Sunday 25 February 2018

Early decisions are looming on Ireland's euro future

The Taoiseach travels to Brussels today and will face the daunting spectre of another referendum on European Treaties. Even as this process begins, he will need to keep a back door open for Ireland.

Franco-German summits are now habitually followed by a flurry of eurozone meetings but the current round has particular urgency.

Euro leaders must report to the G20 in three weeks and need -- for once -- to present a credible plan. The IMF and the United States are in no mind to support further muddling and there is, more generally, an air of finality about.

Germany now insists on what it wanted all along -- treaty changes to formalise bailout mechanisms and toughen sanctions on spendthrift countries -- and France will expect financial assistance to bail out its banking system without having any sanctions or conditions attached.

Therefore, it is likely that the grand bargain leading to a new treaty will itself breach the new standard. But this is euroland.

Since its inception, the eurozone has lurched from contortion to contradiction and, now, double standard. Ireland is well aware that, unlike France, it was forced into strict IMF conditionality before it got the funds to recapitalise its banks and had to bear most of the associated costs.

The Government will seek some retroactive relief but this is now just one more issue in a larger concern.

There will be a lot of early sermonising on how Ireland should vote on a revised treaty, and about how European ideals must advance, but Ireland has probably been on the receiving end of one ideal too many for now.

The future of the euro depends on credibility and trust -- not on revamped institutions alone -- and this will take some time and genuine sacrifice to rebuild. We cannot assume it will work.

Ireland has paid the costs for its own mistakes and stuttering recovery and its credibility has risen while belief in the eurozone has shattered.

The path to a more solitary pursuit of European ideals has opened up for Ireland and this should be kept very clear while the eurozone -- as a group -- tries to re-establish a credible future for itself. We should not recommit too early to a damaged enterprise.

The future cannot be known with certainty, of course, and any system will require periodic adjustments. This is understandable.

But the principles that guide a system -- including its reforms -- are another matter and more important. There was a presumption of the fledgling eurozone that policymakers knew what they were doing and would stand behind one another. This belief has gone.

Markets also expected a spirit of solidarity to persist and this is why there were minimal divergences in government bond yields across countries in the early years. Everybody had lower borrowing costs because of their association with one another.

But these conditions are unlikely to return.

Instead, markets have learned that it is difficult to impose sanctions for excessive deficits on countries that are, by definition, short of cash. Punitive interest rates on the early recovery programmes were also self-defeating.

So markets will henceforth look to countries to establish their own reputations and will largely ignore any new arrangements for sanctions.

Moreover, the institutions of the eurozone have performed badly and there is little confidence left in their ability to address problems.

From the outset, the ECB failed to identify the crisis as a banking and financial problem and, as recently as last month, insisted that banks were adequately financed. This week, the head of the ECB called for urgent recapitalisation.

The benefits from membership in a common currency are derived from market credibility in the system, but eurozone leaders have consistently tried to defy markets and have wasted a lot of time and resources on the wrong approach.

The new system must put trans-national bank supervision and responsibility at its core and resist an otherwise-debilitating fascination with fiscal rules. Let's see.

In the meantime, any changes to treaties are likely to create a more definitive split between the eurozone and the rest of the EU.

The UK will likely insist on a return of power from Brussels and could try to establish working relations within a "Non Euro Group" (as proposed by David Owen and David Marsh).

By the time a referendum rolls around, membership in this group could appeal to Irish voters who will remember opportunistic attempts to undermine their own fiscal independence.

Moreover, by 2014, the recovery programme should have concluded and Ireland should have access to renewed market financing.

The IMF expects a surplus on the balance of payments at that stage and this is the crucial requirement to launch a new monetary arrangement. Ireland could even choose to persist with the euro for a while -- but to leave the official club and its restrictions behind.

The euro has a difficult road ahead and there will be a bumpy ride after Greece defaults and the banks make painful adjustments. Ireland has earned the right to have its options left open and is slowly -- but surely -- securing the ability to exercise them.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies.

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