Friday 19 July 2019

Currency, Credit and Crisis: Honohan's account of how our economic bubble burst

Economics: Currency, Credit and Crisis: Central Banking in Ireland and Europe

Patrick Honohan,

Cambridge University Press, €27.99.

Patrick Honohan took the helm during the rock and roll circus of the bubble years. Photo: Gareth Chaney Collins
Patrick Honohan took the helm during the rock and roll circus of the bubble years. Photo: Gareth Chaney Collins
Currency, Credit and Crisis
Colm McCarthy

Colm McCarthy

In the autumn of 2009, a year after the Irish bubble burst, Patrick Honohan commenced a six-year stint as governor of the Central Bank of Ireland, which gave him a central role in cleaning up the mess in Dublin and a ringside seat on the European Central Bank's governing council in Frankfurt.

He has written a comprehensive volume, part-memoir but largely an analysis of the pitfalls of central banking in Ireland and Europe, with much sage guidance for the avoidance of future trouble in both locations.

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Ireland has, in almost a century of independence, pursued just about every exchange rate policy imaginable. The State established in 1922 initially used sterling, with no national currency at all, moved through a currency board arrangement from 1928 to a central bank from 1942 with a rigid one-for-one link to sterling. This was abandoned in 1979 for an adjustable peg to a continental European system until 1993, followed by a brief period of floating and back to having no currency at all in 1999.

It now uses a different foreign currency, the euro, rather than the involuntary choice of sterling at the State's foundation. The choice of currency regime generates intense controversy in countries large and small. Honohan insists that mistakes have been made in Ireland in all weathers.

A lack of discipline in macroeconomic management, in financial supervision, or both, will create crises under any regime and Ireland has suffered from the pursuit of unbalanced macroeconomic policy. The fiscal indiscipline of the 1970s and 1980s commenced under the one-for-one parity with sterling, the repetition 20 years later after the currency had been abolished, accompanied this time by a comprehensive failure of bank management and supervision.

Honohan draws the important lesson that there is more to macro policy than settling on a strategy for the exchange rate: even deciding to have no currency at all does not eliminate the scope for grievous errors and politicians, after a decent interval, can press repeat.

The sheer speed with which the Irish crisis unfolded from early 2008 onwards is very striking. A low debt ratio, a balanced budget and a AAA credit rating led, inside three years, to an inability to borrow at all and a first-ever IMF programme by the end of 2010.

The next Irish crisis, whenever it comes, is unlikely to contain a large component of bank bail-out costs because the banks are fewer, smaller and better supervised. But the proclivity to take chances with the public finances is uncured and the inherited debt burden so high that there are already warnings about overheating and its fiscal consequences.

There are two great might-have-beens - was Europe wise to establish the common currency at all, and was Ireland wise to opt in? The euro was not a full monetary union at inception and remains in key essentials more akin to a common currency area, a far more fragile construct.

There is no common safe asset, no significant mutualisation of risk, still no capital markets union and sovereign debt markets at continuing risk of re-fragmentation.

The addition of centralised bank supervision, a partial procedure for dealing with failing banks and bond-buying by the ECB came as afterthoughts during the crisis, likened to repairing a speeding car while leaning out the window, spanner in hand.

Honohan is kind to the agile mechanics in Frankfurt, to whom the EU political leaders passed the parcel, but is reluctant to ponder whether Europe might have been better off politically had the project been avoided. Would the UK now be leaving the European Union had the essentially political and ultimately divisive common currency plan been shelved in the face of the doubts expressed through the 1990s? Political projects need to be assessed on political as well as economic consequences.

Ireland had a choice about joining the euro. Denmark, with a formal opt-out, kept its currency and Sweden has contrived to do the same without any opt-out at all.

Honohan is right to argue that Ireland in 1999 was headed for trouble, in or out. European countries which eschewed euro membership got into serious trouble too, but would Ireland have avoided the worst excesses if the exchange rate canary-in-the-coalmine had been free to chirp as the banks, and the government, lost the plot during the bubble period? Would the proponents of entry before 1999 have been relaxed about the risks had they known what the bankers, and the politicians, were about to get up to?

The financial damage done to Ireland by the form of the 2010 rescue package, especially the initial interest rates charged and the imposition of full payouts on unguaranteed bonds issued by dodgy banks, looked ominous in the early months of the troika period.

There was a real risk that Ireland would not regain market access and that there might have to be a second 'bail-out'. Honohan argues that the reduction in interest charges and the refinancing of the promissory notes altered the picture decisively and that the European Central Bank, under Mario Draghi, thus atoned for the sins of his predecessor.

He has no explanation, nor did the Oireachtas banking inquiry, for the great mystery of the Irish bubble, unanticipated by the proponents of euro entry before 1999. How did a traditionally cautious and conservative banking system mutate with such speed into the rock-and-roll circus of the bubble years?

An unprepared oversight system in Dublin met the design and policy weaknesses in Frankfurt to produce a perfect storm from which recovery has been due to good luck as well as good management. It is to Honohan's credit in his stewardship at the Central Bank that the authorities will be better prepared to deal with a recurrence, and he has written a fine account of these extraordinary events.

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