Ireland Slips Into Recession

I recently wrote about Ireland and how its troubles relate to its membership of the euro area, and how this affects the case for and against monetary unions. In short, the answer was that monetary unions are other things being equal superior to separate currency areas, but if joining such a union implies significantly less sound monetary policies, then a country would have been better off not joining it. And Ireland certainly is a good concrete example of the latter case, as the low interest rate policy of the ECB has caused excessive house price inflation and debt accumulation. Until recently, Ireland has enjoyed the boom part of the boom-bust cycle, but now it is clear it has entered the bust part of the cycle.

Housing prices started to fall last year, and it is now increasingly clear that Ireland has entered a formal recession. Unemployment has reached an 8-year high and the latest GNP figures indicate that Ireland entered a recession during the fourth quarter of 2007.

Note that I use GNP and not GDP figures. Normally GDP is used, but as Ireland's GDP includes a lot of pure accounting fiction, created by multinational companies trying to benefit from the low corporate income tax rate here, GNP is a better indicator of Irish economic activity as it excludes this accounting fiction. However, because corporations can often choose to sometimes formally withdraw more money than usual, so even the GNP number needs to be taken with several grains of salt (all government numbers needs to be taken with a grain of salt, so what I mean is that it is even more unreliable than usual).

What the numbers show is that volume GNP in the fourth quarter of 2007 is up a mere 1.2% compared to the fourth quarter of 2006. What's worse, the quarterly GNP contracted a full 2.2%, i.e. nearly 9% at an annual rate. Quarterly GDP contracted 0.8%, or more than 3% at an annual rate. So there can be little doubt that economic activity in Ireland contracted during the fourth quarter of 2007.

Looking at the details, you can see a dramatic decline in fixed investments in general and residential investments in particular. Private consumption seems to be holding up, but one can question how sustainable that is. What is even more worrisome is the rapid increase in government spending. That is certainly not sound from a long term perspective and this implies that private economic activity is faring even worse than the GDP/GNP numbers suggest.

Ireland's short-term economic outlook thus appears grim and the downturn could possibly in the short term be even worse than in America. However, because the ECB seem determined not to cut interest rates and because Ireland is unlikely to leave the euro area, this means that the problems won't be postponed and aggravated to the same extent as in America. That means that Ireland has a much better chance than America of recovering a sound economy. While for example Thailand and South Korea suffered more severe downturns after the Asian crisis in 1997-98 than Japan did after the bursting of its stock- and real estate bubble in 1990-91, at least they got rid of the excesses and could recover strongly. Japan by contrast kept postponing the problem, preventing any permanent recovery. Ireland is likely to suffer a more severe downturn in the short term, but it will likely soon get rid of the excesses and then return to strong growth, as was the case in Thailand and South Korea. America like Japan, by contrast seem determined to postpone and aggravate the problems, and so make them more permanent.