Sunday 4 December 2016

Imagine if we hadn’t taken a punt on the euro

As the eurozone totters on the brink of disintegration, George Garvey considers what might have happened if Ireland had decided to stay out of the single currency

Published 20/09/2011 | 05:00

Ever since the euro crisis first erupted in the autumn of 2008, Europe's leaders have proved themselves utterly unable to agree on the measures needed to stabilise the common currency.

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Which of course begs the question: would we have been better off staying out of the eurozone and sticking with the punt? Based on the evidence of our first 12 years of membership, the answer is almost certainly yes.

By the late 1990s, the Irish economy was booming. The Sick Man of Europe had given way to the Celtic Tiger. Multinationals flocked to Ireland and the domestic economy was creating tens of thousands of new jobs every year. The twin scourges of unemployment and emigration disappeared and Irish incomes, which had long been among the lowest in western Europe, climbed to the EU average.

Contrary to what supporters of our euro membership have frequently asserted, this had all happened before we joined the euro at the beginning of 1999.

Fast forward a dozen years and the Celtic Tiger is a rapidly receding memory. Not alone has the prosperity of the '90s and Noughties been replaced by the worst economic downturn for at least 80 years, the banks are bust, the State is insolvent and we have experienced a catastrophic property crash.

In fact, when measured in terms of lost economic output, the cost of the bank bailout and the rise in the national debt, the post-Celtic Tiger blowout is, proportionately, the worst economic bust experienced by any developed country for at least a century.

And it was the euro which allowed this to happen. As late as the end of 1997, almost 90pc of all Irish bank lending was financed by Irish bank deposits while property-based lending made up less than a third of the combined loan books of the Irish banks.

While Irish bank customers could borrow in foreign currency, in practice, with the borrower forced to carry the exchange rate risk, such loans were expensive and relatively rare.

Our membership of the euro removed this de facto cap on Irish bank lending. Suddenly Irish banks could go out and borrow money from other eurozone banks without any exchange rate risk and lend it on to their customers.

Not alone did our membership of the euro effectively remove the cap on Irish bank lending, it also halved the cost of borrowing as Irish interest rates converged on German rates during 1998. This combination of a massive increase in the availability of credit and a halving of interest rates was the economic equivalent of crack cocaine.

By the end of 2007, Irish bank lending was almost seven times greater than it had been a decade earlier while over the same period Irish bank deposits had "only" tripled. This meant that the proportion of Irish bank lending financed by Irish bank deposits fell to less than 45pc.

Even worse, most of this explosion in bank lending went to the rapidly over-heating Irish property market, with property-based lending jumping to two-thirds of total lending in the space of just 10 years. As a result, average house prices more than trebled over the same period.

These soaring property prices pushed up Irish costs and destroyed our international competitiveness. By 2008, Irish prices were 27pc higher than the EU average, while we slipped from fifth to 29th place in the World Economic Forum's global competitiveness rankings.

Even worse, not alone did the credit binge that was fuelling the Irish property bubble effectively bankrupt the Irish banks -- which when prices began to fall in 2007 suddenly found themselves saddled with tens of billions of bad property loans -- the sudden evaporation of the once-off revenues generated by the property bubble also bankrupted the State.

So would things have been different if, like the UK, Sweden and Denmark, we, too, had opted to stay out of the euro in 1999? If we had it is likely that the Irish pound would, like sterling and the dollar, have initially risen against the euro while our interest rates would also have stayed higher than those in the eurozone.

This would almost certainly have meant that the Celtic Tiger boom and the associated property bubble would have fizzled out sometime around 2001-2. In fact, we could have experienced quite a nasty recession soon after the turn of the century as unemployment temporarily rose and house prices fell.

But with our own independent currency, we would then have been able to cut interest rates in response to this recession. Meanwhile, with the euro strengthening from 2002 onwards, the Irish pound would have fallen in value on the foreign exchange markets. With a lower exchange rate and without the higher costs caused by the property boom, Ireland would have been spared the catastrophic loss of competitiveness which she suffered during the first decade of the 21st Century.

An early-Noughties recession would, by popping the property bubble five or more years earlier than actually happened, also have saved both the Government and the banks from going bust.

A 2001-2 property downturn would have forced the banks to stop their reckless lending far sooner. It would also, by denying the Exchequer tens of billions of once-off revenues from property-based taxes, have compelled the Government to jam the brakes on public spending early in the decade.

This would have meant that, when the global credit crunch struck in 2007, Ireland would have had both a solvent Exchequer and banking system. Even better, with our own currency, we would have been able to follow the British example of cutting interest rates and letting the Irish pound fall in value against the euro, further boosting the competitiveness of our exports in overseas markets.

After a short recession in 2008-9, the hyper-competitive Irish economy would now be experiencing a strong recovery. After a decade in hibernation the Celtic Tiger would once again be roaming free.

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