… two partial escapes exist. The more trivial would be a reduction in the rate of interest on Ireland’s borrowing: a 1 per cent reduction in the rate of interest would save the state 0.4 per cent of GDP a year. That would be a small help, at least. A more valuable possibility would be a writedown of existing subordinated and senior bank debt, which currently amounts to €21.4bn (14 per cent of GDP).
The ECB and the other members of the European Union have vetoed this idea, fearful of contagion. Indeed, the assistance package was partly to prevent just such an outcome. Yet the idea that taxpayers should bail out senior creditors of massively insolvent banks at such risk to the solvency of their state is both unfair and unreasonable. If the rest of the EU is determined to protect senior creditors, it should surely share in the cost of doing so. Why should the taxpayers of the borrowing country pay all? The new Irish government should make this point firmly…
… this particular episode has at least two specific lessons for the eurozone, as well. First, entry can turn out to be a massive economic shock. Second, the view, popular in Germany, that tighter fiscal policy would solve all problems, is clearly wrong. Before the crisis, Ireland’s ratio of public debt to GDP was 40 percentage points less than Germany’s. True, Irish fiscal policy could have been tighter. But that would have made next to no difference to the outcome, unless it had been able to generate a large surplus in net assets. Indeed, with such a policy, long-term interest rates might have been lower and the asset boom even bigger.
Ireland’s fiscal calamity is not a cause of its crisis but a consequence. The big failure was the behaviour of private lenders and borrowers. That is what must be tackled. Start now.