European Economic Policy & Ireland
This document was uploaded by user and they confirmed that they have the permission to share it. If you are author or own the copyright of this book, please report to us by using this DMCA report form. Report DMCA
Overview
Download & View European Economic Policy & Ireland as PDF for free.
More details
- Words: 1,745
- Pages: 2
European Economic Policy
European economic policy & Ireland Charles Larkin gives an overview of the interaction between current European monetary policy and the Irish economy
Since August 2007 Ireland and the rest of the world have witnessed extraordinary economic events that have fundamentally changed economies. The global “Great Recession” has plunged economic activity into its longest downturn since the Great Depression of the 1930s. All European economies have suffered increases in deficit and debt levels as rising unemployment and reduced tax revenues have placed strains on their respective fiscal systems. This has highlighted the role of monetary policy as key to liquidity supply, regulatory support and inflation management. The European Central Bank’s (ECB) monetary policy is clearly defined as maintaining HICP inflation at no more than 2 per cent and M3 money supply growth at no more than 4.5 per cent (2 per cent inflation + 2.5 per cent annual Gross Domestic Product (GDP) growth). The recent economic downturn has de facto changed the ECB’s principal concern from one of inflation to deflation and to supporting the various European economic stimuli plans. This has placed it in direct political confrontation with France and Germany. The ECB, much like its counterparts in Washington and London, is engaged in firefighter operations, attempting to keep markets sufficiently fluid to facilitate the steady flow of funds between banks and provide the day-today liquidity that enables the economy to function. Central banks are now having to consider the long-term implications of these actions and the question of an exit strategy. Furthermore, quantitative easing has created concern about future inflation and the difficulty of reducing central bank liquidity without stalling a delicate recovery. Given the moderate recovery of France and Germany, these are the ECB’s main concerns.
Interest Rates
Will there be an interest rate increase? Not in the immediate future, but if the FrancoGerman recovery is robust and the Benelux countries see similar improvements, the ECB may slowly begin the process of reducing liquidity and potential increasing Public Affairs Ireland
“Any discussion of the monetary
policy of the Eurozone must start
from the following essential facts. Ireland is a small open economy.
This means that it subsists through trade and does not have any
position of market dominance, so that it cannot determine prices, interest rate or incomes.”
interest rates. The economic status of other members of the Eurozone, especially larger members like Spain and Italy, and European Union countries with extensive banking (i.e. borrowing) connections to major Eurozone banks may however delay actions that would suit France and Germany alone. So where does this leave Ireland? Any discussion of the monetary policy of the Eurozone must start from the following essential facts. Ireland is a small open economy. This means that it subsists through trade and does not have any position of market dominance, so that it cannot determine prices, interest rate or incomes. Ireland is thus a price taker, subject to all economic decisions and disturbances originating in larger economies such as the United States, France or Germany. Furthermore, Ireland has never since the foundation of the State had direct or indirect control over its monetary policy. From 1922 to 1979 Ireland’s monetary policy was determined by the Bank of England
“Quantitative easing has
created concern about future inflation and the difficulty of
reducing central bank liquidity without stalling a delicate recovery.”
directly. From 1979 to 1999 a system of exchange rate mechanisms linked Irish monetary policy to the Bundesbank. For the past decade, membership of the Eurozone has given Ireland extensive protections from speculative currency attacks. This protection has been particularly beneficial during the current crisis. Finally, Ireland’s economy is asymmetric vis-à-vis the major economic centres of the Eurozone, namely France and Germany. These are the factors which must colour discussion of Ireland’s monetary policy. Interest rates have been held at 1 per cent since 13 May 2009. Germany and France have begun the process of pulling out of their recessions with second quarter GDP gains of 1.3 per cent and 1.4 per cent respectively. Ireland’s first quarter 2009 returned an 8.5 per cent reduction in GDP. (German and French GDP shrunk by 6.9 per cent and 3.2 per cent respectively in Q1.09). Ireland’s economic downturn remains much deeper, its deficit much larger (2009 estimate -10.8 per cent), and its unemployment rate moderately higher (12.2 per cent) than the Eurozone and EU averages. This relative asymmetry places Ireland’s economy is a difficult position of being subject to an ill-fitting monetary policy. This lack of symmetry was partly responsible for the unsustainable expansion of the construction sector due to easy credit prior to the Great Recession. This is not to say that Ireland would have been protected if it had been taking policy direction from the Bank of England or the Federal Reserve. Both the US and UK economies had policies of easy credit and slid into a destructive housing boom-bust cycle. The bursting of the credit and asset bubbles has also brought about a degree of introspection on the part of all central banks: lavishing attention on price inflation is now seen as being too parochial. In hindsight it was the massive and largely ignored asset price inflation that fed the housing/construction and capital market booms. Monetary policy, like many elements of the economic policymaker’s toolkit, is a blunt instrument, more akin to a mallet than a scalpel. National governments, through regulation (which can have unintended consequences) and fiscal policy (which is slow to take effect and imprecise in its targeting) can significantly influence economic policy even without control over monetary policy. Many aspects of
3
European Economic Policy
macroeconomic policymaking are more art than science. In spite of these caveats, it would be wrong for Ireland to dwell too extensively on interest rate policy when there exists a much larger and more menacing elephant in the room – fiscal unsustainability.
