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Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
Brendan Walsh 27-02-09
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Brendan Walsh 27-02-09

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  • 1. Designing a Strategy for Recovery Economics Seminars Graduate Centre of Business Kemmy Business School University of Limerick Ireland Friday , February 27th, 2‐3pm
  • 2. Designing a Strategy for Recovery The Irish Economy Between a Rock and Hard  Place Brendan Walsh Professor Emeritus Department of Economics University College, Dublin
  • 3. Outline • The International Financial and           Economic  Crisis • The Irish Case • What is the Way Forward? My presentation is journalistic rather than  scholarly!
  • 4. The global crisis took somewhat  complacent policy makers and  economists by surprise
  • 5. The Golden Decade (1997‐2008)  of Steady Growth and Low  Inflation had made us  complacent Things were NICE, especially for the global banking industry Non‐Inflationary Consistently Expanding
  • 6. Contrite central bankers “Shocked disbelief” Former Federal Reserve Chairman Alan  Greenspan testifies during a House Oversight  and Government Reform Committee hearing  on Capitol Hill October 23, 2008, in  Washington, DC. 
  • 7. Disputatious economists Still no agreement about the Great Depression quot;The prevention and cure of depressions is a  central mission of macroeconomics, and if we  can't understand what happened in the  1930s, how can we be sure it won't happen  again?“ Robert E. Lucas Jr.,  1995 Nobel Laureate in economics John Dewey Distinguished Service Professor of Economics   University of Chicago. 
  • 8. Did the New Deal help? Referring to the National Industrial Recovery  Act of 1933, two UCLA economists recently  claimed: “The economy was poised for a beautiful  recovery, but that recovery was stalled by  these misguided policies.” [Cole and Ohanian, JPE, August 2004)
  • 9. “I think the stability of monetary aggregates and  nominal spending in the post‐war United States  is a major reason for the stability of aggregate  production and consumption during these years,  relative to the experience of the interwar period  and the contemporary experience of other  economies. If so, this stability must be seen in  part as an achievement of the economists,  Keynesian and monetarist, who guided  economic policy over these years.” Robert Lucas, Nobel prize winner in economics  1995
  • 10. “The question I have addressed in this lecture is  whether stabilization policies that go beyond  the general stabilization of spending that  characterizes the last 50 years, whatever form  they might take, promise important increases in  welfare. The answer to this question is No: The  potential gains from improved stabilization  policies are on the order of hundredths of a  percent of consumption, perhaps two orders of  magnitude smaller than the potential benefits  of available “supply‐side” fiscal reforms..” Lucas, Presidential address to American  Economic Association, January 2003
  • 11. The global background For years, in macroeconomics courses, we  lectured students on the unsustainable  global imbalances, principally  the large US “twin deficits” ‐ fiscal and balance of payments ‐ And the corresponding surpluses in the  emerging giants, especially China
  • 12. The financial industry – which attracts the  bright, if not necessarily the best,  through its extravagant reward  structure ‐ responded enthusiastically   and developed numerous dazzling new  products that made it impossible – until  it was too late – to measure and locate  the risks to which it was exposed
  • 13. The global background Allen Greenspan applauded the creativity of  these innovations  The Federal Reserve (and the European Central  Bank) argued that asset price bubbles were  not a concern so long as consumer price  inflation remained low
  • 14. The expansion of credit allowed consumer in the US  and some European countries to finance an  amazing , seemingly endless consumption and  housing boom/bubble Ben Bernanke argued that the global saving surplus  was finding a natural home Despite some forebodings, the system was believed  to be stable
  • 15. According to a leading international economics  textbook published in 2006 major banking  crises belonged in the history books “Today, bank runs are not a major problem for  the banking systems of advanced economies.” Students would only see them depicted in films  like Mary Poppins and It’s a Wonderful Life
  • 16. But, the world remained  uncertain
  • 17. Knightian uncertainty The sense in which I am using the term is that  in which the prospect of a European war is  uncertain, or the price of copper and the rate  of interest twenty years hence . . . About  these matters there is no scientific basis on  which to form any calculable probability  whatever. We simply do not know. (J.M. Keynes, 1937)
  • 18. 2008 was the year of the Black Swan But so was 1998 ‐ LTCM
  • 19. As Donald Rumsfeld would have said: “What we have to fear are the unknown  unknowns” Combinations of events that “should” only  occur once in a billion years.  No‐one can predict these, although bankers are  paid as if they could.
  • 20. A perfect storm The subprime mortgage crisis that spread in the US during 2007  was initially believed to be contained to a small part of the  US financial system But it spread throughout the US and then world‐wide The crises of September 2008 and in particular the collapse of  Lehman Brothers on the 15th convinced people that the  existing financial structure was in danger of collapse No sign of new equilibrium
  • 21. Meanwhile in Ireland The Irish economy became fully integrated into  the global economy with the adoption of the  euro in 1999. As the currency risk associated  with the Irish pound was removed, Irish  interest rates quickly converged with the  lower German rates.   From 1999 to 2008 real interest rates were  negative in Ireland. 
