eye on the economy
‘Even as a crisis, it was badly handled. It is quite a contest between Dublin, Berlin and Frankfurt as to who made the biggest muddle’
finances and borrow their own money. Their bond yields can vary quite a lot. One reason is that,
in the US at any rate, they can theoretically default on their loans. In practice, this is seen as unlikely because the federal government might jib at the consequence, as President Gerald Ford did when he – reluctantly – rescued New York City from default. Nevertheless, the risk is not zero, or the interest rate for
the states would be the same as for theUS Treasury. In the euro area, though, it was implied that the risk was zero. Eurozone countries could not default. Such a remarkable guarantee would require remarkable
backing. In effect, the whole euro area would have had to back the debt of each state. No such guarantee was made. Nor could it be made politically.
Recurring theme This is a recurring theme, where European leaders desire the ends, but are unwilling to apply the means. They tried instead to make sure the problem would not arise, by applying strict budget discipline via the Stability and Growth Pact (SGP). It is easy to forget how strict the condition of a 3pc of
GDPmaximumdeficit really is, given the benign conditions in the first decade of the euro, whichmade compliance rel- atively easy. Even so, compliancewas not absolute. The fact is that not
evenGermany would havemet the conditions over the past 30 years. It had larger deficits on a number of occasions – the last one as a member of the euro. The costs of unifica- tion may have been to blame for some breaches, but then there are always exceptional circumstances somewhere. The lesson of the Irish experience is that, even if obeyed,
the SGP was not sufficient to remove the risk of a debt cri- sis. For that, one would need an accurate measure of the underlying “structural” budget position. But economists cannot agree on how to measure this concept, and it is politically impossible to run a country on a figure that is invisible. The risk of default cannot be removed, so it must be
recognised. European leaders are inching towards this, and Ireland is a test case. Not only did it technically keep within EU rules before its finances imploded, but it combines both a fiscal crisis and a banking crisis. This runs up against the second bit of wishful thinking at
20 Irish Director Winter 2010
the heart of the single currency – that there can be no bailout. Of course, if there was never to be a default, a bailout would not be needed. Once default has become a possibility – as it has now – then the choice is between default and bailout, or a bit of default combined with a bit of bailout.
Case in point Ireland’s twin crisis provides an opportunity to neatly draw these distinctions. There could be losses for lenders to the banking system, but full repayment to lenders to the sov- ereign. The courts would have a field day, given that both were guaranteed by the sovereign, but there is a certain logic to such an approach. Alternatively, eurozone taxpayers, especially the German
ones, could be persuaded to stand over all debts up to 2013, with new mechanisms applying after that. This seems to be the position into which Merkel stum-
bled after her ill-judged speech. This implied that lenders might take a hit once a country found itself facing punitive rates on the markets and having to seek cheaper funding from the eurozone institutions. It was ill-judged because it came in themiddle of a crisis,
andmade the crisis worse, but shemay be on to something. Such a rule should make the markets more careful about lending to euro countries and thereforemore diligent about analysing their underlying positions. Of course borrowing costs would be higher, but they were
far too low for countries like Ireland – never mind Greece – which should never have been regarded as representing the same risk as Germany. Paper rules will never keep politicians away from the
tempting tap of borrowing, only financial cost can do that. The combination of that discipline, plus a permanent crisis mechanism of the kind being fiercely debated in Europe, could well provide a template, at least, for future crises. Only for future ones, though. The present, enormous, one
must be tackled under totally inadequate formal arrange- ments. That is why it poses a real threat to the whole euro project. One would like to think that the enormity of that risk
would persuade euro governments to do whatever it takes now, on the basis that something better will then be put in place for the future. Given their past record, one cannot be entirely optimistic.
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