Recovering from the Crisis: Whither the Irish Economy?

John McHaleNational University of Ireland, Galway

Irish Fiscal Advisory Council

European Commission Conference: Challenges Facing the Irish EconomyGalway, March 24, 2012

Overview

• The shock

• Adverse feedbacks and the stabilisation challenge

• Failure to “manage” without outside assistance

• The recovery strategy: (Phased) adjustment with assistance

• The banking challenge

• The fiscal challenge

• The growth challenge

The bubbles bursts

1975 1980 1985 1990 1995 2000 2005 20100

2,000

4,000

6,000

8,000

10,000

12,000

Monthly House Completions, January 1975 to January 2011

Based on ESB Electricity Connections

Source: Department of Housing, Hertiage and Local Government

Adverse feedback loops

In the end, we failed to manage the crisis without outside assistance

Loss of bank fundingSource: NTMA

Dec-08 Dec-09 Dec-10 Jun-11 Sep-110

20

40

60

80

100

120

140

160 152 146136

118 121

Retail DepositsBillions of Euro

Dec-08 Dec-09 Dec-10 Jun-11 Sep-110

20

40

60

80

100

120

140

160

103

80

3221 21

Billions of EuroCorpotate Deposits

Dec-08 Dec-09 Dec-10 Jun-11 Sep-110

20

40

60

80

100

120

140

160140

123

6958 55

Billions of EuroDebt Capital Markets

Dec-08 Dec-09 Dec-10 Jun-11 Sep-110

20

40

60

80

100

120

140

160

89

50

3019 21

Billions of EuroRepo/Interbank

Heavy dependence on ECB/CBI

Dec-08 Dec-09 Dec-10 Jun-11 Sep-110

20

40

60

80

100

120

140

160

37

62

142

123 122

Billions of EuroCentral Bank

Loss of Government creditworthinessApprox. 10-year yields (monthly averages)

Jan-01Jul-0

1

Jan-02Jul-0

2

Jan-03Jul-0

3

Jan-04Jul-0

4

Jan-05Jul-0

5

Jan-06Jul-0

6

Jan-07Jul-0

7

Jan-08Jul-0

8

Jan-09Jul-0

9

Jan-10Jul-1

0

Jan-11Jul-1

1

Jan-120

2

4

6

8

10

12

14

Ireland

Germany

Source: ECB; http://www.ecb.int/stats/money/long/html/index.en.html

Recovery strategy• (Phased) adjustment with financing

• Banking adjustment– Recapitalise/deleverage– Credit supply/debt resolution

• Fiscal adjustment– Bring deficit & debt to safer levels– Limit fall in domestic demand

• Real economy– Restore competitiveness– Restore growth in domestic demand

• Fiscal adjustment harms disposable income• Need for confidence in future path of disposable income

As seen by Government . . . Stabilisation, reputation, confidence

The Banking Challenge

Objectives

• Functioning credit system– Rational credit decisions– Access to funding

• Limit liability to the State• Secure future financial

stability • Reduce burden of private-

sector debt

Policies

• Guarantees– Original “blanket” guarantee– ELG guarantee (new borrowing)

• Remove “toxic” assets– National Asset Management

Agency (NAMA)

• Recapitalisation• Deleveraging• New regulatory / supervisory

regime• Debt forgiveness

Cost of the Banking RescueBillions of Euro

Cost Prior to March 31

March 31 Stress Tests Total

AIB/EBS 8.1 12.7 20.8

Bank of Ireland 3.5 1.2 4.7

IL&P 0 2.7 2.7

Anglo /INBS 34.7 0.0 34.7

Total 46.3 16.6 62.9

Securing bank funding

Capital

Deleverage/de-risk Reliable lender of last resort

Guarantees

Big challenges

• Recapitalise/deleverage without a severe credit contraction

• Debt forgiveness without further undermining bank balance sheets

The Fiscal Challenge

Actual and planned austerity measuresBillions of Euro

July 2008Expenditure adjustments

1.0

Budget 2009 (October 2008)Revenue raising measures

2.0

February 2009Expenditure adjustments

2.1

Supplementary budget (April 2009)Revenue-raising & expenditure-reducing measures

5.4

Budget 2010 (December 2009)Revenue-raising & expenditure-reducing measures

4.1

Budget 2011 (December 2010)Revenue-raising & expenditure-reducing measures

6.0

Budget 2012 (December 2011)Revenue-raising & expenditure-reducing measures

3.8

Planned Adjustments: 2013 – 2015Revenue-raising & expenditure-reducing measures

8.6

Total actual and planned adjustment 33.0 (≈ 21 % of GDP)

