MARKETS are forward- looking. That's the first thing I say to students when I teach them financial economics at the University of Limerick. This one statement has everything students need to understand about how and why financial markets work. They deal in expectations about the future, and discount the past heavily.
As a nation, we've rightly been obsessed by changing the expectations of the markets, because we want them to lend us money to have the standard of living we have today. We also want them to lend us money so we can roll over some of the €125bn or so of debt we've racked up since 2007. What should Ireland do next to change the expectations of the markets further?
The Government has every right to savour its success with the European authorities on changing the repayment rates of the promissory notes. Like most people, I congratulate Ministers Noonan and Hayes for taking such a big step towards righting the ship of State. Looking forward, however, they don't have the right to be complacent about the remaining challenges facing the State.
Two big, messy, intertwined issues remain unresolved.
First, unemployment. The Government's own projections forecast over the lifetime of the Government only a 1pc drop in unemployment, and that's if everything goes to plan. There are now more than 200,000 people unemployed for more than one year, with more than 80,000 people on some form of labour market activation scheme like community employment and back-to-education schemes.
UCD economist Philip O'Connell recently estimated that almost none of these schemes had any benefit for their users. Recent research by the ESRI has also found a large regional variation. The national unemployment rate is 14.6pc, but if you're in the mid-west, it is 16.6pc; in the midlands, it is 17.4pc; in the south-east, it is 19.4pc. (To give you a sense of scale, at the height of the Great Depression in the US in 1932, the unemployment rate was just over 20pc.)
Unemployment also costs the State dearly. In 2012, 38pc of all the State's spending was on social welfare, 30pc was on pay, 6pc on pensions and 26pc on everything else. The State's finances will not recover without a change in the policies around unemployment and the clear lack of a coherent strategy to deal with the problem. When we begin to see unemployment falling steadily, that will be a sign to the markets that growth is returning to the economy, and the State will be capable of repaying any debt it incurs.
Next, the Government must focus on the long-neglected issue of excess household debt, particularly mortgage arrears. We are all waiting for the new insolvency service to kick off, but the banks have been terribly slow to move cases through the system, a matter of some frustration for the Central Bank.
But never mind them. The stress and anxiety caused by unsustainable debt levels has not been fully examined, but a 2011 study of more than 7,000 people found that those in debt in the UK were twice as likely to think about suicide, after controlling for sociodemographic, economic, social and lifestyle factors.
The human cost of excess debt is extremely high, and not well studied in the Irish context. From the point of view of the economy, the mortgage crisis hammers personal consumption, because those in great debt don't spend, so demand for goods and services is depressed.
Excess debt also depresses local markets, and it represents a claim on the assets of the banks who hold those loans, which scares potential investors.
Eventually, someone will have to resolve each and every bad loan, and someone will take the hit for restructuring the debt. Another thing I tell my students: debt doesn't go away. There is no such thing as a write-off. It's probably more accurate to say someone else has to pay a part of the debt, and that someone is usually the bank or the State.
Despite last week's good news, our banks are still reliant on the State, and won't get outside investors to pour cash in unless the mortgage crisis begins to resolve itself.
Then the recapitalised banks will be able to lend with relatively clean balance sheets, and the issues around credit for businesses and households will resolve themselves.
The Government should focus on these issues, because resolving either, even partially, would have much more beneficial effects on Irish society, and much more beneficial effects on the electoral outcome, edging ever closer.