Back in February 2009, as the scale of the financial crisis facing Ireland was becoming clear, two economists from Trinity College Dublin wrote an article for the economics website Vox in which they said: “The problem of the banks has received greatest international attention, yet is likely to be the smaller of the two sources of additional borrowing requirements“.
They were right – borrowing to keep the state going cost a lot more than borrowing to bail out the banks.
They also said of Ireland’s economic prospects – “its attractiveness as a globalised economy with a highly-open labour market means that there is no reason why Ireland cannot emerge from this crisis as a mature, high-productivity contributor to the wider European economy”.
But managing the fallout from the failure of Ireland’s banking industry came to define the subsequent careers of those two Trinity Professors – Patrick Honohan, who was appointed Central Bank Governor later that year, and Philip Lane, who succeeded him as Governor at the end of 2015.
On Monday, Dr Lane starts a new post as Chief Economist of the ECB – becoming the first Irish representative on the six person executive board in the ECB’s two decade-long existence.
In a final interview with RTÉ News as Governor of the Central Bank of Ireland, Philip Lane reflected on the state of the economy and banking industry in Ireland now, the main risks, and his economic advice to the Government.
He said there is no property bubble of the type that burst so spectacularly in 2007, and said that what was most important in his term as Governor was ensuring the Central Bank became more “proactive” in addressing problems.
What he regrets is that this was not clearly communicated to the public, whom he admits, are often frustrated at what they perceive as the slow pace of change.
But there has been plenty of change at the Central Bank during the decade long rule of the two professors – change in the institution itself, and change in the financial services industry, both in Ireland, in the EU and in the wider world.
But for an institution designed, above all else, to ensure financial stability, constantly trumpeting about change may be counterproductive.
Hence the communications dilemma: say too much and you risk making things worse; say too little and people think you aren’t doing anything.
“I can understand people being frustrated when things move too slowly“, he told Sean Whelan.
“I think my successor will have an important job in explaining what we do. I think the frustration I see in public commentary is not based on what we are actually doing, but on a misperception that we are too slow or too inactive”.
Professor Lane said he came into the job to be the very opposite of inactive: “my intention was that the Central Bank should be proactive in guarding financial stability, proactive in protecting consumers, proactive in ensuring factors such as Brexit don’t derail the financial system.
“So what we have now is the philosophy that rather than being passive, rather than sitting around worrying about something, we try to take steps. So I am pleased that I came in with that intention – let’s have a proactive Central Bank, which by the way is recognised internationally as being to the forefront in being proactive”.
He cites as an example of being a proactive Central Bank the concerns that some have over the influx of foreign capital into the Irish commercial real estate market – if it flows in quickly, pushing up asset prices, it can flow out quickly too, and push property prices down.
“This is why our supervisory model is so different now – it very intrusive, we have a lot of people whose job it is to keep an eye on that type of risk. But the fact we have foreign investors in this economy is to make sure that if there was to be a downturn in the future, not all of it gets landed on the local banking system, on local depositors, on local taxpayers – that happened before we can’t have it happen again,” he stated.
So how does he respond to the charge that he has presided over the inflation of another property bubble in Ireland, given the extraordinary price rises in both commercial and residential property?
“It’s very important we remember the lessons of the property bubble we did experience here in the mid-2000s. The market had fallen so much there was a case for a degree of recovery in property prices.
“But what we have been intent on making sure is that the credit system doesn’t add to that. So, as you know, we have brought in rules limiting the size of mortgages – limiting them to the size of someone’s income.
“Prices (of homes) are stabilising here in Dublin, but it is not the case that these rises are being driven by excessive credit – that’s something we can do as the Central Bank, to not add fuel to the fire.
“In the end the solution to this is greater supply of housing. Construction going up each year, but the shortfall is so big there is pressure on pricing. And this reinforces the need to keep credit limited, because adding more credit and chasing the same number of houses is only going to be inflationary,” Philip Lane said.
He acknowledges the “tremendous frustration” of people trying to get somewhere to rent or buy, but points to the challenges of trying to grow the construction sector in a country that is running short of building workers, and ramping up construction projects.
