Ireland's woes are due to the euro, not spending cuts

October 01, 2010 2:32 PM

Allister Heath has a really important article in City AM. You will have heard a lot of commentators recently claiming that Ireland's troubles show that spending cuts are bad news for the economy.  But the reality is that Ireland is still running a major deficit, and therefore isn't getting a lot of the benefits from cutting spending, because it is having to keep putting more money into the banks.  It has been hit harder than other countries by the financial crisis because it had a greater asset boom that turned into a greater bust.  The reason why that happened was the euro.


Allister explains what happened:


"For years, sensible economists had been warning that the euro’s one-size-fits-all interest rates and monetary policy would trigger uncontrollable bubbles in high-growth countries, such as Ireland, while depressing activity in weaker economies, such as Germany. For years, these warnings were not heeded, neither by politicians desperate to construct a political Europe, nor, regrettably, by the big financial institutions. Many banks and economists chose to toe the party line, in some cases to placate Europe’s political establishment and in other cases because they were fooled into believing that the single currency afforded smaller countries a free lunch of lower interest rates and stable currencies.


Ireland would have needed very high interest rates during the bubble years; instead, Frankfurt gave it ultra-cheap money. Even in January 2006, when many of the more idiotic lending decisions taken by Irish banks were being planned, the European Central Bank’s main interest rate was just 2.25 per cent. This probably made sense for Germany and maybe even for France. But it was an absurdly low rate for Ireland, which could have done with rates of eight per cent or even nine per cent. Inflation in the Emerald Isle hit 4.2 per cent in August, way too high; for 2006 as a whole, Ireland’s GDP surged by 6.0 per cent and its gross national product by 7.4 per cent. In other words, at the height of a property, economic and mortgage boom, Ireland was enjoying negative interest rates after adjusting for inflation. Companies and consumers were being paid to borrow; projects that would never have been worthwhile were the authorities pricing money properly were being signed off left, right and centre. The whole country was drunk on cheap credit, courtesy of the euro; the commercial banks, as ever, were acting as the highly paid transmission mechanism linking central bank to consumers. Everybody believed that Ireland’s excellent tax and microeconomic reforms – including the 12.5 per cent corporation tax rate – caused the boom. Of course, they did account for a large chunk of the growth and played the key role in transforming Ireland from backwater to global hub – but the remainder of the “growth” was mere froth caused by excessively low interest rates.


Ireland’s membership of the euro was thus the single most important reason for yesterday eye-wateringly large bailout of the Irish banks, which will take the budget deficit to 32 per cent of GDP and its gross government debt to 96 per cent of GDP. The tragedy is that nobody is pointing this out: the political establishment is too closely implicated and may yet need to draw on a European bailout fund."


If we cut spending then we can reassure people that the deficit is under control.  That way, they can invest and spend in the confidence that there aren't big tax hikes round the corner; that their returns tomorrow won't be raided to pay for today's borrowing.  In Ireland, they can't do that because their political class made the tragic mistake of joining the euro and they are still having to borrow to pay for the consequences despite cuts.  Without cuts their public finances would have completely collapsed and their situation would be far worse (and even more draconian cuts would be on the way).  Thankfully, people here listened to eurosceptics who pointed out the risks of joining and hard working campaigners and the public stopped politicians signing us up.

Allister Heath has a really important article in City AM. You will have heard a lot of commentators recently claiming that Ireland's troubles show that spending cuts are bad news for the economy.  But the reality is that Ireland is still running a major deficit, and therefore isn't getting a lot of the benefits from cutting spending, because it is having to keep putting more money into the banks.  It has been hit harder than other countries by the financial crisis because it had a greater asset boom that turned into a greater bust.  The reason why that happened was the euro.


Allister explains what happened:


"For years, sensible economists had been warning that the euro’s one-size-fits-all interest rates and monetary policy would trigger uncontrollable bubbles in high-growth countries, such as Ireland, while depressing activity in weaker economies, such as Germany. For years, these warnings were not heeded, neither by politicians desperate to construct a political Europe, nor, regrettably, by the big financial institutions. Many banks and economists chose to toe the party line, in some cases to placate Europe’s political establishment and in other cases because they were fooled into believing that the single currency afforded smaller countries a free lunch of lower interest rates and stable currencies.


Ireland would have needed very high interest rates during the bubble years; instead, Frankfurt gave it ultra-cheap money. Even in January 2006, when many of the more idiotic lending decisions taken by Irish banks were being planned, the European Central Bank’s main interest rate was just 2.25 per cent. This probably made sense for Germany and maybe even for France. But it was an absurdly low rate for Ireland, which could have done with rates of eight per cent or even nine per cent. Inflation in the Emerald Isle hit 4.2 per cent in August, way too high; for 2006 as a whole, Ireland’s GDP surged by 6.0 per cent and its gross national product by 7.4 per cent. In other words, at the height of a property, economic and mortgage boom, Ireland was enjoying negative interest rates after adjusting for inflation. Companies and consumers were being paid to borrow; projects that would never have been worthwhile were the authorities pricing money properly were being signed off left, right and centre. The whole country was drunk on cheap credit, courtesy of the euro; the commercial banks, as ever, were acting as the highly paid transmission mechanism linking central bank to consumers. Everybody believed that Ireland’s excellent tax and microeconomic reforms – including the 12.5 per cent corporation tax rate – caused the boom. Of course, they did account for a large chunk of the growth and played the key role in transforming Ireland from backwater to global hub – but the remainder of the “growth” was mere froth caused by excessively low interest rates.


Ireland’s membership of the euro was thus the single most important reason for yesterday eye-wateringly large bailout of the Irish banks, which will take the budget deficit to 32 per cent of GDP and its gross government debt to 96 per cent of GDP. The tragedy is that nobody is pointing this out: the political establishment is too closely implicated and may yet need to draw on a European bailout fund."


If we cut spending then we can reassure people that the deficit is under control.  That way, they can invest and spend in the confidence that there aren't big tax hikes round the corner; that their returns tomorrow won't be raided to pay for today's borrowing.  In Ireland, they can't do that because their political class made the tragic mistake of joining the euro and they are still having to borrow to pay for the consequences despite cuts.  Without cuts their public finances would have completely collapsed and their situation would be far worse (and even more draconian cuts would be on the way).  Thankfully, people here listened to eurosceptics who pointed out the risks of joining and hard working campaigners and the public stopped politicians signing us up.

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