JOINT COMMITTEE ON EUROPEAN UNION AFFAIRS debate -
Thursday, 2 Feb 2012

Draft International Agreement on a Reinforced Economic Union: Discussion

Chairman

Good morning. Our agenda this morning is the draft international agreement on a reinforced economic union. The negotiations on the treaty concluded in Brussels on Monday and this is the first opportunity the committee has had to discuss the final draft published then. To facilitate our discussion, we have invited a cross-section of people to address the committee this morning. We have here today, Dr. Alan Ahearne of NUI Galway, Professor Karl Whelan of UCD and Mr. Tom McDonnell, the TASC policy adviser. We also hope to be joined shortly by Professor John McHale, chairman of the fiscal advisory council. We asked Mr. David Byrne, the former Attorney General and EU Commissioner, to attend and he had hoped to be here, but was forced to withdraw at the last minute.

Before we begin, I remind all here to turn off their mobile phones. They should not just put them on silent because if not turned off they will interfere with the recording equipment. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official, either by name or in such a way as to make him or her identifiable. By virtue of section 17(2)(l ) of the Defamation Act of 2009, witnesses are protected by absolute privilege in respect of the evidence they are about to give to this committee. However, if witnesses are directed by the committee to cease giving evidence on a particular matter and continue to do so, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that where possible, they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable.

Senator Terry Leyden

I congratulate the Deputy on his election as Chairman.

Chairman

That is very kind of the Senator.

Senator Terry Leyden

This is the first I heard of it. Normally, a person is proposed and seconded and then takes his place, but that is only a detail.

Chairman

That happened at the last meeting. I was proposed and seconded and elected unanimously. I am sorry the Senator could not have been there.

Senator Terry Leyden

My apologies, I was at the Council of Europe in Strasbourg.

Deputy Joe O’Reilly

I was at the same meeting as Senator Leyden last week and I missed Deputy Hannigan's election as Chairman. I congratulate him and wish him well in the role. I have worked with Deputy Hannigan on the Joint Committee on the Implementation of the Good Friday Agreement of which he became Chairman and I Vice-Chairman and he did an excellent and professional job and won the respect of both the committee and the groups we met in the course of our work. I believe he will do the same here and wish him well.

Chairman

Thank you. I had the advantage of having an excellent Vice Chairman on the previous committee and could not have done it without Deputy O'Reilly. I look forward to working with him on this committee.

Deputy Timmy Dooley

I would like to be associated with the remarks made by Deputy O'Reilly. The Chairman will have the full co-operation of the Fianna Fáil delegation on this committee and we look forward to working with him. We know his reputation and I believe he will bring the same skills he brought to other committees to our deliberations here. I wish him well in that.

Chairman

Thank you. I now invite Dr. Alan Ahearne to make his opening remarks.

Dr. Alan Ahearne

I thank the Chairman for the invitation to appear before the committee today. I would like to make some brief comments about the intergovernmental treaty agreed on Monday and what I believe its implications are for Ireland.

The biggest risks to a robust recovery of the Irish economy stem from the crisis of the euro. To overcome the current crisis, and to prevent future crises, the fiscal architecture of monetary union in Europe must change. Those who argued two decades ago in the run-up to the Maastricht treaty that a successful monetary union requires an accompanying fiscal union have been proved right. Closer fiscal integration, indeed, most likely some form of fiscal federalism, is required in Europe for the single currency to survive.

The treaty, otherwise known as the "fiscal compact", falls a long way short of an EMU architecture that will restore stability and growth to the euro area. The compact has a much narrower focus - strengthening fiscal discipline through the introduction of more automatic sanctions and stricter surveillance. To be sure, ongoing fiscal consolidation is necessary in countries with large fiscal deficits, especially in countries with sizeable structural deficits, like Ireland. However, the treaty does not offer a comprehensive set of measures to address the imbalances at the core of the crisis. These imbalances show up not just in large fiscal deficits and public debt, but also in excessive private debt, current account imbalances, misaligned real exchange rates and competitiveness problems and weak balance sheets of banks.

