2008-10 irish crisis_managerial economics
TRANSCRIPT
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2008-2010: Irish Crisis
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• The Irish Crisis is perhaps the most dramatic turnaround of any country in the euro zone
• Many had rated Ireland high in its economic achievements– High rates of economic growth and low
unemployment combined with budget surpluses– The country appeared to be well placed to cope
with any slowdown
• However...– Irish Government was unable to manage economic
crisis on its own
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The Celtic Tiger• Refers to economy of Ireland from mid-1990s
to mid 2000s– A period of real economic growth fuelled by foreign
direct investment
• Pre-Tiger era– In 1960s, Ireland moved away from protectionist
trade policy– January 1,1973: Ireland joined European Economic
Committee– Export oriented industrial policies– Gradual Improvement in Education Standards
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• Pre-Tiger era(contd.)– However Ireland’s macroeconomic stabilization
policies were not so good
1970s Global Slowdown
Ireland reacted by
running Very large fiscal
deficit
Resulted into 1980s Debt
crisis
In 1979, traditional currency link with Sterling
was dropped
Resulted into unstable monetary regime featuring
regular devaluations
• By mid 1980s Ireland had Public debt-GDP ratio over 110 per cent
• Tax rates had raised to punitive levels• Growth had stagnated
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Ireland’s famed Celtic era began• The period from 1987 onwards saw fiscal
problems dealt with via a program that focused on restraining spending
• By 1989, Ireland’s debt dynamics had clearly moved in direction of sustainability
• European Monetary System(EMS) started delivering a period of monetary stability
• As a result Irish economy began to grow at an impressive rate
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Fraction of Population Aged 15-64
By late 1990s, Ireland had a higher fraction of its population in working age bracket than either the US or the UK
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Labor Force Participation RateWhen economy recovered, Irish people abroad began taking jobs at homeA large female labor supply actively participated in economy
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Drop in Unemployment RateEmployment rose steadily from 1.1 million in late 1980s to 2.1 million in 2007
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• Steady improvements in productivity resulted into extraordinary economic growth– From 1987 to 2007, economic growth averaged 6.3 per
cent per year
• Irish Government lowered tax rates and increased public spending year in and year out
• Yet economic growth delivered sufficient tax revenues to Government to a string of budget surpluses
• High productivity and a business friendly environment enabled Ireland to position itself well as a gateway to EU markets & primarily to US FDI
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The Housing Boom• At the turn of the millennium, Ireland still had
a relatively small housing stock• Ireland had the smallest per capita housing
stock in the EU
Rapid expansion
in Incomes
Low mortgage interest
rates
Increase in housing demand
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Decrease in Mortgage Interest Rates
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House Prices in Ireland and US
As a result house prices quadrupled between 1996 and 2007
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• Response to this increase in housing demand was an extraordinary construction boom
• Construction became a dominant factor in Irish economy
• By 2007, construction accounted for 13.3 per cent of all employment, the highest share in OECD
• Much of the labor employed in construction boom came from new EU member states
• Inward migration itself further fuelled demand for housing
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Year The Total Stock of Dwellings
1991 1.2 Million
2000 1.4 Million
2008 1.9 Million
Year House Completions
1990 19000
2000 50000
2006 93000
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House Completions Per Thousand People
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The Bubble Pops• Irish house prices had became increasingly over-
valued
• As world entered into severe recession in 2008, Irish Government believed economic growth slowdown would occur at an acceptable degree
• As a result very little was done by the Government or central bank to cool the property market
• A number of political parties campaigned during the 2007 election for abolition of stamp duty to assist young buyers
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• When International financial crisis had gotten into full swing, Irish house prices began to fall from peak levels
• Prices fell Demand for new houses collapsed
• Attitude of potential buyers changed swiftly from being desperate to wait to get better price later
• In mid-2008, house prices fell about 50 per cent from their peak values
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Collapse in Housing Construction
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Fraction of Labor Force in Construction : DecreasedUnemployment: Increased
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Booming Housing Activity
Surging House Prices
During the periods of boom, Ireland’s tax revenue was primarily collected from asset based taxes
Stamp duties Capital gains tax Capital acquisition tax
Reduction in share of revenues collected from
income taxes
Share of asset-based tax revenue increased
rapidly
&
The Fiscal Crisis
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Collapse in Construction Activity