  • 22. There were benefits from adopting the euro  but also costs Especially in the overheating of the economy  after 2002 The one‐size‐fits all policy of the ECB was not  appropriate for Ireland and our Central Bank  and Financial Services regulator failed to  exercise their residual powers
  • 23. We spent too long sharing the credit for the  Celtic Tiger or Irish Hare Forebodings and warnings about the looming  storm were too muted And many in official Ireland choose to ignore or  even ridicule policy critiques Preferring instead to don the Green Jersey
  • 24. While the economy went into recession briefly  in 2002, rapid growth quickly resumed  fuelled by The ECB’s easing of monetary policy and The inflow of labour from the New Accession  States 
  • 25. May 1997 26
  • 26. Oct 2004 27
  • 27. The Centre for the Study of Small States, The Source of Wealth in Small States University of Reykjavik, Iceland Small States as Financial Centres Ireland as a Case Study Brendan Walsh University College Dublin 14th September 2007 http://bobbiblogger.files.wordpress.com/20 08/11/iceland-11.jpg
  • 28. Fallout from US sub‐prime mortgage market • On 15th August 2007 Sachsen LB Europe plc  confirmed that its Dublin subsidiary in Dublin,  the Ormond Quay conduit, had to be rescued by  a loan of €17.3 billion.   • This episode highlights the need to have a single  financial regulator across the Eurozone and drew  some unwelcome attention to the nature of  some of the firms in Irish International Financial  Services Industry.  29
  • 29. Another Lap for the Irish Hare? Patrick Honohan and Brendan  Walsh,  Dublin Economics  Workshop, Kenmare October  2007
  • 30. Our forebodings were mild: “Some financial vulnerability is evident”
  • 31. In 2008, all changed, changed utterly
  • 32. 11 February 2009
  • 33. Warning signs Whereas the earlier boom had been led by  inflows of FDI and rapid export growth, the  second wave was increasingly led by a boom  in the non‐traded construction sector (which  masked the contraction in industrial  employment) and financed by ballooning  borrowing from abroad (which allowed the  Irish banks’ balance sheets to explode).
  • 34. Warning signs Dependence on construction both employment and taxes Dependence on foreign capital inflows
  • 35. % of total employment 08
  • 36. We were warned! Many commentators drew attention to the  looming crisis facing Ireland, Notably the IMF after its official visits. Here, for example, is a quote from their 1999  Country Report: 
  • 37. “In light of the rapid growth in credit and strong  housing price increases, a number of Directors  expressed concern about the risks of an asset  price bubble and the potential vulnerability of  the banking system. Directors stressed the need  to enhance the forward‐looking aspects of  regulatory policy and, in this regard, welcomed  the supervisory authorities’ recent initiative to  assess the financial system’s vulnerability to  specified macroeconomic shocks. They felt that  a peer review, particularly by supervisors from  a country that had undergone a real estate  boom, might be helpful”
  • 38. Apportioning the blame How much of Ireland’s meltdown has been due  to  • Home‐grown, domestic policy errors and how much to  The global crisis (+ a bit of Paddy bashing in the  UK press)?
  • 39. Domestic policy issues The housing bubble was more extreme here  than in any other EU country  including Spain Failure of Central Bank to exercise its residual  authority over lending to moderate this The dependence of the banks on foreign  borrowing was also greater than in other  countries Iceland excepted
  • 40. Domestic policy issues The growth of the banks’ balance sheets  ‐ based on foreign borrowing – should also  have been restrained  The financial stability assessment was a useless  exercise
  • 41. Regulatory issues
  • 42. “The central expectation, based on an  assessment of the risks facing both the  household and non‐financial corporate  sectors, the health of the banking sector and  the results of recent in‐house stress testing is  that, notwithstanding the international  financial market turbulence, the Irish banking  system continues to be well placed to  withstand adverse economic and sectoral  developments in the short to medium term.” CBFSAI, Financial Stability Report 2007
  • 43. “But risk management models have during this crisis proved themselves wrong in a more fundamental sense. They failed Keynes’ test – that it is better to be roughly right than precisely wrong. With hindsight, these models were both very precise and very wrong. . . . Stress-testing was not being meaningfully used to manage risk. Rather, it was being used to manage regulation. Stress-testing was not so much regulatory arbitrage as regulatory camouflage. ” Andrew Haldene, Bank of Eng, February 2009
  • 44. Loss of competitiveness Due to strength of euro and failure of social  partnership to deliver wage moderation 
  • 45. Index Fe b- 75.00 80.00 85.00 90.00 95.00 100.00 105.00 110.00 115.00 7 Fe 5 b- 7 Fe 6 b- 7 Fe 7 b- 7 Fe 8 Sterling Link b- 7 Fe 9 b- 8 Fe 0 b- 8 Fe 1 b- 8 Fe 2 b- 8 Fe 3 b- 8 Fe 4 b- 8 Fe 5 b- 8 Fe 6 b- 8 Fe 7 EMS Period b- 8 Fe 8 b- 8 Fe 9 b- 9 Fe 0 b- 9 Fe 1 b- 9 Fe 2 b- 9 Ireland 1975-2009 Fe 3 b- 9 Fe 4 b- 9 Real Effective Exchange Rate Fe 5 b- 9 Fe 6 b- 9 Floating Period Fe 7 b- 9 Fe 8 b- 9 Fe 9 b- 0 Fe 0 b- 0 Fe 1 b- 0 Fe 2 b- 0 Fe 3 b- 0 Fe 4 EMU Period b- 0 Fe 5 b- 0 Fe 6 b- 07
  • 46. Loss of fiscal control The loss of control of the public finances has  also been very rapid here, fuelled by the  dependence of property‐transactions‐related  taxes loss of control of expenditure over the  electoral cycle
  • 47. The booming property market created fiscal  complacency, with expenditure expanding on  the assumption of continued revenue  buoyancy
  • 48. Tax bonanza from property boom  to continue?
