Misjudging the Fiscal Stance: Lessons from Ireland's Boom ...€¦ · Misjudging the Fiscal Stance: Lessons from Ireland's Boom and Bust Alan Ahearne . NUI Galway, Bruegel and Central
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Misjudging the Fiscal Stance: Lessons from Ireland's Boom
and Bust
Alan Ahearne
NUI Galway, Bruegel and Central Bank of Ireland
Presentation at the Workshop organised by the Norwegian Ministry of Finance’s Advisory Panel
12 November 2012
Outline
Overview of boom and bust.
Fundamentals or a bubble?
The fiscal stance. Conclusions.
House price boom and bust
Source: Ronan Lyons, July 2011
Rapid increase in household debt
Bubble in construction sector New homebuilding, share of GDP
0
2
4
6
8
10
12
14
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
%
residential investment to GDP
long run average
Ireland lost competitiveness in euro area
Source: Regling and Watson, 2010
Relative unit labour costs
Consumption and investment spending plunged after bubble burst
Surge in lending by Irish banks…
0%
5%
10%
15%
20%
25%
30%
35%
2003 2004 2005 2006 2007 2008
Source: Regling and Watson, 2010
Private sector credit growth of the Irish banking system
…funded by international capital markets
Source: Regling and Watson, 2010
Loan-to-deposit ratios
0%
50%
100%
150%
200%
250%
Ireland Portugal Spain
2004
2005
2006
2007
2008
100% loan-to-value common
Source: Regling and Watson, 2010
Large external imbalances
Fundamentals or a bubble?
How do we distinguish a bubble from a rational response to fundamentals?
Plausible fundamental arguments: Strong growth in GDP and incomes. Low interest rates and financial integration. Young population and immigration. Profitable, well-funded banking system.
Measures of overvaluation
Source: IMF
Measures of overvaluation
Source: Ronan Lyons, July 2011
Measures of overvaluation
Source: Marius Jurgilas and Kevin J. Lansing, 2012
Ratio of house price to rent
Consumer price inflation relatively low and stable…
-8
-6
-4
-2
0
2
4
6
8
jan-
99
jul-9
9
jan-
00
jul-0
0
jan-
01
jul-0
1
jan-
02
jul-0
2
jan-
03
jul-0
3
jan-
04
jul-0
4
jan-
05
jul-0
5
jan-
06
jul-0
6
jan-
07
jul-0
7
jan-
08
jul-0
8
jan-
09
Consumer price inflation (%)
…with no clear evidence that unemployment was below NAIRU
Employment Unemployment (%)
The value of anecdotes in diagnosing a bubble
Media’s role in inflating the bubble. Tax breaks. Auctioneers & Valuers. Amateur real estate investors. Vacant properties. Joe Kennedy and the shoe-shine boy.
The fiscal stance
Ireland ran headline budget surpluses during the boom.
At the time, estimates for the cyclically-adjusted balance also looked benign. Trends (H-P filter) missed bubble. Estimates of output gap (and structural
deficit) ignored financial imbalances.
Headline budget surpluses during boom
Bubble generated windfall tax revenues
0%
20%
40%
60%
80%
100%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
% o
f T
ax
Re
ve
nu
e Others*Capital Gains TaxStamp DutiesCorporation TaxIncome TaxVAT and Excise
*Customs, CAT, RPT, MVD, Ag. & Emp. Levies
Source: Regling and Watson, 2010
Benefits of hindsight 2006
Seen then Seen now 2007
Seen then Seen now
Output gap 0.4 0.2
Structural Budget
2.7 0.7
Source: Max Watson, 2012
Benefits of hindsight 2006
Seen then Seen now 2007
Seen then Seen now
Output gap 0.4 2.8 0.2 6.5
Structural Budget
2.7 -4.0 0.7 -7.2
Source: Max Watson, 2012
Conclusions
Fiscal stance was misjudged because financial imbalances were ignored.
Something like “finance-neutral” output gap (Borio et al, 2012) would have been useful.
Self-reinforcing spirals between economic activity and asset values.
Asymmetric risks.
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