The compact will therefore not, in and of itself, solve the euro crisis. However, it is an indispensable bridge to a set of policies that probably can resolve the crisis. Strengthening fiscal discipline at the member state level paves the way for more aggressive counter-cyclical policies at the euro area level. An appropriate macro-economic stance at the federal level is critical, because along with fiscal consolidation and competitiveness improvements at home, the crisis countries in the euro area need favourable external conditions to resolve their problems. For example, in a paper published this week by the Bruegel think tank, my colleague Guntram Wolff and I call for a targeted euro-area-wide strategy centred on European investment. We suggest that raising tax revenues at the European level, for example, by taxing the financial services industry to help leverage borrowing for European smart energy initiatives, could be an efficient way of supporting the euro area economy. However, such policies are unrealistic unless fiscal discipline at the national level is nailed down.

Similarly, the ECB over recent months has increased significantly its support to the euro area economy against a backdrop of calls by ECB President Mario Draghi for euro area leaders to provide a fiscal compact. There are essentially four key elements of note in the fiscal compact: the establishment of a balanced budget rule to ensure budgetary discipline; the policing of the balanced budget rule at national level; the policing of national budgetary control at supranational level through a stricter excessive deficit procedure, including legal penalties and control by the European Court of Justice; and new institutional architecture for euro area governance.

Much attention has focused on the balanced budget rule contained in Article 3. It stipulates that a general government structural deficit should not be greater than 0.5% for countries that have a debt-to-GDP ratio of over 60%, and not greater than 1% for countries whose debt-to-GDP ratio is below 60%. The rule will operate in tandem with three other numerical benchmarks, two of which are from the Maastricht criteria. These are a 60% general government debt-to-GDP ratio and a 3% annual government deficit-to-GDP ratio. In addition, the treaty now requires budgets to be balanced or in surplus over the medium term, as opposed to pre-fiscal compact rules which required budgets to be "close to balance". The fiscal compact includes a fourth numerical target, which was first introduced last November, requiring member states to reduce their debt-to-GDP ratio by one twentieth of the difference between their present debt-to-GDP ratio and the 60% target every year.

What effect will the fiscal compact have on budgetary policy in Ireland over the coming years? It is difficult to give a definite answer, because the interpretation of some key terms and conditions is not completely clear. For example, how will the structural deficit be calculated? What is meant by terms such as "exceptional circumstances", "country-specific sustainability risks", and "unusual events"? Notwithstanding these ambiguities, it is worth considering that the Department of Finance is projecting a structural deficit of 8% of GDP for this year, declining to somewhere in the 3-4% range by 2015. Given the current planned pace of fiscal consolidation, the balanced budget rule implies that additional fiscal adjustment efforts will likely be required for several years after 2015 to bring the structural deficit below 0.5% of GDP.

Adhering to the treaty's balance budget rule will be challenging. It is important to note, however, that fiscal consolidation at the pace and scale demanded by the rule is probably necessary in any event. After all, this country is projected still to be running a headline budget deficit of about 3% of GDP in 2015, and this is unsustainable. By 2015, our national debt is forecast to be declining as a percentage of GDP, but at a relatively slow pace and the debt will still be at elevated levels.

Evidence that high levels of public debt damage growth, ambitions to regain access to sovereign debt markets and considerations of inter-generational fairness would all argue for a pace of debt reduction that is probably in the ballpark of what the balanced budget rules imply.

As a final remark, I would note that independent of treaty developments, Ireland has been undertaking important steps towards strengthening our overall fiscal architecture. Alongside the establishment of the fiscal council and the setting of binding multi-annual expenditure ceilings, provisional fiscal rules have been drafted in the context of the forthcoming fiscal responsibility Bill. Budgetary rules are simply part and parcel of the new economic environment.

Chairman

Thank you Dr. Ahearne. I am conscious of the fact that a vote has just been called in the Seanad, so I can understand if Senators have to leave, but I hope they will return. Before we take contributions, I will ask the other three guests to speak to us, and we will then take questions from committee members. I call on Professor Whelan to make his contribution.

Professor Karl Whelan

Thank you. I thank the committee for inviting me here today. I will begin my remarks by noting that there has long been a debate among economists about whether macroeconomic policy is best set according to pre-specified rules, or whether it is best to let policy makers have discretion to set policy as they see fit. Personally, I am a sceptic when it comes to the desirability of legally binding macroeconomic rules. I am a professional macroeconomist and as such, I think it is important to admit to the limits of our knowledge. Governments can face policy challenges that even the most complex and clever rules may fail to anticipate. We should also acknowledge that we have a limited understanding of how the macroeconomy works. We are often one or two steps behind in understanding how things operate, and the recent global financial crisis is a very good example of that.

