The Irish Crisis Philip R. Lane Trinity College Dublin New Zealand - PowerPoint PPT Presentation

The Irish Crisis Philip R. Lane Trinity College Dublin New Zealand Treasury, 8th December 2010 New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Introduction Economic Crisis: GDP decline of 15 percent between 2007-2010 Fiscal Crisis: Surplus in 2007; ‘core’ GGB of -11.5 percent in 2009 and 2010 Banking Crisis: Heavy losses of Irish banking system New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Ireland: Some Basic Facts 2010 GDP: e 157 billion 2010 GNI: e 125 billion Employment: 1.86 million Population: 4.45 million New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

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, growth in public spending 2001-2002: pause (global hi-tech recession; euro appreciation; ..) New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The 2003-2007 Bubble Period Rapid credit growth: housing; commercial real estate; households; Funded by explosion in net foreign liabilities of Irish banking system 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: Bursting of the bubble, compounded by the global crisis 2008-2010: Crisis Management New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

GDP Growth Rate GDP Growth 18 18 14 14 10 10 GDP Growth 6 6 2 2 -2 -2 -6 -6 -10 -10 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Ratio of Private Credit to GDP 2 1.75 (Private Credit / GDP) 1.5 1.25 1 0.75 0.5 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Year New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Current Account Balance (Ratio to GDP) 6 6 4 4 2 2 CA/GDP 0 0 -2 -2 -4 -4 -6 -6 1995 1995 1997 1997 1999 1999 2001 2001 2003 2003 2005 2005 2007 2007 2009 2009 Year New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Net Foreign Liabilities of Main Irish Banks 80 75 70 65 60 55 NFL/GNP 50 45 40 35 30 25 20 15 10 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The Economic Crisis Shuddering Halt in Construction Sector Approx 50% decline in housing prices; 90% for some development land Collapse in Investment Hike in household savings rate (2% in 2007; 12% in 2010) Jump in unemployment but also signi…cant exit (participation, emigration) Fiscal tightening adding to demand slump Tightening of credit conditions Negative in‡ation (in part, terms of trade gain from Sterling decline) Aggregate exports doing well but driven by FDI-dominated sectors (2009 GDP -7%; GNP -10.5%) Some level of downward pay ‡exibility in private sector New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The Banking Crisis I Traditional property-driven crisis. Slowdown since late 2006 but hope for ‘soft landing’ 2008 - liquidity pressure on Irish banks International …nancial crisis - trigger for ‘hard landing’ Extensive guarantee of existing liabilities: September 2008-September 2010 (Plus ongoing guarantees of new debt issuance) Heavy reliance on ECB liquidity Initial State capital injections into banks National Asset Management Agency (NAMA): announced April 2009 NAMA acquiring property development loan books Transfer values at a steep discount to face value of loans Post-transfer: recapitalisation of banks New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The Banking Crisis II Prospect of other bad debts (mortgages, HH, SMEs). Central Bank PCAR exercise: March 2010, update September 2010. 8 percent core Tier 1 ratio target. Large government ownership stakes in the main banks; nationalisations of ‘extreme o¤enders’ (Anglo-Irish Bank, Irish Nationwide) 2008-2012 projected losses e 70 billion- e 80 billion for domestically-owned banks (about 16% of peak loans) Shareholder equity at start of crisis about e 23 billion Subordinated bonds at start of crisis about e 20 billion Senior bonds about e 85 billion Fiscal outlay: e 35- e 40 billion in capital transfers; e 10- e 20 billion in …nancial investments New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The Fiscal Crisis 2007: budget surplus; gross public debt 25% of GDP (net debt 14% of GDP) 2008 budget (announced December 2007): rapid spending increases Summer 2008: brake applied ( e 1 billion in spending cuts) October 2008: early announcement of 2009 budget ( e 2 billion in tax increases for 2009) February 2009: expenditure adjustments ( e 2.1 billion) April 2009 ‘emergency’ budget ( e 5.4 billion) December 2009: Adjustment of e 4.1 billion for 2010 Cumulative total so far: e 14.6 billion 2011-2014 …scal plan: e 15 billion of discretionary tightening ( e 6 billion in 2011). (2/3 spending; 1/3 taxes) Goal: Debt stabilisation; 3% GGB in 2014/2015/? New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Some Features of the Fiscal Adjustment De facto average 7.5 percent pay cut [‘pension levy’] in public sector in January 2009 Further 5%-12% cuts in public sector pay in 2010 budget - but no further nominal cuts (Pay levels still very high) Recruitment freeze; cuts in capital spending (from a high level; also tender prices down) Major increase in top marginal tax rate: 45% to 52% (kicks in at low level) Cuts in welfare payments (but pensions not touched) - roll back after very rapid growth Narrow tax base: much scope for raising taxes A …scal “hangover” New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The Fiscal Multiplier Open Economy: fall in domestic demand implies fall in imports (improvement in trade balance) - working assumption is that multiplier is only 0.5 But …nancially-stretched households: fall in disposable income raises bank losses? 2010: (some) GDP growth despite major …scal austerity package New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The EU/IMF Deal I Trigger: Funding of banking system (exit of private wholesale funding in September 2010; excessive reliance on ECB and Irish central bank for funding) Also: revision to 2009 GDP, lower GDP de‡ator, less optimism about future GDP growth Banks need protection against tail risk - extra capital; extra asset transfers to NAMA; asset sales Sovereign needs assured funding - on its own account but also to comfort bank funders Deal: if banks de-risked, ECB will maintain large-scale long-term liquidity provision New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

The EU/IMF Deal II Sources of e 85 billion e 17.5 billion domestic (NPRF; cash balances) e 22.5 billion EFSM (European Commission) e 22.5 billion EFSF e 22.5 billion IMF Allocation of e 85 billion e 10 billion now for banks e 8 billion extra capital (target 12 percent core tier 1 ratios) e 2 billion for credit enhancements of asset sales e 25 billion contingency fund for banks e 50 billion to fund sovereign 2011-2013 New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Some Issues Treatment of bank bondholders e 12 billion of subordinated bonds - exchanges (already e 7 billion in face value recovered) e 20 billion of senior unguaranteed bonds (issued before September 2008) guaranteed bonds national versus European ‘solutions’ Cross-border risk transfer Uncertainty about growth prospects Limited scope for structural reforms - minimum wage cut by 12 percent; more deregulation of professions New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

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 (operational since 2001) Counterexamples: Sweden/Finland; Chile ‘Rainy Day’ Fund Rethink appropriate de…nition of “prudence” 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 New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22

Ireland and the Euro 2003-2007 Bubble period: not exclusive to euro area; limited role for interest rate mechanism Independent currency can be destabilising during boom-bust cycles High euro-denominated foreign debt: in e¤ect, ‘foreign-currency’ debt but with access to liquidity provider (ECB) Adjustment process: nominal ‡exibility playing a role but not universal New Zealand Treasury, 8th December 2010 Lane () The Irish Crisis / 22