Corresponding jump in unemployment
• Ireland's apparently strong fiscal situation was heavily dependent on health of its property sector
• When property sector collapsed, substantial source of Government revenue disappeared almost overnight
Huge Loss in Income Tax Revenues
Big increase in social welfare payments
&
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Composition of Tax Revenues
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Impacts of fiscal crisis
Irish real GDP declined by ten per cent over 2008 and 2009
Nominal GDP contracted even more sharply, from 190 billion Euros in 2007 to 161 billion Euros in 2009
Ireland was heading for annual deficits of as large as 20 per cent of GDP
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Measures taken by Irish Government• From late 2008 onwards,
there had been a series of contractionary budgets
• Public sector pay had cut by significant amounts
• Income tax and VAT rates had raised
• Non-welfare current spending had cut back
• Capital spending had slashed
• As a result total amount of discretionary tax increases and spending cuts by 28.8 billion Euros
• These budgetary adjustments were equivalent to 6270 Euros per person, one of the largest budgetary advancements in the advanced economic world in modern times
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The Banking Crisis• Ireland’s recession became a crisis due to the
collapse of its bank– Housing activity was largely financed by the Irish banks
• Irish banks rapidly expanded their mortgage lending
• Property related loans to construction businesses expanded from 45 billion Euros in 2003 to a peak of 125 billion Euros in 2008
• Fate of most of these loans were dependent on rise in property prices
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The total stock of mortgage loans in Ireland exploded from €16 billion in 2003 to a peak of €106 billion in 2008 about 60 percent of that year’s GDP
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• Loans were largely concentrated in a small number of banks
• Change in funding model– Prior 2003, loans were mainly funded by deposits– After 2003, loans were largely financed with bonds
issued to international investors– This source of funding was comparably less stable
• Although Irish banks had big cushions, they were dealing with credit concentration risk
• As Irish construction collapse, banks found it increasingly difficult to raise funds on bond markets
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From less than €15 billion in 2003, international bond borrowings of the six main Irish banks rose to almost €100 billion (well over half of GDP) by 2007
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Measures taken by Irish Government
• On September 30,2008 government decided to issue a blanket guarantee for all of the existing and all future liabilities of domestic Irish banks
• Large costs of these measures further exacerbated budget deficit
• Significant budget deficit coupled with bank debt caused international investors to question the sustainability of Irish sovereign debt
• Government was effectively locked out of international bond markets and was unable to borrow to fund the deficit
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Public debt and Deficit ratios to GDP
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EU-IMF
• European Commission(EC) & IMF got fund commitments from Irish government, despite no providing official money, ECB involved seeing the birth of ‘Troika’
• Funding commitments of €67.5 billion by ECB
• Money would spend for reasons like restructure the banking sector, implement further fiscal adjustment and restore competitiveness and strengthen the economy's growth potential
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Breakdown of EU-IMF financial assistance programme
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• Banking sector reforms
Recapitalisation of the domestic banks, Deleveraging of bank balance sheets, Renewal of bank boards
• Fiscal consolidation
Restoration of the long-term sustainability of public finances, Reduction in budget deficit target
• Structural reforms
Reformation in sectoral labour market agreements, Improve labour market activation, Encouragement for competition in sheltered sectors
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Ireland’s recovery story
• Budget deficit is projected to 7.3% of GDP in 2013, 4.3% in 2014, 2.1% in 2015. Primary budget is projected to record a surplus of 3 percent
• A gradual return to healthy economic growth for a number of years, only to have the forecasted recovery to be continually delayed
• Ireland’s cost competitiveness was eroded and net exports declined as a share of GDP
• Ireland’s export growth in recent years partly reflects an improvement in competitiveness
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Euro zone Economic policy from Irish Crisis
• Monitoring macroeconomic imbalances is adopted by EC because of problem caused by housing bubble and employment & tax revenue are overly dependent
• Macro-prudential approach to regulation in which macro stress scenarios and feedback effects are given more prominence
• Strongly in favour of the proposed harmonized approach to banking supervision across the euro area
• Greater success in reducing costs and raising exports because crisis has provided an illustration of the benefits of a less regulated labour market
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Current economic condition of Ireland
• 1.5% increase in gross domestic product (GDP) in the second quarter
• Rise by 13% increase in exports in the second quarter and 1.8% rise in household spending, the largest annual rise in almost four years
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