For these reasons, macroeconomic rules that constitute "frontier macroeconomic thinking" at one time can end up being viewed later as overly rigid and outdated. The adherence of international policy makers to the gold standard during the 1930s provides a good example of this. It is now looked upon as incredibly bad policy that deepened the Great Depression, but at the time it was considered the exemplar of monetary rectitude. However, what is noteworthy about the new EU fiscal compact - here I would echo Dr. Ahearne's thoughts - is that it already does not correspond to mainstream thinking among economists as to how an ideal fiscal policy framework should operate. Therefore, we are already starting with something that is clearly sub-optimal.

Most economists would agree that a good fiscal framework should have two key elements. First, it should guide an economy towards a moderate and sustainable level of public debt. Second, it should allow public debt to fluctuate around this moderate level in a counter-cyclical fashion, with higher-than-usual deficits in times of recession being offset by improvements in the fiscal position during expansions.

This ability to allow counter-cyclical movements in fiscal policy is particularly important in areas that do not benefit from centralised federal government transfers. Dr. Ahearne referred to the possibility of an EU federal budget, but that does not exist yet and it may never exist. It is particularly important for countries like Ireland that do not have control over their own exchange rates or interest rates. This is the crucial macroeconomic tool that we have and it is really important that we can use it in future in a counter-cyclical fashion, as opposed to the way we have traditionally used it, which is pro-cyclical.

In terms of those two elements, moderate debt levels and counter-cyclical fiscal policy, the fiscal compact echoes the already-existing "six-pack" in emphasising the need to get the debt trajectory down towards 60% of GDP. I think that is a good thing. It is not new in the fiscal compact as it already exists in the "six pack", but we could argue for putting a formal trajectory for getting the debt towards 60% of GDP on an EU treaty footing.

However, the key innovation in the compact is the so-called golden rule, setting a maximum structural deficit of 0.5% of GDP when a country has a debt ratio above 60% and a maximum of 1% when a country has a debt ratio lower than 60%. In addition, independent of the cyclical adjustments that are factored into structural deficits, the maximum overall deficit is supposed not to be higher than 3% of GDP.

Much of the press coverage on this issue makes it seem as though a balanced budget over the cycle is just innately desirable, and the people who designed this think that this corresponds to the homespun wisdom of the famous Swabian housewife. However, an aggregate economy is not a single household and these comforting comparisons can be highly misleading. In my opinion, the golden rule is in fact a very poor rule that does not correspond to either of the two principles of good fiscal policy that I have outlined.

The rule on moderate debt levels, if followed over time, will lead to debt ratios that are far below what anybody would consider moderate. We can say that most European countries have very high debt ratios now, so why are we worried about having low debt ratios in future? These are fixed and irrevocable rules. We are supposed to obey these rules for many years. We need to think ahead. An economy's debt-to-GDP ratio tends to converge over time towards the ratio of the average deficit to the average growth rate of nominal GDP. What does that mean in this case? Let us suppose that the nominal GDP of a country grew at 4% and consists of 2% real growth and 2% inflation - that is a pretty moderate level of growth - then an average deficit of 1% of GDP, when debt is below the 60% figure, will not stabilise the debt at 60%. It sends the country's economy steadily towards 25%, which is the ratio of the 1% deficit to the 4% growth rate.

If these rules are adopted, they will see all European countries on a steadily declining debt down to the point of a maximum of 25%, but in practice it is a call for the elimination of sovereign debt markets. Of course, people think debt is a bad thing, but one person's debt is another person's asset. Government bonds are used by pension funds and banks all around the world, and people need to think in a joined-up way about this proposal to effectively abolish sovereign debt in the long run. The rules will also severely limit the ability to use fiscal policies for stabilisation purposes in a manner consistent with long-run stable debt levels. For instance, if a 60% debt-to-GDP ratio is considered acceptable with a 4% nominal GDP growth rate, a country could have an average deficit of 2.4% per year and still stabilise the debt at 60%. That would allow the country to have cyclical fluctuations in which the deficit goes two or three percentage points above or below that; thus, it could have deficits ranging from 0% or a small surplus to 5% and still stabilise the debt at 60%. That would be a perfectly sensible counter-cyclical fiscal policy. A country could not run that under this system, because it would hit the 3% debt limit with the smallest downturn in the economy.

