with a mandate “to strengthen oversight of consumer issues and to expand consumer education in the financial sector”. However, according to its website, it has a budget of only 8 million Canadian dollars.

So on the face of it, the relevant part of the Canadian model to which the Taoiseach refers, is the hiving-off of the consumer protection aspect of regulation.

There is little further detail at the moment of the new regulatory system but there are some very important questions. We are told that a new Head of Banking Regulation will be appointed, but how will insurance and securities regulation fit into the Commission?  What will be the relationship between the Governor of the Central Bank and the Head of Banking Regulation, given the demands of the Maastricht Treaty in terms of determining the governor’s accountability towards the domestic political system? Will the present 50/50 funding arrangement between the industry and the Central Bank continue with the new model? What will be the powers of the new consumer agency outside the Banking Commission?

The government has clearly decided, yet again, not to set up a stand alone single financial regulator, but to go for a variant of the Twin Peaks model where all prudential regulation is the responsibility of the Central Bank and conduct of business regulation is regulated separately. However, in the Dutch case, which is the Twin Peaks exemplar, the conduct of business function is more comprehensive than appears to be the case with the proposed Financial Services Consumer Agency.  With details so limited at this stage, this assumption may not be accurate.

Many governments are wrestling with reforms at the moment, with the UK’s Financial Services Authority promising “a revolution” in financial regulation in their proposed reforms due before the end of the month. The government has moved quickly but more detail is required before making assumptions about how the system might work. Given the fairly immediate need to hire the new head of banking regulation, questions about the model will presumably be clarified very quickly.”