Monetary policy without the euro

Daniel Hannan is blaming the euro for Ireland’s woes. This raises a paradox.
Hannan’s argument seems reasonable. Had Ireland stayed out of the euro, the Central Bank of Ireland would have been free to run a tighter monetary policy, and this would have prevented the boom in credit and house prices, the ending of which destroyed the banks and crippled the economy.
There is, however, an obvious counter-argument to this. Central banks which have been free to set monetary policy without regard to external factors have not succeeded in avoiding bubbles in credit and asset prices - just look at the Fed. An independent national monetary policy - even assuming one is feasible for a small open economy such as Ireland - is no guarantee of avoiding financial crises.
Why? There are, roughly speaking, three possible reasons:
1. The Fed - under both Greenspan and Bernanke until at least 2008 - believed markets were rational and so underweighted the danger of asset prices bubbles. On this view, monetary policy failure was a temporary and corrigible error.
2. Central bankers’ reputations depend disproportionately upon what bankers think of them; in most times, the ordinary man in the street doesn’t give a thought to central banking. This gives central bankers an interest in erring on the side of low interest rates, because investment banks love cheap and easy money.  This is why Bob Woodward could get away with describing Greenspan as a “maestro.”
3. It’s just impossible for central bankers to spot bubbles, especially in the presence of the sort of supply-side changes Ireland experienced in the 00s, because centralized experts cannot know better than even imperfect markets.
Which brings me to my paradox. If I were a rightist, I’d have more sympathy with (2) or (3) than (1) - in fact, I do. But if this is the case, the value of monetary policy autonomy is low, in which case the argument for Ireland having stayed out of the euro becomes weaker. To believe that Ireland could have avoided a bubble by staying out of the euro requires one to believe that centralized policy can reliably out-perform markets and prevent bubbles. Which is an odd thing for a right-winger to believe.

Comments

[Left Outside]

The Eurozone bares remarkable similarities to the Gold Standard age of globalisation 100 years ago. You'd think the right would be loving it.

1) Fixed exchange rates, this time with reference to other European economies rather than Gold, but as most European countries trade mostly with one another, this is a pretty good substitute.

2) Low Tariffs, I know Germany and other industrialisers had higher tariffs in the mid 19thC but there's not been anything comparable to the free tradeism of the 19th C outside modern Europe.

3) Homogenising markets, in the 19th C markets for different good became more similar which was good for economies of scale and scope. A similar trend is occurring now through the standardisation of many many different regulatory regimes. (The right might prefer that there were no regulatory regimes, but there are and their existence are likely to persist).

In fact in many ways the Euro offers a better than 19th C world for the right.

1) More commitment to sound money than ever before - countries could and did go off gold when it was unfavourable and then region later at a different value. Eurozone countries would face the mother of all bank runs and political ruin if they did this.

2) Information is more widely spread and capital markets are probably more integrated than ever before because of it.

3) The free movement of people (the most vital factor of production) is back to the status quo ante bellum of the era of mass migration except travel is EVEN cheaper than it was.

4) Europe, for once, is almost certainly not going to descend into war. The Elbe hasn't been crossed in anger in over 65 years! Hooray!

It is almost as though people come to their opinions on prejudice rather than analysis.

If you think monetary autonomy is of low value do you prefer a Gold Standard, chris? I mean it offers stable exchange rates, free movement of capital and a (almost unreplicated [1]) credible commitment to keep things that way. You don't strike me as a gold bug though... what about a Worldo?

___

[1] Hong Kong's finances comes close. They saw off a HUGE speculative attack to maintain their peg in 1997.

[Luis Enrique]

If Ireland had been outside the Euro, but had had a similar property fuelled bubble and crisis of its own accord, would it be better or worse off without the Euro there to bail it out?

I suppose the magnitude of any indigenous crisis would likely have been smaller, outside the Euro? Dunno.

[Matthew]

Presumably if the CBoI had managed to run a perfect anti-bubble monetary policy, which I agree given their peers is doubtful, they would have had a problem of a super-strong currency? I thinkt therefore the crisis would have been rather different, although not necessarily less.