The legal invocation of the idea of a structural deficit is unfortunate. This is a purely theoretical concept; empirical measures of it can differ widely depending on how the analysis is done, and can often be subject to big historical revisions. The European Commission now says that Ireland was running large structural deficits prior to the crisis, but that is not what it said before the crisis happened.

I have no doubt that the political realities of a post-EFSF European Union require a greater commitment to fiscal responsibility, but Europe could have achieved this with a far better set of rules than were arrived at in this rather hastily put-together treaty. At least those who inflicted damage on the world economy by sticking to the gold standard in the 1930s can claim to have been following prevailing economic thinking. I do not think the politicians who have designed these rules will be able to invoke that defence in the future.

All that said, although I think the economics of this treaty are pretty terrible, on balance, the arguments favour Ireland's signing up to it. There are two reasons for that. As Dr. Ahearne noted, our current debt ratio is so high that we are set for a long period of tight fiscal policy with limited or no room for the use of counter-cyclical fiscal policy. Thus, in the medium term, we will have to do what we have to do anyway. Second, if indeed it is the case, as the preamble to the compact asserts, that the treaty needs to be passed to allow a country access to ESM funds, this is a powerful argument, on its own, for signing the treaty. Even those who believe we are on course to return to the sovereign bond market before the end of the EU-IMF programme must acknowledge that the possibility of the ESM safety net is there, and this is an important factor in investors' minds. If we remove that safety net, the chances of our being able to walk away from the EU-IMF programme on our own and return to the sovereign bond markets are extremely low.

Economic policy-making rarely amounts to picking the best possible policy suggested by economic theory. In a choice between an overly restrictive and badly designed fiscal compact and the potential alternative of being denied funding for our fiscal deficit next year - and the more extreme possibilities of sovereign default or exit from the euro - we should stick with the European project and hope, however difficult this may be, that we can work to improve its design in the future.

Chairman

Our next contributor is Mr. Tom McDonnell from the TASC think-tank.

Mr. Tom McDonnell

I thank the Chairman for inviting me to speak before the committee. TASC is an independent, progressive think-tank dedicated to promoting equality, democracy and sustainability in Ireland through evidence-based policy recommendations.

I will make a general observation and then emphasise three specific points about the fiscal compact. My general comment is that there is no consensus among economists about how best to manage budgetary policy, particularly over the short term, and there is certainly no consensus that legally binding targets are superior to more discretionary and flexible fiscal policy. Virtually everyone agrees that economies need responsible fiscal policy to thrive, with deficits under control and sustainable debt ratios. Targets and timing should follow sound theoretical principles and the best available evidence, and as evidence of best practice changes we should have the flexibility to adjust accordingly. Experience suggests that fiscal policy requires flexibility in the short term, and would be unduly restricted by procyclical rigid targets.

The first specific point I want to make is that the deficit brake and debt brake provisions outlined in Articles 3 and 4 are potentially damaging. This includes the mechanism that requires countries with debt-to-GDP ratios over 60% to reduce that excess by an average of one-twentieth per year. The idea of a debt brake superseding other economic considerations is problematic. It can prevent governments from borrowing to make investments that pay long-term dividends, such as in education or the provision of general purpose technologies. Unless the peripheral countries have the flexibility to borrow to close their infrastructure deficits relative to the eurozone core, they will continue to struggle within the currency union in perpetuity. The proposed one-twentieth rule would kick in as soon as Ireland left the EU-IMF programme of assistance. The debt-to-GDP ratio is likely to peak at approximately 120% of GDP. Reducing the excess at the rate implied by the one-twentieth rule will choke off any nascent recovery in the Irish economy. The ongoing deleveraging in the private sector and fiscal consolidation in the public sector, as well as weakening prospects for exports, will constrain Ireland's growth outlook in the short and medium term. The one-twentieth rule will trigger a prolonged period of fiscal tightening - that is, continued tax increases and public spending cuts beyond the current 2015 time horizon.

Second, there are conceptual and quantification issues that make the measurement of structural deficits highly controversial, if not practically impossible. This has implications for compliance and monitoring of the proposed fiscal compact. Economies are highly complex and dynamic systems and there is disagreement about what long-term baselines should be used to indicate how much of a deficit is structural, as opposed to a function of the economy's place in the business cycle. Previous attempts to measure structural deficits by bodies such as the IMF have been subject to major retrospective changes in recent years. This illustrates how difficult it can be to accurately forecast a country's structural deficit. Third, the fiscal compact does not address the existing design flaws that lie at the heart of the eurozone. There is a problem with focusing solely on the fiscal compact, as it can offer at best only a partial solution. It provides only a few pieces of a much more complex jigsaw of rules and institutions that are actually required. The usefulness or otherwise of the fiscal compact can only be judged in the context of a fuller set of reforms and supports for sustainable growth at European level.