Simulation of zero-adjustment scenario

General Government Deficit

2011 2012 2013 2014 20150

1

2

3

4

5

6

7

8

9

10

11

IrelandGreecePortugalSpain

Overall Deficit % of GDP

Source: IMF

Primary (non-interest) surplus

2011 2012 2013 2014 2015

-8

-6

-4

-2

0

2

4

6

IrelandGreecePortugalSpain

Primary Balance % of GDP

Source: IMF

Determining the fiscal stance

• Difficult balancing act: – Supporting domestic demand vs.

ensuring sustainability/creditworthiness

• Fiscal Council recommended a more ambitious fiscal adjustment in October 2011– Funding vulnerabilities– Risks to debt sustainability– Slow pace of debt reduction post-2015

• Negative growth surprise → Worsens the dilemma

The Growth Challenge

Real economySeasonally Adjusted Quarterly Aggregates, 1997Q2 – 2011Q3

1997Q1

1997Q4

1998Q3

1999Q2

2000Q1

2000Q4

2001Q3

2002Q2

2003Q1

2003Q4

2004Q3

2005Q2

2006Q1

2006Q4

2007Q3

2008Q2

2009Q1

2009Q4

2010Q3

2011Q215,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Real GDPReal GNPReal Domestic Demand

€m

Massive rise in unemployment . . .

0

2

4

6

8

10

12

14

16

Unemployment Rate

Long-term Unemployment Rate

. . . Large fall in employment

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0Millions

Consistent downward revisions to 2012 forecasts

Autumn 2010 Winter 2010 Spring 2011 Autumn/Summer 2011

Autumn/Winter 2011

Winter/Spring 2012

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

DoF CBI ESRI EC IMF

%

Unusual uncertainty: Whither the Irish Economy?

• Uncertainty about the starting output gap

• Uncertainty about the speed at which the gap will close

• Uncertainty about the underlying potential growth rate

Output gap

2008 2009 2010 2011 2012 2013 2014 2015

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

Output Gap (IMF) Output Gap (Budget 2012)

Percent of Potential Output

Actual and Potential GDP (IMF)

2008 2009 2010 2011 2012 2013 2014 20150.86

0.88

0.90

0.92

0.94

0.96

0.98

1.00

1.02

1.04

1.06

Real GDP (IMF) Potential Real GDP (IMF)

Actual and Potential GDP (IMF & Budget 2012)

2008 2009 2010 2011 2012 2013 2014 20150.86

0.88

0.90

0.92

0.94

0.96

0.98

1.00

1.02

1.04

1.06

Real GDP (IMF) Potential Real GDP (IMF)Real GDP (Budget 2012) Potential Real GDP (Budget 2012)

Growth strategy

Demand

Supply

Domestic Demand

Net Exports

Competitiveness

Smart Economy

Focus by necessity

Nominal GDP growth, 2007 - 2011

2007 2008 2009 2010 2011

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%6.5%

-5.2%

-10.8%

-2.9%

0.3%

Source: CSO

A dual economy: Contributions to nominal GDP growth, 2007 - 2011

2007 2008 2009 2010 2011

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

6.6%

-4.8%

-15.5%

-5.9%

-2.2%

0.0% -0.4%

4.8%

3.1%2.4%

Domestic Demand

Net Exports

Source: CSONote: Statistical discrepancy included under domestic demand

Q4 National Accounts

• 2011– Real GDP: +0.7 percent– Real GNP: -2.5 percent

• Back in recession: Two successive quarters of contraction

• Tentative signs of stabilisation in domestic economy– Final domestic demand up 1.3 percent in final quarter– Consistent with surprise 10,000 job gain in quarter

Other heavily debated topics

• Restructuring the IBRC promissory notes

• Referendum on the fiscal compact

• Building the euro zone firewalls