Thursday 29 September 2016

Draghi's monetary magic will have little impact on Ireland's economy

Irish growth is strong, but not stellar. Europe's languishing economy is the biggest threat and needs to be revived

Published 13/03/2016 | 02:30

Mario Draghi, President of the European Central Bank (ECB) Photo: AFP/Getty Images
Mario Draghi, President of the European Central Bank (ECB) Photo: AFP/Getty Images

Last Thursday was an eventful day, and that was quite apart from the convening of the 32nd Dail. In the morning, the State's statisticians revealed - to the wonderment of the world - that the Irish economy grew at a jaw-dropping 8pc last year. A couple of hours later Mario Draghi, speaking from his skyscraper eyrie in Frankfurt, announced that the European Central Bank would dabble in even more alchemy-like activity, all in the hope of stimulating a European economy which causes glumness across the planet by hardly growing at all.

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Ireland's unbelievable growth and Draghi's latest actions leave many people scratching their heads. There is very good reason to be perplexed.

For any economy, at any time, anywhere in the world to grow by 8pc in a single year is unusual. For a European economy to do so these days is pretty much unheard of.

Developed economies have been growing very slowly in recent decades. Since the Great Recession eight years ago, growth in many of our peer economies has decelerated further (for those interested, your columnist recently wrote a paper on this phenomenon - and what might be done about it - which is available via the link* at the end of this article).

When a western European economy grows by anything above 2pc in a year it is now viewed with envy by most of its neighbours. Ireland last year grew at four times that rate. If you find this hard to believe, your instincts are not doing you a disservice.

Economists usually look at output, as measured by GDP, and the numbers at work to gauge growth in an economy. The two measures are almost always very similar, with GDP tending to grow a little more strongly than employment as the productivity of everyone at work rises over time, mostly thanks to technological changes.

In Ireland recently the relationship between these two measures has completely broken down. In the final three months of last year GDP grew at more than 10 times the rate of employment. Moreover, while GDP accelerated, employment growth slowed.

The puffing up of the GDP figures is all down to the way in which the Irish economy is so connected to the globalisation process (a subject discussed in greater detail in an accompanying column in the business section of this newspaper). The enormous multinational presence combined with the hugely successful Irish-owned aircraft leasing sector make a muddle of measuring GDP, rendering the headline rate largely irrelevant as an indicator of how economic activity is changing.

But if all that causes befuddlement, there is no need to fret, for the moment at least. The economy is certainly doing very nicely. Compared to our peers in the rest of Europe we are indeed growing faster than most. But it is the less stellar jobs growth, rather than the stratospheric GDP growth, that better reflects what is happening on the ground. And, it should be said, that Ireland has enjoyed one of the fastest rates of jobs growth over the past three years.

It is also reassuring that the inconclusive outcome of the General Election and the prospect of a period, perhaps very protracted, of weak and ineffective government has not yet appeared to have had negative consequences for the economy.

But one only has to look to what went on in Frankfurt last week to see how fragile things are in our European corner of the world. The ECB cut the interest rate that is most relevant to consumers and businesses to zero - something that was utterly unimaginable just a few short years ago. It yet again made it more costly for commercial banks to park money at the central bank - in the hope that this will encourage them to lend more of it out, thus stimulating the eurozone economy.

Yet another move was to announce that the printing presses in its vaults will whirr faster in the future. The ECB will print - for all intents and purposes - one third more euros each month, bringing the monthly total to €80bn. More significantly, it said that instead of using this newly created cash to buy government bonds, as it has mostly done in the year since it began "quantitative easing", it will now also buy the IOU's of companies (that is designed to push the effective interest rate of these IOUs down, making companies issue more of them and using the cash raised to invest in machines, computers and the like).

From a narrow Irish perspective, these measures won't amount to a hill of beans. First, even if the tiny cut in interest rates were to be passed on to borrowers, the effect would be small. But don't hold your breath for that to happen. Irish banks have been among the slowest in Europe to do just that for borrowers. By contrast, they have been most expeditious in cutting the interest they pay to savers who have cash on deposit.

Last Friday the latest official figures showed that the gap between the average interest rate Irish borrowers pay banks and the rate banks give savers in January was the second highest on record, and a staggering four times greater than it was at its low point a little over three years ago.

A second reason the ECB action won't do much for Irish economy is because it is very unlikely to boost fresh lending to businesses and consumers. Feeble growth in lending has a lot to do with the still dire state of Irish banks. They remain stuffed with dud loans. A fifth of the banks' collective loan portfolio is non-performing, even now still one of the highest proportions in Europe. Until that changes, new lending will be lower than a growing economy needs regardless of Frankfurt's monetary magic.

A final reason the policy change won't do much here is because few Irish companies issue their own bonds. As such, there is very little for the ECB to buy.

But as the Irish economy is growing at a good clip, we can rub along nicely without a stimulus from the ECB. The benefit to Ireland from the measures is indirect - that they could give the continental economy a kick in the pants and get it moving again. Although, admittedly, it is very far from certain that the measures will do much for the real economy in Europe - how such measures work is even more brain-straining than making sense of Irish GDP figures.

But they are worth trying, even if they bring their own risks. Without a return to growth it is only a matter of time before the eurozone crisis blows up again. And if that happens, it will in all likelihood be a very big country - Italy - not a tiny peripheral one - Greece - at the epicentre. Italy is too big to bail out and will bring the euro down if it crashes. It is worth throwing the kitchen sink at the eurozone economy to try to get it growing again. Draghi's move on Thursday was hailed as radical, but it wasn't the kitchen sink. As Europe stagnates, the day is coming when really radical measures will have to be considered.

*http://www.iiea.com/publications/european-recovery-project

Sunday Independent

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