For years, sensible economists had been warning that the euro’s one-size-fits-all interest rates and monetary policy would trigger uncontrollable bubbles in high-growth countries, such as Ireland, while depressing activity in weaker economies, such as Germany. For years, these warnings were not heeded, neither by politicians desperate to construct a political Europe, nor, regrettably, by the big financial institutions. Many banks and economists chose to toe the party line, in some cases to placate Europe’s political establishment and in other cases because they were fooled into believing that the single currency afforded smaller countries a free lunch of lower interest rates and stable currencies.
Ireland would have needed very high interest rates during the bubble years; instead, Frankfurt gave it ultra-cheap money. Even in January 2006, when many of the more idiotic lending decisions taken by Irish banks were being planned, the European Central Bank’s main interest rate was just 2.25 per cent. This probably made sense for Germany and maybe even for France. But it was an absurdly low rate for Ireland, which could have done with rates of eight per cent or even nine per cent. Inflation in the Emerald Isle hit 4.2 per cent in August, way too high; for 2006 as a whole, Ireland’s GDP surged by 6.0 per cent and its gross national product by 7.4 per cent. In other words, at the height of a property, economic and mortgage boom, Ireland was enjoying negative interest rates after adjusting for inflation. Companies and consumers were being paid to borrow; projects that would never have been worthwhile were the authorities pricing money properly were being signed off left, right and centre. The whole country was drunk on cheap credit, courtesy of the euro; the commercial banks, as ever, were acting as the highly paid transmission mechanism linking central bank to consumers. Everybody believed that Ireland’s excellent tax and microeconomic reforms – including the 12.5 per cent corporation tax rate – caused the boom. Of course, they did account for a large chunk of the growth and played the key role in transforming Ireland from backwater to global hub – but the remainder of the “growth” was mere froth caused by excessively low interest rates.
Ireland’s membership of the euro was thus the single most important reason for yesterday eye-wateringly large bailout of the Irish banks, which will take the budget deficit to 32 per cent of GDP and its gross government debt to 96 per cent of GDP. The tragedy is that nobody is pointing this out: the political establishment is too closely implicated and may yet need to draw on a European bailout fund.
Imagine what would have happened had Britain also embraced the single currency: our interest rates – which were substantially higher than the Eurozone’s, albeit still too low – would have stoked our own bubble to an even greater extent than anything managed by the Bank of England. The UK property bubble would have been even larger and its implosion even more devastating. We don’t realise it – but Britain’s bust of 2008-09 could easily have been much, much nastier.