Thoughts on Ireland

I have found the Irish experience of the worldwide recession to be one of the most intriguing. From 1990 up until the beginning of the recession, the Irish economy grew over four-fold. However, since the recession began the economy has contracted by almost 20%. Part of my interest in Ireland is due to the fact that with the economy growing as rapidly as it did during its “Celtic Tiger” phase, rising productivity should have put downward pressure on prices. However, Ireland uses the Euro as its currency. As a result, it is possible (likely?) that monetary policy was comparatively loose in Ireland compared to other European Union members. Thus, if monetary policy became tight following a negative aggregate demand shock, this could potentially explain — at least in part — why the contraction was so severe in Ireland as one would expect to see a number of projects financed as a result of loose monetary policy fail. I haven’t yet delved sufficiently into the data to examine this more rigorously, but nevertheless, I find this to be an interesting hypothesis.

As one would expect with such a severe economic contraction, Ireland experienced substantially rising budget deficits from the resulting decline in tax revenue. In addition, Ireland experienced a severe banking crisis. Interestingly enough, Ireland was actually out in front of some of these issues. They quickly (in political terms) responded by attempting to get their fiscal house in order and creating a “bad bank” (a concept that was floated in the U.S. as well). The fiscal austerity measures have resolved Ireland’s short term debt problems. Recent increases in Irish bond yields seem to have more to do with Greece than with Ireland.

Nonetheless, the real issue is the bad bank. The amount of potential losses to the Irish government are substantially large. Morgan Kelly writes over at VoxEU that:

This debt would probably be manageable, had the Irish government not casually committed itself to absorb all the gambling losses of its banking system. If we assume – optimistically, I believe – that Irish banks eventually lose one third of what they lent to property developers, and one tenth of business loans and mortgages, the net cost to the Irish taxpayer will be nearly one third of GDP.

Adding these bank losses to its national debt will leave Ireland in 2012 with a debt-GDP ratio of 115%. But if we look at the ratio in terms of GNP, which gives a more realistic picture of the Ireland’s discretionary tax base, this is a debt-GNP ratio of 140% – above the ratio that is currently sinking Greece. Even if bank losses are only half as large as we expect, Ireland is still facing a debt-GNP ratio of 125%.

Again, the central bank is an issue. For example, if Ireland had an independent central bank, it might be able to have been able to have the central bank absorb some of these losses through non-standard open market purchases of non-performing loans — a policy I am not recommending, by the way. On the other hand, although the government acted quickly on these issues, the development of the bad bank has potentially set Ireland up as the next Greece once these losses are realized.

UPDATE: Simon Johnson piles on.

8 responses to “Thoughts on Ireland

  1. During the period of rapid expansion, there was a reduction in the cost and prices of goods. However due to the Euro agreements Ireland was not permitted to sell goods at such low prices except for a limited petiod internal to the country. The surplus “profit” due to this enforced level playing-field, could have been usefully taken-up by the government instead of other taxes. This would have provided a reserve against the current economic crisis. But this is apparently not what happened. So how was this “profit” used?

  2. Great post. I too have been interested because I had a start-up based out of Ireland in the Celtic Tiger phase — and appreciated their low-tax stance.

    Would you go so far as to say that they would have been better off not joining the Euro? People are piling on, but I always thought Ireland was a poster child for common currency. They got Trichet’s banking and mobility to support the benefits of a low tax structure.

  3. It’s Nice Post, keep posting and have a nice day… 09:02

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