Ireland
Ireland is currently borrowing €400 million a week in order to sustain current spending plans. This clearly cannot be supported over the medium term. The Growth and Stability Pact was approved in 1997 as the method for enabling the convergence of the original European Monetary Union economies prior to the introduction of the Euro. Countries that deviated from the Growth and Stability Pact after the introduction of the single currency would be required to comply with the Excessive Deficit Procedure, which resides in Article 104 of the European Community Treaty (Amsterdam), which outlines, in conjunction with Council Regulation (EC) No 1466/97, the procedures necessary to maintain budgetary discipline. Because of excessive deficits and rapidly increasing public debt levels (the ESRI estimates Gross Debt at 99 per cent of GDP in 2009: comprising normal debt at 57 per cent, NAMA at 30 per cent and recapitalisation at 12 per cent) Ireland was required to submit a Stability and Convergence Programme at the end the 2008 under the framework of the Excessive Deficit Procedure. This was amended in January 2009. The programme, which was agreed with the European Commission, outlines how Ireland will eliminate its budget deficit by 2013. To quote the submission itself: The Government has agreed to put in place a five year plan to restore balance to the public finances by 2013. This will include as a priority the elimination of the current budget deficit by 2013, that is to stop borrowing for day-to-day spending, and in that period to also bring the General Government deficit to below 3 per cent of GDP, while maintaining a high level of capital expenditure. The Report of the Special Group on Public Service Numbers and Expenditure Programmes led by Dr Colm McCarthy of UCD attempts to effect the fiscal policy changes necessary to place Ireland’s budget deficit level below 3 per cent by 2013. Dr. McCarthy has recommended approximately €5 billion in budget cuts in his report and provides the basis for reducing the fiscal burden over the medium term. As he outlined in several statements over the past year, the key to remedying 1980s fiscal impasse was not by cutting directly but slowing growth in public expenditure to zero. Now, with
4
“Ireland is currently
borrowing €400 million
a week in order to sustain
current spending plans. This clearly cannot be supported over the medium term.”
considerable quantities of “low hanging fruit,” it is necessary both to make direct cuts and to stop growth.
Exchange rates
The Irish Government in its submission to the European Commission raised concerns with respect to exchange rate exposure with major trading partners. Ireland’s recovery will be partly driven by the export sector, which defined the heady days of the Celtic Tiger. Even though Ireland trades extensively with Eurozone countries, the UK and the US are significant markets, especially since the US is Ireland’s main source of Foreign Direct Investment (FDI). This exchange rate exposure has been highlighted by the Government as a potential pitfall to the 2013 target, most especially if it is exacerbated by continued weak demand due to a weak recovery. International Monetary Fund (IMF) statements on the US and UK economies, as well as
the considered opinions of economists such as Professors Paul Krugman, Brad DeLong and Simon Johnson indicate a slow “L-shaped” recovery with a “jobless recovery” being the most likely scenario over the medium-term. Such predictions do not bode well for Irish exporters. European economic policy does have a significant impact upon the Irish economy but it alone does not shape economic destiny. Economic policies undertaken by all large economies have affected Ireland’s economic debt. Ireland cannot be sole master of its economic destiny, as a matter of fact, not as a matter of choice. Membership of the Eurozone has placed the Irish economy under a protective umbrella while the country experiences structural adjustment. This does not mean that Ireland’s domestic policymakers are absolved of their prudential responsibilities. As outlined above, the role of domestic policy is now more significant than ever as the government attempts to fulfill its obligations to the Excessive Deficit Procedure. Ireland’s position requires it to be prepared for its economic partners to enter recovery with competitive exports and an amiable environment for FDI. Continued fiscal iniquity is the true road to perdition and domestic policymakers must not only seek economies in public expenditure but also engage with the expertise of the elements of the European Union and ECB to discover novel solutions to the “Great Recession.” Dr Charles Larkin is a research associate in Trinity College Dublin Public Affairs Ireland
European economic policy & Ireland Charles Larkin gives an overview of the interaction between current European monetary policy and the Irish economy