  • 49. Tax receipts crash Budget 2009 
  • 50. Still in Denial? Mr Cowen took issue with “commentators in  the public debate” who blamed the current  crisis entirely on an overreliance on revenues  from the construction industry. He described  that analysis as “futile and facile”. Irish Times 12 Feb 2009
  • 51. The world credit markets have  taken a dim view of our  predicament
  • 52. Eurozone 10 year Government bond  spreads over Germany (in bps) 300 250 200 150 100 50 0 Germany France Belgium Italy Spain Portugal Austria Ireland Greece NL
  • 53. What is to be done? I tell you naught for your comfort  Yea, naught for your desire  Save that the sky grows darker yet  And the sea rises higher. G. K. Chesterton, 1911
  • 54. What must be done? • Repair the banking system • Restore balance to the public finances • Regain lost competitiveness
  • 55. No one seems to know the  magnitude of the government’s  guarantee to the banks
  • 56. Fixing the banking system • There is no off‐the‐shelf recipe for success  here • The best financial minds in the world are  grappling with the problem in the US, Britain,  and Europe – So far without a winning model emerging
  • 57. are all Swedes Now”. So said oft-quoted finance “We professor Nouriel Roubini last week, calling for large-scale nationalisation of the US banking system. With agreement on that point even from thinkers on the right of the political spectrum, Roubini’s Swedish comparison is looking less exaggerated by the day. Alan Greenspan stunned many when he said this week it might be necessary to “temporarily nationalise some banks” to engineer a “swift and orderly restructuring” of the broken sector. “Once in a hundred years this is what you do.”
  • 58. Elements of the solution • Overcome the denial of the extent of the  losses arising from the reckless lending of the  past few years and clearing the way for an  adequate recapitalisation of the main banks  • Restore international confidence in our  banking supervisory and regulatory system  
  • 59. Fixing the banks • Overcome the denial of the extent of  the losses arising from the reckless  lending of the past few years  • Should the toxic assets be “marked to  market” even when no market for them  exists? • Should they be hived off into a “bad  bank” or asset management company?
  • 60. “Even as the solutions to the financial crisis are debated in Congress and among economists, the F.D.I.C., one of the agencies that deals most closely with the nation’s banks, has already been transformed. The rising tide of foreclosed real estate is so overwhelming that the agency, which had shrunk to a relatively tiny 4,800 employees from as many as 15,000 in the last period of bank meltdowns in the 1990s, is in the midst of a military-scale build-up as it undertakes one of the greatest fire sales of all time. “ New York Times, 13 February 2009
  • 61. blitz by the F.D.I.C. may offer “The lessons for the Treasury Department, which is separately struggling with an even more monumental challenge: how to help still-operating banks move giant loads of toxic debt off their balance sheets, in the hope that the banks will begin taking risks again and stimulate the economy.”
  • 62. Restoring balance to the public  finances • The collapse of tax revenue has been so  dramatic that here is no alternative to a  major downsizing of the public sector  • The burden of taxation will also have to rise,  but in a way that minimises disincentives – taxing the stock of real property will have to be  part of this 
  • 63. Restoring competitiveness  • A fall in our costs relative to those of our  trading partners is required • As members of a currency union, a  devaluation is ruled out • The effects of a devaluation have to be  mimicked 
  • 64. Mimicking a devaluation • This requires reducing the domestic  components of our cost base – Wages and salaries – Fees – Rents – Regulatory hindrances • Think back to the 1920s and Britain’s attempt  to achieve these outcomes
  • 65. • So far deflation has been confined to  imported effects – Interest rates – Energy – Exchange rate effects
  • 66. Restoring competitiveness  • Rebuilding international confidence in  Ireland as a suitable place in which to do  business • Cementing our commitment to the single  currency – Sorting out our hang‐ups over Lisbon • Boosting the productivity of our labour force  and the contribution of our educational  system to our children’s economic prospects 
  • 67. Do we tackle the problem  ourselves or do we have to ask for  outside assistance?

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