One man saw it coming….

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By Cormac Lucey

At a recent meeting of the Statistical and Social Inquiry Society of Ireland, Frank Barry looked back at the 1990s debate on joining the euro. Barry, who was one of the UCD economists who queried the merits of joining the single currency, had unearthed a great quote from the Belgian economist Paul de Grauwe from February 20, 1998.

De Grauwe wrote: “Suppose a country, which we arbitrarily call Spain, experiences a boom . . . As a result of the boom, output and prices grow faster in Spain than in the other euro countries. This also leads to a real estate boom and a general asset inflation in Spain. Since the ECB looks at euro-wide data, it cannot do anything to restrain the booming conditions in Spain . . .

Unhindered by exchange risk, vast amounts of capital are attracted from the rest of the euro area. Spanish banks, that still dominate the Spanish markets, are pulled into the game and increase their lending. They are driven by the high rates of return produced by ever-increasing Spanish asset prices, and by the fact that in, a monetary union, they can borrow funds at the same interest rate as banks in Germany, France etc. After the boom comes the bust. Asset prices collapse, creating a crisis in the Spanish banking system.”

That pretty much described the fate of the Irish banking system a decade later.

Former Central Bank of Ireland governor Patrick Honohan, who championed the euro in the 1990s, responded to Barry. He warned that, even outside the euro, Ireland would have been hit by the cheap credit that sloshed around the globe after 2000 and would have experienced a credit bubble.

Yet the economist Colm McCarthy argued, if we had kept out currency and interest rate regime, these would have acted as “canaries” to warn us of the bubble and to limit its extent. He concluded we should campaign aggressively for completion of European economic and monetary union.

Published in The Sunday Times (Irish edition)

March 5th 2017

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