“In an economy where unemployment is below 5%, in an economy where construction workers are needed not just for new house building but for the public capital programme, and for retrofitting homes to deal with climate change, this is a challenge for an industry that was really crushed by the crisis: it needs to get bigger for all these reasons – new homes, retrofitting and public investment”.
That’s one particular sector of the economy. But what about the overview of the whole Irish economy. Professor Lane said that “since I’ve been here it’s been in a phase of continued recovery – in unemployment from peak above 15% to unemployment below 5%, so we should all recognise that this has been a remarkable recovery“.
He pins that on two things – Ireland’s role as a very globalised economy, well entrenched in the current growth industries like pharmaceuticals, electronics and digital services, and the kind of bounce back economists expect to see in a country that has suffered a very deep recession.
Former Finance Minister Michael Noonan with Professor Lane at the opening of the Central Bank;s new headquarters in 2017
But that strong economic rebound and current level of business success has implications for the way the Central Bank believes the Government should manage the public finances.
“What we say here is that we should recognise that these are good times for the Irish economy in the overall picture, and if you are in a situation of good times – especially if you can see risk factors ahead, risk factors to do with Brexit, the future of international taxation, the future of international trade, then – and I know it’s difficult – but it does mean saving for the rainy day,” he states.
This sounds like the classic analogy of the Central Banker being like the person who takes away the punch bowl just as the party is getting started.
But Professor Lane is at pains to point out that saving for the rainy day – by which he means running a big fiscal surplus – does not mean cutting public spending, just doing something potentially more politically difficult – raising taxes.
“As the Central Bank have that policy for the banks – they need to save for the rainy day in terms of their capital positions (which as Governor he has recommended the Government raise so banks don’t have to impose a credit squeeze in the downturn), but equally for the Government in terms of the public finances moving from the small surplus that he been achieved now to significant surpluses“.
“I know it’s not easy: taxes have gone up, there are many calls for public spending – and by the way this is not a statement about the level of public spending – any level of public spending is consistent with prudence if you raise the taxes to pay for it,” Philip Lane said.
“So what we say is we don’t comment on the spending plans, that for the political system, but at this level of the economy, if you want to spend more money you need to raise revenues to more than cover that: we need to run significant surpluses“.
The rapid increase in the amount of Corporation Tax revenue the Government has been getting – it has doubled over the last five years – is seen by many as a source of vulnerability in the public finances.
Some have likened the Government’s dependency on Corporation Tax (which is now almost 20% of all tax revenue) to the dependence the state had on property related taxes such as stamp duty.
When those taxes collapsed, the Government finances fell apart. This was the reason ordinary government borrowing to finance the resulting deficit exceeded the cost of the bank bailout.
For Philip Lane, that experience and the current situation reinforces the “necessity of running surpluses”.
“It’s not an easy problem (basing permanent spending increases on possibly temporary revenue flows) but we should appreciate that this unexpectedly high tax revenue is a positive windfall for the economy.
“But when you receive a windfall, yes, you can do more public investment – which is one way of creating something of lasting value from it – but you can also put money aside, because we know what happens when you have a boom bust cycle in the public finances, and we really don’t want to go through that again”.
Sean Whelan also discussed the state of the Irish banks now with Professor Lane. He thinks the new policy instrument, the Systemic Risk Buffer which he has urged the Government to activate, will help tide the banks through the next crisis, while the EBA stress test has already concluded they have enough capital to withstand a very big shock.
On bankers’ pay, the Governor bats the issue of top executive pay over to the Government, but says there is a case for paying other employees with key skills – such as cyber security experts – the going market rates.
It appeared that nobody in Ireland knew anything about Gabriel Makhlouf, the man chosen by the Government to replace him as Governor of the Central Bank. But Professor Lane said he did know him.
“As it happens I do know him, because when I was in Trinity I did a project for the New Zealand treasury a number of years ago, so I got to know him then. We’ve been talking in the phone in recent weeks as well, and I can tell you that he brings a lot of experience, has had a varied career, and knows what a small open economy is: there’s a lot of similarities between Ireland and New Zealand”.
But from Monday on, Philip Lane will be concentrating on the economics of the whole Euro Area – all 19 countries – and preparing the economic reports that the governing council will use when making their decisions about interest rates.
Source & Copyright: RTE – Sean Whelan