A number of solutions are required at European level to compensate for the fact that the eurozone is not an optimal currency area. Eurozone member states need a guaranteed lender of last resort, which requires us to change the mandate of the European Central Bank. At present, governments cannot oblige their central banks to buy government debt. Governments can literally run out of money, which creates the risk of sovereign default. As the fiscal balance deteriorates in a recession, the risk premium increases, thereby creating a progressively worsening feedback loop. This is known as the multiple equilibrium problem. Yet a guaranteed lender of last resort creates issues of moral hazard and the risk of cheating. This is why there is a need for fiscal rules. However, these rules must have a sufficient degree of flexibility. Other flexibilities are also needed in terms of policy, not least measures to counterbalance the one-size-fits-all interest rate that creates localised private credit bubbles and amplifies the cycle of boom and bust. In this context, we must recognise that successful currency unions require some form of cyclically based fiscal transfer mechanism. Fiscal federalism, of course, brings its own concerns. There must be clear rules for managing future crises, including protocols and conditions for writing down and restructuring sovereign debt. We also need Europe-wide special resolution mechanisms for insolvent banks as part of centralised eurozone financial regulation.

In summary, economists do not fully agree that a debt brake is a good idea, and there is certainly not strong evidence in favour of the type of mechanism proposed in the fiscal compact. There are technical problems with measurement that could seriously impede attempts to monitor member states' structural deficits. At best, the fiscal compact is incomplete and various other jigsaw pieces are needed at eurozone level to resolve the crisis. At worst, it will damage recovery in the Irish and other European economies by reinforcing procyclicality in the recession-hit periphery.

Chairman

We will now have a contribution from Professor John McHale, chairman of the Irish Fiscal Advisory Council.

Professor John McHale

I apologise for being late; I was held up at the gate. I thank the Chairman for the invitation to appear before the committee today.

The Irish Fiscal Advisory Council released a report last week on the upcoming fiscal responsibility Bill. The report, Strengthening Ireland's Fiscal Institutions, included an analysis of proposed fiscal rules. However, as only leaked drafts of the proposed intergovernmental treaty were available when the council finalised its report, the report focused on Department of Finance proposals for the Bill. As the council has not had the opportunity to discuss the proposed treaty in detail, my comments today do not necessarily reflect the consensus views of the council.

In considering the treaty, it is important to note that the substance of the rules is already contained in the revised Stability and Growth Pact, which came into force in December. This includes the so-called golden rule in the treaty which states that "the annual structural balance of the general government is at its country-specific medium-term objective defined in the revised Stability and Growth Pact with a lower limit of a structural deficit of 0.5% of gross domestic product at market prices".

The real innovation in this treaty relates to enforcement. The revised Stability and Growth Pact has already strengthened European-level enforcement, notably the shift to reverse qualified majority voting for some decisions and a new system of sanctions, including, for the first time, in respect of the structural balance. The treaty can be viewed as a belt-and-braces approach in that national-level enforcement mechanisms are also to be brought to bear to increase the probability that the Stability and Growth Pact rules will be respected.

The core of the treaty is the proposal for the correction mechanism. Article 3.1.e) states:

In the event of significant observed deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically. The mechanism shall include the obligation of the Contracting Party concerned to implement measures to correct deviations over a defined period of time.

Unfortunately, the proposed treaty does not provide much detail on the form the correction mechanism should take, noting somewhat vaguely in Article 3.2: "The Contracting Parties shall put in place at national level the correction mechanism mentioned in paragraph 1.e) on the basis of common principles to be proposed by the European Commission, concerning in particular the nature, the size and the time-frame of the corrective action to be undertaken, also in the case of exceptional circumstances, and the role and independence of the institutions responsible at national level for monitoring the observance of the rules". These principles should be clarified as soon as possible.