[Nick]

Scott Sumner ( http://www.themoneyillusion.com/ ) argues that central bankers can't and should not try to beat the market. Instead, they should target it, either by picking an inflation or NGDP growth target. Anti-Euro rightists don't need to claim that Irish central bankers would have popped the bubble, only that that they could have inflated out of the rough patch when the bubble burst. In the same way, Mervyn King didn't see the bubble coming but he knew what tools to deploy to get the UK out of the worst of it.

[chris strange]

When real interest rates are negative, as they were in Ireland for a very long time during the boom thanks to the Euro, the rational thing to do is to take on as much debt as possible. Inflation will remove the value of the debt, but not that of the asset you used it to buy. Hence the giant property bubbles that blew up in Spain and Ireland. These were not the result of people behaving irrationally, their actions were completely rational based on the way that the Euro had distorted the market by setting Irish interest rates for the German economy.

Central bankers reputations are over valued, and they certainly cannot process as much information as the market as a whole; but even they can see when real interest rates have gone negative during a boom and do something about it. Had Spain and Ireland not been in the Euro then they could have had positive interest rates and so a smaller bubble and smaller crash. Then once the crash came (and crashes are always going to happen since any economy is far to big and complex to plan or control) they would have some tools to try and mitigate it.

[Keith]

Surely the form of the Euro bubble in Ireland, portugal,spain and greece. arises from the effect of a single monetary unit covering divergent economies forced to accept a monetary policy that works for Germany/ france but not for the pigs. So that is the fault of the system. And as Nick says monetary policy cannot be relaxed to respond to the credit bust as all independence has gone from the National Central Bank.

However it seems true to also say that it is unlikely the Central Bank can stop credit booms by itself as that requires direct regulation.
Bankers have repeatedly shown that they cannot be trusted to refrain from creating booms to the detriment of the National and world economy regardless of the currency and payment regimes in force; and whatever the economic theory fasonable at the time of the boom / bust.

[Richard T]

Before joining the euro, Ireland had close financial ties between the punt and the pound sterling. Looking at the position of the UK up excrement alley through a not dis-similar rake's progress of Inland revenue incompetence, loose financial regulation, cronyism and an obsession with property is it credible to suggest their posiiton would be much different?

[Guido Fawkes]

As a rightist let me say I agree with you on (1), (2) and (3).

However the property bubble in Ireland was so manifestly obvious that in the last years of it even the participants realised and were working on the basis of the greater fool theory - "I know it is a crazy price, but that's what they are going for nowadays."

Even an apprentice central banker could see it - indeed the newly appointed head of the Irish Central Bank was one of those who did see it. If Ireland had at the time monetary sovereignty they would not have kept rates too low for too long, the property bubble would have been much smaller and the banking collapse would have been lessened to a more manageable magnitude. Maybe only Anglo-Irish would have failed.

That and europe forcing Irish politicians to pay off european investors in Irish bank bonds did for Ireland.

[Luis Enrique]

accepting 1) 2) 3), they don't quite amount to "an independent Ireland central bank would have set negative real interest rates" do they? Which, as I understand it, did prevail in Ireland. Never mind the ability to identify and preemptively pop bubbles, merely bog-standard (hah! sorry) inflation targeting would have left them better off, no?

[Jim]

Ignoring whether being out of the euro would have avoided the property bubble (it would probably have been a bubble, but not quite as big) do you think being in the euro is helping Ireland get out of its problems? Or is being locked into a currency that you cannot let float free imposing huge stresses on the population?

The UK may be in trouble, but a 25% devaluation of sterling has helped considerably to cushion the blow. If we were in the euro we would be having to impose similar REAL cuts in spending like the Irish, not the pretend cuts we're getting now, which are really spending freezes, or increases not as large as planned.

If the Left are complaining about George Osbournes plans, perhaps they should thank their lucky stars they aren't in Dublin.

[Whig]

Unfortunately, the answer is not trying to pick which central bank is the best (independent or European or any other option). The assumption you make is that central banks are actually necessary, rather than the problem. This assumption is highly questionable and lies at the root of the problem. The real solution to asset price bubbles lies in eliminating central banks and manipulation of the money supply, not in debates over Europe.

