The Irish Crisis
Philip R. Lane
IIIS, Trinity College Dublin and CEPR
Oslo, January 12th 2010
Lane ()
The Irish Crisis
Oslo, January 12th 2010
1 / 17
Introduction
Economic Crisis: GDP decline of 15 percent between 2007-2010
Fiscal Crisis: Surplus in 2007; -11.5 percent in 2009 (-17 percent if no
correction)
Banking Crisis: Heavy losses of Irish banking system
Lane ()
The Irish Crisis
Oslo, January 12th 2010
2 / 17
The Celtic Tiger Years: 1994-2001
Rapid productivity-driven output growth
Long-delayed Catch Up Process
Major expansion in inward FDI: European integration; the ‘weightless’
hi-tech sectors
Little in‡ation: large over-hang of surplus labour
Start of housing boom: rising incomes, lower interest rate under
entry to EMU
1999-2001: very weak euro against $/£
1999-2001: big tax cuts
Lane ()
The Irish Crisis
Oslo, January 12th 2010
3 / 17
Temporary Deceleration 2001-2003
Global recession in Hi-Tech Sector
Post-election …scal retrenchment in 2002
Rapid euro appreciation against dollar in 2002
Lane ()
The Irish Crisis
Oslo, January 12th 2010
4 / 17
The 2003-2007 Bubble Period
Rapid credit growth: land development; households; SMEs
Rapid growth in property prices
Major expansion in construction activity: large proportion of male
workforce
Tax breaks for property investment
Substantial inward migration (New Member States etc)
Associated revenue windfall and rapid growth in public spending
Expansion in current account de…cit
Real exchange rate appreciation
Relative contraction of tradables sector
2008/2009: Bursting of the bubble, compounded by the global crisis
Lane ()
The Irish Crisis
Oslo, January 12th 2010
5 / 17
GDP Growth Rate
GDP Growth
18
14
GDP Growth
10
6
2
-2
-6
-10
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Year
Lane ()
The Irish Crisis
Oslo, January 12th 2010
6 / 17
Ratio of Priv ate Cre dit to GDP
2
(Private Credit / GDP)
1.75
1.5
1.25
1
0.75
0.5
1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
Year
Lane ()
The Irish Crisis
Oslo, January 12th 2010
7 / 17
Curre nt Account Balance
(Ratio to GDP)
6
4
CA/GDP
2
0
-2
-4
-6
1995
1997
1999
2001
2003
2005
2007
2009
Year
Lane ()
The Irish Crisis
Oslo, January 12th 2010
8 / 17
Net Foreign Liabilities of Main Irish Banks
80
75
70
65
60
NFL/GNP
55
50
45
40
35
30
25
20
15
10
1999
Lane ()
2000
2001
2002
2003
2004
The Irish Crisis
2005
2006
2007
2008
2009
Oslo, January 12th 2010
9 / 17
The Economic Crisis
Shuddering Halt in Construction Sector
Approx 50% decline in housing prices; 90% for some development land
Collapse in Investment
Hike in private savings rate
Jump in unemployment but also signi…cant exit
Fiscal tightening adding to demand slump
Credit crunch for SMEs, households
In‡ation currently minus 5.7% (terms of trade gain from Sterling
decline)
Aggregate exports holding up but driven by FDI-dominated sectors
(2009 GDP -7%; GNP -10.5%)
Some level of downward pay ‡exibility in private sector
Lane ()
The Irish Crisis
Oslo, January 12th 2010
10 / 17
The Banking Crisis
Traditional property-driven crisis
Extensive guarantee: September 2008
Preference Shares in AIB / Bank of Ireland
Nationalisation of Anglo-Irish Bank (early 2009)
Severe funding pressures in Q1 2009
Heavy reliance on ECB liquidity
National Asset Management Agency (NAMA) plan announced April
2009; legislation December 2009
NAMA to acquire property development loan books (transfer value
about 30% of GDP)
Transfer values at a steep discount to face value of loans (average
30%): but 15% uplift relative to market value (‘long-term economic
value’concept)
Also prospect of more bad debts (mortgages, HH, SMEs)
Post-transfer: recapitalisation of banks
Likely scenario: large government ownership stakes in the main banks
Lane ()
The Irish Crisis
Oslo, January 12th 2010
11 / 17
The Fiscal Crisis
Summer 2008: brake applied
October 2008: early announcement of 2009 budget; de…cit mostly
‘structural’; signi…cant tax increases (levies)
Q1 2009: jump in sovereign spread; funding risk [interaction with
bank funding]
April 2009 ‘emergency’budget
2009: ongoing decline in tax revenue; 2009-2014 …scal adjustment
schedule
December 2009: tough budget for 2010, cuts of 2.5% of GDP in
order to stabilise de…cit at about 11 percent of GDP
Lane ()
The Irish Crisis
Oslo, January 12th 2010
12 / 17
Features of the 2008/2009 Fiscal Adjustment
De facto 7.5 percent pay cut [‘pension levy’] in public sector in
January 2009
Further 5%-12% cuts in public sector pay announced for 2010
Major increase in top marginal tax rate: 45% to 54% (kicks in at
e37K)
Large fraction of workers pay no income tax
Narrow tax base
Further …scal adjustment required over 2011-2014
2012 next election
Lane ()
The Irish Crisis
Oslo, January 12th 2010
13 / 17
Regrets
Failure of macro-prudential banking regulation
Excellent new CB governor and bank regulator now appointed
Failure to run large …scal surpluses during good times
Exception: National Pension Reserve Fund
Exception: Special Savings Incentive Account (2001/2002 to
2006/2007)
Counterexamples: Sweden/Finland; Chile
‘Rainy Day’Fund (Lane, 1998)
De…cient Tax System
Over-reliance on asset-driven revenues
Unsustainable cuts in income taxes
Inappropriate tax incentives for property investment
Excessively narrow tax base
Lane ()
The Irish Crisis
Oslo, January 12th 2010
14 / 17
Ireland and the Euro
Bubble period: not exclusive to euro area; limited role for interest rate
mechanism
High euro debt: in e¤ect, ‘foreign-currency’debt but with access to
liquidity provider (ECB)
Disciplinary impact of discriminating sovereign debt market
Adjustment process
contrast to own-currency economies (di¤erent types, depending on
reliance on foreign-currency debt and policy stability)
Key issue: interplay between …scal crisis and banking crisis
Lane ()
The Irish Crisis
Oslo, January 12th 2010
15 / 17
Lessons for Members of the Euro Area
Importance of long-term …scal anchor (SGP inadequate): new
institutional arrangements
Costs of banking crises inside a monetary union
Costs of real over-valuation (limits to wage ‡exibility)
Big gain: Liquidity support (but requires …scal backstop to ensure
bank solvency)
Hypothetical alternative: no euro membership?
Lane ()
The Irish Crisis
Oslo, January 12th 2010
16 / 17
Future Prospects for the Irish Economy
Shift in composition of economic activity: more tradables activity, less
construction
‘Internal’devaluation: slow adjustment process but faster in Ireland
than in some other locations
Overhang of high debt levels: tepid recovery in domestic spending
Growth expected in 2010 H2; moderate pace for 2011 onwards
Institutional reforms required: “never again”
Stay informed: www.irisheconomy.ie
Lane ()
The Irish Crisis
Oslo, January 12th 2010
17 / 17