Another important question relates to how the requirement in Article 3.2 of "binding force and permanent character" will be met in Ireland's case. In respect of binding force, what will be the mechanism to compel the Government to meet the requirements of the correction mechanism, including the role of national courts? In respect of permanent character, what formulation, short of constitutional provision, would be considered acceptable?

Several commentators have criticised the proposed treaty for focusing on the wrong problem for exiting the euro crisis. While the solution to the crisis goes well beyond fiscal adjustment, I believe that this criticism underestimates the important facilitating role of the treaty.

Recent events have made clear how vulnerable a country's creditworthiness is within a monetary union with underdeveloped mutual insurance mechanisms. With governments increasingly concerned about the extent of their potential liabilities under these mechanisms, it is almost impossible to see these mutual insurance mechanisms being strengthened without credible commitments to shared fiscal discipline. As Professor Whelan has pointed out, recent revisions to the proposed European Stability Mechanism, ESM, treaty make clear that access to ESM funding will now be conditional on being a contracting party to the fiscal treaty.

Critics are right to be concerned that excessive fiscal adjustment could be imposed under the Stability and Growth Pact framework in terms of the speed of required adjustments in the face of weak growth, and in terms of excessive non-interest surpluses and rates of debt to GDP ratio reductions required of countries with still high debt levels. However, there are margins of flexibility built into the Stability and Growth Pact, SGP, notably in terms of the identification of required adjustment paths. It is critical that this flexibility is used, with or without this treaty.

In sum, in debating this treaty it is important to view it in conjunction with the already agreed revisions to the SGP. The central innovation is the leveraging of national-level enforcement mechanisms. Although it would be better if the linkages were explicit, it should also be recognised that the treaty is likely to play an important facilitating role in the development of mutual insurance arrangements critical to the resolution of the euro crisis.

Chairman

Thank you Professor McHale. I will now take contributions from members in batches of three. I hope that by doing so we will give everyone a chance to comment a second time at the end of the meeting. The first person that signalled was Deputy Colm Keaveney.

Deputy Colm Keaveney

I thank the Chairman. Like some previous speakers, I thank the economists who have come here today and who have given us a presentation in a professional manner. In effect, the treaty obliges us to do one simple thing, that is, to manage Government spending and the economy in a prudential manner. I challenge a notion that has emerged in recent days from certain economists to the effect that the treaty obliges us to reduce our debt to GDP ratio to 60% within 20 years. Will the delegation comment on this? Will the delegation be clear in its commentary about whether this would involve our having to pay interest and capital repayments over the course of that reference period of 20 years? In effect, this would result in an annual payment of €13 billion. As the delegation is aware, this amounts to our entire tax take per annum.

I believe certain economists have been rather mischievous with respect to the analysis. Last night on "Tonight with Vincent Browne" one eminent economist claimed that this was the net effect of the treaty. There is a certain lack of understanding in this respect. Is it the case that Article 4 of the treaty means that the country must get the debt to GDP ratio down to 60% within 20 years? Is this what the treaty means? From the little I have read of it, my understanding of the rule is that a country with a debt to GDP ratio of 120% can take 35 years to get it back to 70% or 40 years to get it to 60% and still remain within the terms of the treaty. The one twentieth rule to which the delegation referred means that one could close one-twentieth of the GDP gap. Therefore, if the ratio was 120%, this figure would have to be 60 multiplied by 0.5% which, in essence, equates to 3%. So far as I can establish, the rules of the treaty do not require a deduction in the value of the debt but a reduction of the value of the debt to GDP ratio. In fact , there has been a good deal of progress with regard to the one-twentieth rule. Some would suggest that it is rather lax.

Will the delegation offer an opinion on the growth rate? The 3% growth rate referred to includes both inflation and real growth in our GDP. A mixture of inflation of 1.5% and growth of 1.5% would represent modest rates. Does the delegation believe the target of 60% of GDP can be hit in the medium term? Within time reference does the delegation suggest the targets could be achieved? Will it be 30 or 40 years? Does the delegation believe it can be achieved within the context of the terms of reference of the treaty?

Deputy Kieran O’Donnell

I thank the Chairman. Am I right in saying that the fiscal compact and the 60% debt to GDP ratio were already in place under the Stability and Growth Pact? There was a figure of 3% of general government balance to GDP ratio already in existence. This is being changed now to 0.5% above a 60% debt-to-GDP ratio and 1% below it. The one-twentieth rule appears to be the big change. What nominal growth is necessary for a country to be able to maintain a debt-to-GDP ratio of 60%?

