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News : Irish Economy Last Updated: Oct 17, 2011 - 4:38 PM

Irish Economy: Deleveraging by banks and economic recovery in Ireland
By Finfacts Team
Oct 17, 2011 - 3:28 PM

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Irish Economy: Dermot O'Leary, chief economist at Goodbody Stockbrokers and Don Walshe, an economics lecturer at University College Cork (prior to joining UCC, Walshe worked as investment manager in Setanta Asset Management [Canada Life] with responsibility for global asset allocation, interest rate, and foreign exchange strategy) presented a paper (pdf) on deleveraging, banks and economic recovery in Ireland at the 34th Dublin Economics Workshop Policy Conference at the weekend in Kenmare, where the IMF chief of mission for Ireland also spoke about its views on strengthening the financial stability framework of the Eurozone.

Ireland making progress, but significant challenges remain - - Ireland has recently been rightly lauded for its efforts on fiscal consolidation, its return to economic growth and re-emergence of a current a/c surplus, which makes it stand out from other peripheral countries. That growth, however, is all down to net exports, while domestic demand continues to contract sharply.

Policy considerations for Ireland - - For a paper prepared and presented at the 34th Annual Policy Conference in Kerry, Ireland on the 14th October 2011, the economists analysed the policy implications of the current direction being taken in Ireland. Simplistically, the Irish economy now has a high stock of private, public and banking debt. The goal is to reduce these stocks to more sustainable levels over the coming years. They believe that not enough focus has been placed on the damaging interactions between simultaneous deleveraging in these three sectors of the economy.

Households need to repair balance sheets - - Too little focus has been placed on the role of private sector credit in the current crisis. This is particularly important for Ireland. A collapse in asset prices of up to 60% is expected to lead to an unprecedented fall in household net worth of over €250bn (280% of disposable income). Households will thus need to repair balance sheets by paying down debt. Given the high level of debt relative to disposable income (220% versus international average of 120%), this process will be prolonged and may weigh on consumer spending for longer than is currently anticipated.

Slower bank deleveraging recommended - - Specifically, O'Leary and Walshe believe that the process of deleveraging in the banking system should be slowed. The current process is creating incentives for the banks to shrink their loan books, thus contributing to further losses and general economic weakness. Slowing this would act to remove some of the supply-side constraints on lending.

Economic growth can happen while economies deleverage, but the pace of deleveraging is important - - Studies have shown that if private sector deleveraging can be slowed, this can have positive implications for GDP growth. For this to occur, further European assistance is needed to solve Ireland’s banking problems. Measures enacted to solve banking sector problems, such as a euro-wide agency for recapitalisation, are unlikely to be solely beneficial to Ireland.

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