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Sunday 31 August 2014

Colm McCarthy: Crisis is nowhere near end despite all that austerity

Of the Troika members, only the IMF departs Ireland with reasonably clean hands, says Colm McCarthy

Colm McCarthy

Published 10/11/2013 | 01:00

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Bon voyage: The IMF's Peter Breuer, left, Craig Beaumont, centre, and other delegates leave the Finance Department after the Troika's final visit in October last

As Ireland prepares to exit the three-year Troika lending programme, the first country to do so, the European economy remains mired in recession with no sign of leadership in economic policy at European level. It is timely to consider the curious travelling three-ring circus that has overseen the disbursement of non-market finance to the struggling eurozone countries and to assess their contribution in Ireland, the star pupil.

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It began to emerge, in the summer of 2010, that Ireland would succumb to the alarming rise in bank-related debt and would have to exit the bond market. Mutterings began to surface in the media about Ireland being 'forced into the arms of the IMF', this being presumed a fate worse than death. The Fearsome Threesome of the IMF, the EU Commission and the European Central Bank had made their inauspicious debut in the first, and botched, Greek bailout in May 2010.

Ireland was next up. One prominent politician of my acquaintance, then in opposition and now in Government, asked me around July 2010 what it would be like, should the same fate befall Ireland. My answer was to the effect that, "the IMF will be the least of your worries".

He was surprised but agreed to suspend judgement. He understands now the point I was trying to make.

It is an open secret that the IMF officials were not happy about the terms imposed in the Irish bailout of November 2010, which saw the official loans, including €22.5bn of the IMF's money, one of the biggest loans it has ever made, used to pay off departing and undeserving creditors of bust banks.

This manoeuvre does not feature in the IMF playbook, and was resisted unsuccessfully by its officials, eventually overruled by their political masters, including then IMF president Dominique Strauss-Kahn.

In their numerous reports on Ireland in the period since, the IMF officials have displayed a dispassionate concern for the improvement of economic policy here and a steady standard of professionalism. Since they have a little matter of €22.5bn owing, they will take a continuing interest in what happens in Ireland and this should be welcomed.

The second of the Fearsome Threesome, the EU Commission, has failed to impress throughout. Various middle-level EU Commission officials of modest competence have been drifting around Dublin these last few years offering trenchant, half-baked advice to people with better things to do.

There is no better cure for the rampant Europhilia that infects the Irish civil service than exposure to EU Commission officials in pro-consular mode in a small and mendicant member state.

The third Troika member, the ECB, has been transformed since Mario Draghi took over in mid-2011. His predecessor, Jean-Claude Trichet, will hopefully be called to the European Parliament inquiry into the activities of the Troika to account for the ECB's dysfunctional performance under his stewardship.

As the Troika departs, it is reasonable to rate them out of 10. The IMF earns a comfortable eight in my book, the EU Commission a steady and consistent two. The ECB under Trichet would be lucky to get zero, under Draghi maybe five or six. It is early days, and Ireland has unfinished business with the ECB.

One of the design flaws in Europe's common currency is the absence of co-ordinated overall macroeconomic management. The eurozone has a single currency and a centralised monetary policy but it has 17 different budgetary strategies, one for each member state. There is (unavoidably) a one-size-fits-all exchange rate for all eurozone countries, which rarely suits all of them simultaneously. The financial markets have fragmented, with firms facing higher borrowing costs, and tighter credit availability, in the distressed periphery. Individual eurozone countries which experience sudden capital outflows cannot devalue, cannot use their central bank to finance either their governments or their banks, and cannot restrict capital flows with exchange controls.

Hence the extraordinary situation where the IMF has had to get involved in European bailouts even though the eurozone as a whole has had no capital outflow to finance throughout the crisis period.

The involvement of the IMF in Europe, where most of its balance sheet is now deployed, indeed the whole Troika arrangement, is a creature of the botched design of the euro. There was, and still is, no mechanism for dealing with failing banks and no mandate for the European Central Bank to act as a proper lender of last resort.

As well as a common exchange rate against non-members, eurozone countries share (in theory) a single official interest rate. The external exchange rate of the euro has been strong against sterling and the dollar since the crisis got under way and has recently strengthened as well against the Japanese yen. This does not suit the weaker economies, especially those, like Ireland, which trade extensively outside the zone.

The single official interest rate has been reduced, but banks and governments in the financially distressed countries cannot borrow at this low rate and private sector borrowers suffer.

Finally, there is no strategy for the management of overall demand for the euro area as a whole and many critics have argued that policy has been too deflationary, at a time when the USA, the UK, Japan and several other countries have managed to support overall demand rather better than the eurozone has done. Not surprisingly these countries are coming out of recession more rapidly.

Thursday's decision to knock a further quarter-point off the European Central Bank's policy interest rate is the last shot in that particular locker: the rate is now down to just 0.25 per cent and cannot as a practical matter fall much further.

The latest cut has stopped the rise of the euro against other leading currencies and will help holders of tracker mortgages, but makes only a marginal difference to the overall stance of policy.

Each eurozone state runs its own budgetary policy, subject to deficit-reduction pressures imposed by the official lenders, European Commission rules and the discipline of the markets (in Ireland's case all three).

Distressed countries have been forced to run tight budget policies so the overall position has been too restrictive. The exchange rate has also been too high for the distressed countries and their small firms cannot benefit from the low ECB interest rate.

They are also shrinking their balance sheets through disposing of assets and through restricting credit. In a proper monetary union this could not happen, small firms would be protected from the errors of their governments and of the monetary authority.

Only one central agency has a meaningful economic policy role and that is the European Central Bank. Until Mario Draghi took over as its president in June 2011, the ECB had done little to offset the deflationary bias of budgetary policies.

Since then the ECB has been more proactive, cutting the official interest rate, providing additional liquidity to the banking system and signalling a new willingness in September 2012, as yet untested, to support government bond markets.

But as long as the German government in particular refuses to accept any responsibility to share in the burden of adjustment, the ECB is limited in what it can do to offset the deflationary effects of budgetary policy.

The European Commission has made a dismal contribution to the debate about economic recovery in Ireland and has not exactly covered itself in glory in the faltering effort to bring coherence to eurozone management.

Just one member of the Troika, the IMF, departs Ireland with reasonably clean hands. Sadly the European 'partners' have done no service to this country.

Sunday Independent

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