Brendan Keenan

Friday 25 July 2014

In Good, Bad and the Ugly euro gunfight, the baddie will prevail

The ESRI is hedging its bets on the prospects of recovery but Ireland can help itself by tackling private debt

Brendan Keenan

Published 14/07/2013|04:00

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OF that about which nothing can be said, nothing should be said. According to some critics, that dictum seems to be the motto of the medium-term economic review published by the ESRI last week.

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It is easy to have some sympathy with the authors, led by economist John FitzGerald. He argued forcefully that everything which can reasonably be expected over the next five years is covered in the report. But these are strange times, and the way in which things were presented in the report was unusual.

Normally, the tradition in economic forecasting is to present a range of possibilities; while the tradition in the media is to concentrate on the middle one.

Thus, the last medium-term review five years ago is unhappily remembered for its "benchmark" forecast of 3 per cent growth to 2015. But other, grimmer possibilities were also presented.

A more pertinent criticism, looking back, is that the grimmer, pessimistic scenario should have been presented as the probable "benchmark", rather than a less likely, but still possible, outcome.

Even at the time, the conditions assumed under the pessimistic scenario looked all too plausible. But it was not the "benchmark" and received little attention. Imagine the fuss if it had been.

The ESRI review made its name correctly forecasting the Nineties boom – it just wasn't boomy enough. It would have made its name in a quite different way, had it forecast a severe recession, and would probably have been blamed for causing it.

Since then, the ESRI analysts have done a lot of work on their model of the Irish economy. One result from the work is that we can forget about enjoying German interest rates again. When and if all our problems are over, HERMES finds that the risk premium on the cost of borrowing over Germany will still be 1.5 percentage points.

Until that happy day, the difference will be even greater. The value of the cheap, long-term loans from the Troika is beginning to be appreciated. That still leaves the question of when, and whether, our problems will actually come to an end.

This is the strange bit. There is no benchmark forecast. So the media coverage (mine included) concentrated on the October Budget.

The report argues that there is just too much uncertainty around to say that one outcome is more likely than another. Instead, the three main possibilities are charted – the Good, the Bad and the Ugly, one might call them.

The report charts what it thinks would be required to produce each of these outcomes, but without placing a bet on which is most likely.

One should always be wary of predictions. But, bearing in mind what happened with the 2008 report, one has to say, however reluctantly, that current circumstances fit more with the Ugly scenario.

This is continued stagnation, driven by a failure of the EU economy to recover and a failure by Ireland to deal with private debt and the threat it poses to the banks and to economic growth.

As of now, the eurozone is entering its third year of falling output and incomes. European leaders recognise that they will have to ease up on fiscal "austerity" and improve the potential for growth through reform. But there is no prospect of stimulus, while reform, even if achieved, takes a long time to have any effect.

The only thing which can be said about all of this is that it cannot go on indefinitely. At some point, the euro area will have to change policy radically, or it will break down in some fashion.

The report outlines, as other have done, the dire consequences of a breakdown. So dire, that the authors assume that policy will change as the danger looms.

That, however, may require a few more years of economic failure. The prospects for a small island offshore from a stagnant continent are, not surprisingly, bleak.

The more hopeful scenarios see growth returning to the core EU next year. Not great growth – not even good – but growth. It is not impossible, and what a difference it would make.

Now, something can be said. In such circumstances Ireland can help itself, by tackling the private debt crisis, keeping up the restoration of the public finances and speeding up reform.

The signs are not good here either. The appetite for reform, or even for sound finances, is weak. The banks may not be able to afford sufficient writedowns of company and household debt. The State can no longer afford to make up the difference.

Someone will have to decide whether wrecked banks or wrecked households will do most damage to the economy in the next five years.

Things can be said about that, and we need to hear more of it from the relevant quarters. On any scenario, making the wrong choices over the next few years could prove very costly indeed.

Irish Independent

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