Since August 2007 Ireland and the rest of the world have witnessed extraordinary economic events that have fundamentally changed economies. The global “Great Recession” has plunged economic activity into its longest downturn since the Great Depression of the 1930s. All European economies have suffered increases in deficit and debt levels as rising unemployment and reduced tax revenues have placed strains on their respective fiscal systems. This has highlighted the role of monetary policy as key to liquidity supply, regulatory support and inflation management. The European Central Bank’s (ECB) monetary policy is clearly defined as maintaining HICP inflation at no more than 2 per cent and M3 money supply growth at no more than 4.5 per cent (2 per cent inflation + 2.5 per cent annual Gross Domestic Product (GDP) growth). The recent economic downturn has de facto changed the ECB’s principal concern from one of inflation to deflation and to supporting the various European economic stimuli plans. This has placed it in direct political confrontation with France and Germany. The ECB, much like its counterparts in Washington and London, is engaged in firefighter operations, attempting to keep markets sufficiently fluid to facilitate the steady flow of funds between banks and provide the day-today liquidity that enables the economy to function. Central banks are now having to consider the long-term implications of these actions and the question of an exit strategy. Furthermore, quantitative easing has created concern about future inflation and the difficulty of reducing central bank liquidity without stalling a delicate recovery. Given the moderate recovery of France and Germany, these are the ECB’s main concerns.
Interest Rates
Will there be an interest rate increase? Not in the immediate future, but if the FrancoGerman recovery is robust and the Benelux countries see similar improvements, the ECB may slowly begin the process of reducing liquidity and potential increasing Public Affairs Ireland
“Any discussion of the monetary
policy of the Eurozone must start
from the following essential facts. Ireland is a small open economy.
This means that it subsists through trade and does not have any
position of market dominance, so that it cannot determine prices, interest rate or incomes.”
interest rates. The economic status of other members of the Eurozone, especially larger members like Spain and Italy, and European Union countries with extensive banking (i.e. borrowing) connections to major Eurozone banks may however delay actions that would suit France and Germany alone. So where does this leave Ireland? Any discussion of the monetary policy of the Eurozone must start from the following essential facts. Ireland is a small open economy. This means that it subsists through trade and does not have any position of market dominance, so that it cannot determine prices, interest rate or incomes. Ireland is thus a price taker, subject to all economic decisions and disturbances originating in larger economies such as the United States, France or Germany. Furthermore, Ireland has never since the foundation of the State had direct or indirect control over its monetary policy. From 1922 to 1979 Ireland’s monetary policy was determined by the Bank of England
“Quantitative easing has
created concern about future inflation and the difficulty of
reducing central bank liquidity without stalling a delicate recovery.”
directly. From 1979 to 1999 a system of exchange rate mechanisms linked Irish monetary policy to the Bundesbank. For the past decade, membership of the Eurozone has given Ireland extensive protections from speculative currency attacks. This protection has been particularly beneficial during the current crisis. Finally, Ireland’s economy is asymmetric vis-à-vis the major economic centres of the Eurozone, namely France and Germany. These are the factors which must colour discussion of Ireland’s monetary policy. Interest rates have been held at 1 per cent since 13 May 2009. Germany and France have begun the process of pulling out of their recessions with second quarter GDP gains of 1.3 per cent and 1.4 per cent respectively. Ireland’s first quarter 2009 returned an 8.5 per cent reduction in GDP. (German and French GDP shrunk by 6.9 per cent and 3.2 per cent respectively in Q1.09). Ireland’s economic downturn remains much deeper, its deficit much larger (2009 estimate -10.8 per cent), and its unemployment rate moderately higher (12.2 per cent) than the Eurozone and EU averages. This relative asymmetry places Ireland’s economy is a difficult position of being subject to an ill-fitting monetary policy. This lack of symmetry was partly responsible for the unsustainable expansion of the construction sector due to easy credit prior to the Great Recession. This is not to say that Ireland would have been protected if it had been taking policy direction from the Bank of England or the Federal Reserve. Both the US and UK economies had policies of easy credit and slid into a destructive housing boom-bust cycle. The bursting of the credit and asset bubbles has also brought about a degree of introspection on the part of all central banks: lavishing attention on price inflation is now seen as being too parochial. In hindsight it was the massive and largely ignored asset price inflation that fed the housing/construction and capital market booms. Monetary policy, like many elements of the economic policymaker’s toolkit, is a blunt instrument, more akin to a mallet than a scalpel. National governments, through regulation (which can have unintended consequences) and fiscal policy (which is slow to take effect and imprecise in its targeting) can significantly influence economic policy even without control over monetary policy. Many aspects of
3
European Economic Policy
macroeconomic policymaking are more art than science. In spite of these caveats, it would be wrong for Ireland to dwell too extensively on interest rate policy when there exists a much larger and more menacing elephant in the room – fiscal unsustainability.
