Biffonomics

Judging from some of the media comments on the Irish debt crisis, the Taoiseach is not the only Big Ignorant Fecker involved in this shambles.

The UK's anti-Europeans are, of course, out in force. The crux of their argument is that if Ireland had not joined the euro, it wouldn't have got into this mess in the first place, and if it had still managed to get into a mess, it would be able to restore its fortunes simply by devaluing, an option that membership of the euro precludes.

Chris Dillow has very effectively refuted the first of these. He cites the Greenspan/Bernanke Fed as evidence that the ability to make policy independently is no guarantee of avoiding asset bubbles.

What about the devaluation argument? At the simplest level this can be exposed through a reductio ad absurdam: since the eurozone countries are each other's main trading partners, it would be logically impossible for them all to devalue against each other. More practically, how likely is it that the stronger members of the eurozone, notably Germany, would allow Ireland to continue to enjoy the other benefits of the eurozone if it resorted to a blatant beggar-my-neighbour devaluation? (One commentator today has even suggested that Ireland, perhaps along with the other PIGS, might leave the euro, devalue and then rejoin, which would surely never be acceptable to Berlin or Paris).

More broadly, the whole devaluation argument founders on the fact that it is all but impossible to identify any country that has ever devalued its way to wealth. And no, China doesn't count: refusing to allow your currency to appreciate is not the same as devaluing it, though the Chinese are starting to see at least one of the normal consequences of devaluation: rising inflationary pressures. (As an aside, it would be interesting to see if those calling for Ireland to devalue are the same people who have been castigating China for its cheap currency policy. But I digress).

Devaluation is a sign of policy failure. Leaving aside fuddy-duddy technical stuff like the elasticity of import and export demand, it only works if it's used to provide a breathing space for policy adjustments: restraint of domestic demand, fiscal correction and so on -- exactly the kind of changes, in fact, that the Irish government is looking to implement now in return for the bailout funds. The notion that the bailout is an unnecessarily painful choice, and that things would be just fine if Ireland could just devalue its currency and go its own way, is simply nonsense.

Ireland's problems stem from a toxic combination of unprecedentedly low interest rates (which, given the antics of the Greenspan Fed, might well have been the case even if the euro had never been invented), unsustainable fiscal policy (the fate of the 12.5% corporate tax rate remains uncertain at the time of writing), aggressive banks and weak regulation. Even at the time, the government's decision at the height of the financial crisis to guarantee all deposits in Irish bank looked like a huge misjudgment. As we are now seeing, Ireland could never have made good on the guarantee, and its sole effect was to excuse the banks from taking a hard look at the value of the assets on their balance sheets. Those problems were only deferred, not solved. Even with the bailout, it remains to be seen whether they can be solved without Ireland's creditors taking a nasty haircut.