Ireland's economic crisis: how did it happen and what is being done

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Sound to unsustainable growth

The EU/IMF economic adjustment programme for Ireland

Sound to unsustainable growth

Ireland's economy was widely seen as one of the most successful in the world, yet it has been among the hardest hit
by the global financial crisis. From the mid-1990s to 2007, Ireland enjoyed strong economic growth, but this
reflects two different growth stories. The first lasted from the mid-1990s until the early 2000s, and can be described
as one of catching-up growth: after years of lagging behind, there was a rapid convergence of Irish living
standards towards those of the worlds most successful economies.
There were two main factors behind this. Firstly, favourable demographics gave rise to an increase in the number of
workers entering the labour market. Secondly, an improvement in the educational level of the labour force meant
that these new workers had higher productivity than their predecessors.
Other factors also contributed to this story. In particular, the arrival of the EU single market made Ireland an
attractive location for inward investment, especially from the US, and helped boost Irish exports.
Other factors also contributed to this story. In particular, the arrival of the EU single market made Ireland an
attractive location for inward investment, especially from the US, and helped boost Irish exports.

From roughly 2002 until 2007, however, this growth dynamic changed in fundamental ways. The economy
continued to experience high growth rates, but this was increasingly based on the rapid expansion of credit and an
accompanying build-up of personal indebtedness by Irish households. This was fuelled, above all else, by rising
property prices. During this period, construction activity grew very strongly, accounting for a much larger share of
the economy and employment than was previously the case.

Rapid expansion of credit

The speculative bubble in property was supported by a surge in bank lending, and the balance sheets of Irish banks
grew disproportionately large relative to the size of the economy. The banks had traditionally relied on their deposit
base to fund their lending activity. However, greater financial integration, spurred in part by the birth of the euro,
allowed them to turn more and more to short-term borrowing from abroad, from so-called wholesale money
markets. This period also saw a global increase in risk appetite by financial markets, and Irish banks were caught up
in this.
Rising property prices
This was reflected in both a concentration of lending in property, and increasingly risky lending practices, both of
which would prove highly damaging when the bubble burst. In addition, so-called light touch oversight of banks
meant that there were failures by supervisors and regulators to identify and act on risks that were emerging in the
financial system. And even though the Irish government was running a budget surplus in this period, many
commentators have argued that fiscal policy played a part in exacerbating the imbalances that were building up.

Tax revenue was increasingly derived from cyclical sources capital gains tax and stamp duty that would prove
highly fragile once the bubble burst, while public spending grew more rapidly than would have been the case under
a more neutral policy stance. Finally, this period also saw rapid increases in prices and wages, which led to an
erosion in Irelands international competitiveness.
Falling property prices
When the international financial crisis erupted in August 2007, Irish banks were left vulnerable and exposed. With
falling property prices, banks began to suffer huge losses on their loans. At the same time, short term inter-bank
lending, on which Irish banks had become heavily reliant for their funding, became difficult to access.
From a global perspective, a key event was the collapse of Lehman Brothers, a US investment bank, in September
2008. This gave rise to severe tensions in global financial markets.
Confidence evaporating
With confidence evaporating, Irish banks began to experience deposit outflows, and there were mounting fears
about their ability to access funding from the wholesale money markets.
The crisis erupts

Responding to these pressures, the

government decided to issue a blanket guarantee of the banks liabilities and to recapitalize them using public
funds. The large costs of these measures led to an acute deterioration in the governments fiscal position.
Although the government began to implement austerity measures designed to restore sustainability to its public
finances, it was facing an uphill struggle. International investors became worried about the impact of escalating
bank losses on the governments balance sheet, and risk spreads surged on Irish sovereign debt.
In November 2010 yields on Irish government debt reached an unsustainable 9%, which meant that the government
was effectively locked out of international bond markets.

The EU/IMF economic adjustment programme for Ireland

On November 29 2010, the government negotiated a financial assistance package with the EU and the IMF totalling
85 billion (including a contribution of 17.5 billion from Irelands own resources). The financing provided by the
programme partners is helping to cushion the very large shock which Irelands economy and public finances have
suffered as a result of the bursting of the bubble. It is helping to keep vital public services running. In July 2011, EU
leaders agreed to reduce the interest rate and to extend the maturity on the EU loans provided to Ireland under the
programme. This decision has brought about a significant saving to Irish taxpayers and has helped to improve the
countrys debt sustainability.

Three main elements

The programme contains three main elements. First, a financial sector strategy will help Ireland to have a smaller,
better capitalized banking sector. Second, fiscal consolidation will put the countrys public finances on a sustainable
path over the medium term. Third, an ambitious structural reform agenda will restore competitiveness and
strengthen the economy's growth potential. Progress has been made in each of these areas, thanks to strong
ownership and decisive implementation of the programme by the government:
Banking sector reforms the recapitalisation of the domestic banks has been completed, at a
significantly lower cost than originally anticipated. Deleveraging of bank balance sheets is ongoing,
despite difficult market conditions. In addition, bank mergers have been completed ahead of schedule,
and bank boards are being renewed.
Fiscal consolidation the government is taking steps to restore the long-term sustainability of public
finances. The budget deficit for 2011 as a whole is projected to be well below the 10 percent of GDP
programme ceiling, and the government is committed to reducing it to below 3 percent of GDP by 2015.
Structural reforms the government is reforming the framework of sectoral labour market agreements,
covering areas where unemployment tends to be high. Progress has also been made in opening up
sheltered sectors, such as the legal profession, in order to lower costs and boost purchasing power.
Signs of progress under the programme are becoming more evident. 2011 has seen a return to positive growth on
the back of strong exports, aided by an improvement in competitiveness. Strong programme implementation and
the July 2011 announcement have resulted in a noticeable improvement in Irish government bond yields on
secondary markets.

Europe in the future

While Ireland and the other programme countries are addressing their problems, the euro area is taking steps to
improve its governance arrangements and strengthen its capacity to deal with the sovereign debt crisis. Far-reaching
changes in the way the euro area operates will be needed to deal decisively with the crisis and to prevent future
ones. A strengthened surveillance framework will help to prevent the kind of imbalances which led to Irelands
economic crisis.
The EU has also laid out an ambitious growth strategy called Europe 2020, which aims at generating smart,
sustainable and inclusive growth. These three mutually reinforcing priorities should help the EU and the Member
States to deliver high levels of employment, productivity and social cohesion.

Source
http://ec.europa.eu/ireland/economy/irelands_economic_crisis/index_en.htm