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The Irish Crisis

By Philip R. Lane

“This article has three goals.  First, it seeks to explain the origins of the Irish crisis.  Second, it provides an interim assessment of the Irish government’s management of the crisis.  Third, it evaluates the lessons from Ireland for the macroeconomics of monetary unions.”

Introduction

While the global financial crisis has affected all economies to varying degrees, it has been especially severe in Ireland with a cumulative nominal GDP decline of 21 percent from its peak of Q4 2007 to the trough of Q3 2010 (the economy has since grown modestly) in Ireland. This ranks Ireland among the worst-affected countries in terms of output performance during this period. Relatedly, after a long period of running surpluses, the fiscal balance shifted from positive territory in 2007 to baseline deficits of 10-12 percent of GDP during 2009-2011. Much of this fiscal deficit is structural in nature, such that the resumption of economic growth on its own is not sufficient to restore fiscal sustainability. In addition, the one-off costs of recapitalising the banking system pushed the overall general government deficit to 14.5 percent of GDP in 2009 and 32 percent of GDP in 2010.

The boom and bust in Ireland

The main factor behind these developments has been the devastating boom-bust cycle in the Irish property market. Since the property boom was financed through aggressive lending by the Irish banking system, the decline in property prices and the collapse in construction activity have resulted in severe losses in the Irish banking system. In turn, this has contributed to the economic crisis through a credit squeeze and the fiscal crisis, both directly through the costs of recapitalising the banking system and indirectly through the loss of asset-driven revenues.

“The recession in Ireland in 2008-2009 was driven by a dramatic decline in construction investment, with the sudden reversal in Ireland’s fortunes inducing a pull back in domestic consumption.”

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