'Erin Go Broke'

The winner of the Nobel Prize for Economics says Ireland is bunched.

The title of Paul Krugman's column in the New York Times today is “Erin Go Broke”. Krugman is the current Noel Laureate for economics and, arguably, the most influential columnist in the US. He is writing about how bad the US economic prospects could get and he responds to his own question with: “America could turn Irish”.

He notes the prediction that the Irish economy will shrink by 10 per cent this year and continues: “But there's more to it than that: to satisfy nervous lenders, Ireland is being forced to raise taxes and slash government spending in the face of an economic slump — policies that will further deepen the slump”.

He says: “Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore. One part of the Irish economy that became especially free was the banking sector, which used its freedom to finance a monstrous housing bubble. Ireland became in effect a cool, snake-free version of coastal Florida.

“Then the bubble burst. The collapse of construction sent the economy into a tailspin, while plunging home prices left many people owing more than their houses were worth. The result, as in the United States, has been a rising tide of defaults and heavy losses for the banks.

“And the troubles of the banks are largely responsible for putting the Irish government in a policy straitjacket.

“On the eve of the crisis Ireland seemed to be in good shape, fiscally speaking, with a balanced budget and a low level of public debt. But the government's revenue — which had become strongly dependent on the housing boom — collapsed along with the bubble.

“Even more important, the Irish government found itself having to take responsibility for the mistakes of private bankers. Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country's G.D.P., equivalent to $30 trillion for the United States.

“The combination of deficits and exposure to bank losses raised doubts about Ireland's long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

“Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks' bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders.

He finishes by observing: “And the lesson of Ireland is that you really, really don't want to put yourself in a position where you have to punish your economy in order to save your banks."