[vimothy]

Isn't Hannan half right? If Ireland could set its own monetary policy, it would have been free to raise interest rates during the boom, but unlikely to do so. However, it would be also be free, and much more likely, to loosen now, since it is in a deep recession with no other method of stimulating its economy.

[ortega]

Maybe the question is not about if having their own currency would have avoided them the bubble but whether it would have allowed them to do something about it during the last 2/3 years.

[redpesto]

"Had Ireland stayed out of the euro, the Central Bank of Ireland would have been free to run a tighter monetary policy, and this would have prevented the boom in credit and house prices, the ending of which destroyed the banks and crippled the economy."

Iceland, anybody?

[Jim]

@redpesto: perhaps you should go and ask the Icelanders in a few years time if they would like to swap places with Ireland. I suspect they won't. Ireland will still be in the meat grinder of tax rises/spending cuts leading to less economic activity, lower revenues, bigger deficits, more bailouts, more taxes, more spending cuts. Whereas Iceland's krona halved in value from before the crisis (90 krona/€ to about 180 krona/€) and now has risen back to around 150 krona/€. They will have a few years pain, but the currency fall will make their exports more competitive, and tourism will grow as it will be a cheap place to go. They will come out stronger the other side.

Ireland risks total collapse of the State in its attempt to live up to the European ideal. Its best option would be to leave the euro, reintroduce the punt, let it float. That alone might be enough to save them. If not they could then do a partial default, make the debt holders take a haircut, and start afresh. The politicians should make the decisions that are in the best interests of the population, not foreign bank bond holders. But they seem hell bent on breaking the Irish butterfly on the Germanic euro wheel.

[redpesto]

@Jim - you miss one point: Iceland got into its mess without being in the Euro. Plus, as every other anti-Tory blogger has been pointing out, Ireland was being used by the likes of Osborne as a model of what to do in an economic crisis. Ireland did all that jazz - and now look what's happened. No wonder right-wingers want to talk about the Euro; there's a clear case that it's a complicating factor in any recovery, but that's not why the likes of Hannan are going on about it.

[Jim]

@Redpesto: yes, Iceland got into trouble without the Euro, and they'll get through those troubles without the euro. Ireland would probably have had a property boom & bust even if they weren't in the euro. But if they had they would have a) no-one to blame but themselves and b) the tools (floating exchange rates and control of monetary policy) to (hopefully) get out of trouble, without destroying the entire nations finances.

As it is they are in the same position we were in in 1991/2. Everyone knew we couldn't hold the line and stay in the ERM, but the politicians (of all hues) swore blind we must stay in. Millions lost their jobs and had their houses repossessed, just to try and keep up with a euro-fantasy. Fortunately we weren't as locked in as the Irish are.

This bailout will paper over the cracks for a while (the Greek one is already unravelling, as revenues are not meeting forcasts, and a crisis point isn't far away there either) but eventually the Irish will be forced to face reality, leave the euro and float the Punt Mark 2. They should do it now, but political pride forces them to impose more pain first. What Statesmanship. Of course those imposing the pain won't feel any themselves, they've already negotiated nice redundancy/pension packages.

[Keith]

For once I agree with Jim!

Planned default is the logical answer not only for Ireland but all the pigs ( apologies for using the Name)

where comes the idea that the euro is a system the Left should embrace? It is a damn fool idea as bad as the Gold standard; a policy for deflation, poverty and mass unemployment.

Left wing? I should coco! Why is it that it takes a tory like Jim to see what the Oxbridge elite keep ignoring?

[BG]

But surely the rates that have the most impact on a property bubbles are more long term rates rather than short term rates that the central bank can set.
Rather than stopping the central bank from having a better monetary policy, staying out of the euro would probably have meant that long term rates on irish government bonds would have been a lot higher (because I guess a lot of people assumed - quite rightly - that being part of the euro put some implicit guarantee on government debt and because foreign creditors would have had to worry about foreign exchange risk when lending to Ireland and irish banks in general). That in turn would have meant more difficult borrowing and a smaller property bubble.
The US looks like a good comparison but isn't really as on top of the Fed's behaviour, is the fact that the dollar is the world's reserve currency and US government bonds some kind of safe haven...
Not sure this is the position Ireland would have been in.