Ireland
Ireland is currently borrowing €400 million a week in order to sustain current spending plans. This clearly cannot be supported over the medium term. The Growth and Stability Pact was approved in 1997 as the method for enabling the convergence of the original European Monetary Union economies prior to the introduction of the Euro. Countries that deviated from the Growth and Stability Pact after the introduction of the single currency would be required to comply with the Excessive Deficit Procedure, which resides in Article 104 of the European Community Treaty (Amsterdam), which outlines, in conjunction with Council Regulation (EC) No 1466/97, the procedures necessary to maintain budgetary discipline. Because of excessive deficits and rapidly increasing public debt levels (the ESRI estimates Gross Debt at 99 per cent of GDP in 2009: comprising normal debt at 57 per cent, NAMA at 30 per cent and recapitalisation at 12 per cent) Ireland was required to submit a Stability and Convergence Programme at the end the 2008 under the framework of the Excessive Deficit Procedure. This was amended in January 2009. The programme, which was agreed with the European Commission, outlines how Ireland will eliminate its budget deficit by 2013. To quote the submission itself: The Government has agreed to put in place a five year plan to restore balance to the public finances by 2013. This will include as a priority the elimination of the current budget deficit by 2013, that is to stop borrowing for day-to-day spending, and in that period to also bring the General Government deficit to below 3 per cent of GDP, while maintaining a high level of capital expenditure. The Report of the Special Group on Public Service Numbers and Expenditure Programmes led by Dr Colm McCarthy of UCD attempts to effect the fiscal policy changes necessary to place Ireland’s budget deficit level below 3 per cent by 2013. Dr. McCarthy has recommended approximately €5 billion in budget cuts in his report and provides the basis for reducing the fiscal burden over the medium term. As he outlined in several statements over the past year, the key to remedying 1980s fiscal impasse was not by cutting directly but slowing growth in public expenditure to zero. Now, with
4
“Ireland is currently
borrowing €400 million
a week in order to sustain
current spending plans. This clearly cannot be supported over the medium term.”
considerable quantities of “low hanging fruit,” it is necessary both to make direct cuts and to stop growth.
Exchange rates
The Irish Government in its submission to the European Commission raised concerns with respect to exchange rate exposure with major trading partners. Ireland’s recovery will be partly driven by the export sector, which defined the heady days of the Celtic Tiger. Even though Ireland trades extensively with Eurozone countries, the UK and the US are significant markets, especially since the US is Ireland’s main source of Foreign Direct Investment (FDI). This exchange rate exposure has been highlighted by the Government as a potential pitfall to the 2013 target, most especially if it is exacerbated by continued weak demand due to a weak recovery. International Monetary Fund (IMF) statements on the US and UK economies, as well as
the considered opinions of economists such as Professors Paul Krugman, Brad DeLong and Simon Johnson indicate a slow “L-shaped” recovery with a “jobless recovery” being the most likely scenario over the medium-term. Such predictions do not bode well for Irish exporters. European economic policy does have a significant impact upon the Irish economy but it alone does not shape economic destiny. Economic policies undertaken by all large economies have affected Ireland’s economic debt. Ireland cannot be sole master of its economic destiny, as a matter of fact, not as a matter of choice. Membership of the Eurozone has placed the Irish economy under a protective umbrella while the country experiences structural adjustment. This does not mean that Ireland’s domestic policymakers are absolved of their prudential responsibilities. As outlined above, the role of domestic policy is now more significant than ever as the government attempts to fulfill its obligations to the Excessive Deficit Procedure. Ireland’s position requires it to be prepared for its economic partners to enter recovery with competitive exports and an amiable environment for FDI. Continued fiscal iniquity is the true road to perdition and domestic policymakers must not only seek economies in public expenditure but also engage with the expertise of the elements of the European Union and ECB to discover novel solutions to the “Great Recession.” Dr Charles Larkin is a research associate in Trinity College Dublin Public Affairs Ireland
