Monday 11 December 2017

No crisis cure without some devaluation

THE Central Bank's conclusion that Ireland's bank crisis could prove to be the most expensive experienced by any developed country since the 1970s should come as little surprise.

However, by ignoring the role of falling exchange rates in solving previous crises, the Central Bank may underestimate just how difficult we will find it to escape our own calamity.

For readers of This Time Is Different, the 2009 book by US finance academics Carmen Reinhart and Kenneth Rogoff that analysed hundreds of financial crises stretching back to 1800, there was little that was new in the Central Bank paper published last week.

At €63bn and rising, the cost of fixing the Irish banks is the equivalent of 50 per cent of GNP and about 40 per cent of GDP.

Given that Reinhart and Rogoff put the cost of fixing previous banking crises at somewhere between 2 per cent and 4 per cent of GDP for Norway, 3.6 per cent and 6.4 per cent for Sweden and 8 per cent and 24 per cent for Japan, it is clear that, by comparison with the experience of other developed countries, the cost of fixing the Irish banks isn't so much above average as completely off the scale.

However, unlike Reinhart and Rogoff, the Central Bank paper -- which largely concentrates on the Norwegian, Swedish and Finnish banking crises of the early 1990s -- has very little to say on the role played by falling exchange rates in resolving banking crises, only briefly touching on the subject before moving swiftly on.

That is a pity, as the Finnish markka and the Swedish krona both lost more than 40 per cent of their value against the D-mark, the main predecessor currency of the euro, in the immediate aftermath of their banking crises.

Indeed, without such sharp devaluations it would have been difficult for either country to have recovered so quickly. The property downturn which accompanied the Finnish banking crisis lasted six years, Norway's lasted five years and Sweden's downturn was over in just four years.

Without a currency devaluation of the magnitude experienced by Sweden and Norway, even the Central Bank's "worst case scenario" of Irish property prices taking 22 years to recover their pre-crash levels could prove excessively optimistic.

Sunday Indo Business

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