Duncan’s Economic Blog

Across the Irish Sea…

Posted in Uncategorized by duncanseconomicblog on March 23, 2009

There is a very good article in the Economist on the state of the Irish economy.

Ireland is having a deeper recession than any other euro area country. The economy probably shrank by 2.5% in 2008 and may contract by another 6.5% this year. Unemployment has jumped from 5% to 10.4%, a faster rise even than in America. Irish banks may be free of the toxic securities that have poisoned rivals’ balance sheets, but they are blighted by souring property loans.

The symptoms are familiar: a burst property bubble, broken banks and highly indebted consumers. The response is very different.

In February, in the teeth of union opposition, the government introduced a levy on public-sector pensions that cut take-home pay by an average of 7.5%. The pain will intensify in April. Income-tax rates seem certain to rise, some capital projects may be put on ice and more current spending will be cut. The Irish insist on keeping their 12.5% corporate-tax rate.

In addition VAT has been hiked to 21.5%. With no central bank of their own the Irish cannot cut interest rates to a more appropriate level, the ECB was raising rates as recently as July last year. With no independent currency, the Irish can not devalue externally to support their exporters.

The only possible response is fiscal policy and here the government has chosen to try and cut public debt rather than support the economy. This ‘Treasury View’ policy has gained support from the usual suspects:

Ireland, which is taking the austerity route out of the crisis, slashing government spending, is attracting an entirely private sector solution to recapitalising banks. Property prices are becoming reasonable, tax rates are lower and big British run businesses are relocating to Ireland.

Ireland will probably be out of recession long before an economy crippled by Brown starts to recover – whoever wins the next election.

I disagree. The government is openly aiming for a policy of deflation to regain international competitiveness. It wants nominal wages to fall. It is betting that after a swift fall of GDP, in the order of 10%, things will stabilize at a lower level. All this seems a very large risk. Embracing demand deficit deflation is not a sensible policy.


One Response

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  1. VinoS said, on March 23, 2009 at 5:47 pm

    Yes, indeed, the situation in Ireland does sound grim. Being in the single currency, devaluation and other autonomous monetary policies are not possible. This could well mean that their recession ends up worse than ours – unless the EU can come up with sufficient regional policy funds to help them out.

    By the way, PB argues that there might be an early election there. I hope so. Would be good for FG and Labour.

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