Another matter not dealt with by the presentations but topical at the moment is the Irish Bank Resolution Corporation promissory note. Professor Whelan and others have discussed it a good deal recently. I would like to hear the thoughts of the delegates.

I ask them to clarify some points. Has money that has been provided by the Irish Central Bank to IRBC been borrowed from the ECB or has the bank printed it? What rate of interest is the Irish Central Bank charging IBRC? Something which has not been discussed at length in the media but nevertheless is a key element is that, in terms of the promissory note, interest of over 8% will kick in from 2013 onwards. It will be a charge on general Government spending. It feeds into the general Government balance. I expect the amount involved will be about €1.9 billion in 2013 and for a number of years after that.

Is there a case for considering deferring interest payments for a 20 year period? Such a change would not have an impact on people's lives in terms of the general Government balance. The IBRC will be wound down in a number of years' time. The net effect would be less severe on the Irish taxpayer. The money would be repaid to the Central Bank on an annual basis.

I refer to something which has been overlooked in the discussion. In our consideration of the promissory note, the view is that the interest rate is irrelevant on the basis that the money goes into IBRC and will come back out. However, there is a charge of €1.9 billion, followed by a charge of €1.8 billion the following year, in general Government spending on a yearly basis that has a real impact on people's lives.

I ask the delegates to cover that area. When the Anglo Irish Bank promissory note was created, effectively it was an artificial product. It was created with interest rates which varied from 4% to 8%. As a country we could not afford to borrow on the international markets and this resulted in us having to enter the current EU-IMF package. It is ironic that the interest rate being charged is one by which we as a country were forced into a rescue package. It is something that will have huge significance in people's daily lives from 2013 onwards.

Senator Kathryn Reilly

I welcome the delegates and thank them for lending us their wealth of experience in this matter. No one can doubt that never before have European citizens and economies been in such need of assistance. To date, the credible solutions needed have not been provided by the EU. I am not convinced that this agreement is a solution to the crisis.

There is massive austerity in the State and across Europe since the beginning of the crisis, which feeds into the current disillusionment about the effectiveness of the fiscal compact. Growth is falling, the standards of living have been slashed as public services are being cut, there is rising unemployment and continued emigration. Despite endless rounds of crisis summits, it is clear that the responses to date do not seem to work. An IMF report produced recently on austerity over 30 years in 173 countries stated that in the absence of some growth strategy employment will be driven up and will make conditions worse.

George Soros said the austerity approach would condemn Europe to a deflationary spiral. Joseph Stiglitz described the pact as the medieval practice of bloodletting which will only make the patient worse. Do the delegates think the pact will solve the crisis? In his presentation Dr. Ahearne said it will not do that in itself and called it an indispensable bridge. How sturdy is the bridge? Professor Whelan said the economics of the treaty are pretty terrible.

Is the 0.5% deficit one figure realistic for the State at this time? Is it appropriate for an economy the size of Ireland at all points of the economic cycle? Is it appropriate or inappropriate for the other 25 states have signalled they will sign up to the pact? How long will it take Ireland and others to reach these goals and at what cost, in terms of austerity, above and beyond what has already been committed to? We have heard that it could cost another €6 billion in tax hikes and cuts.

On the 60% of GDP figures for Government debt, can the delegates state how, given that Ireland is expected to have a GDP to debt ratio of 120% by 2012, will the pact's commitment to reduce this figure by one twentieth each year be achieved? How long will it take and what will it cost?

Chairman

There is a range of questions. I hope each delegate will give some answers.

Dr. Alan Ahearne

Deputy Keaveney raised the issue of the debt brake and what the one twentieth rule means. People have said the difference between our current debt ratio of 120% and the target of 60%, divided by 20, equals one twentieth, which is three percentage points per year. They mistakenly think the ratio must be reduced by 3% per year. That is not true because as it is being reduced the difference between the ratio is narrowing all the time. It is not true to say that it needs to be brought to 60% within 20 years. It would take longer. I do not have a number but the sheer arithmetic means we must have longer to do that.

It is also not true that this would have to start immediately. The debt brake probably does not apply until we are out of our programmes, which will be 2014 at the earliest. There are some implications in terms of the debt rule in 2014, and probably 2015. In 2014 the debt ratio will need to be reduced by three percentage points, which is one twentieth of 60%. The budget 2012 documents referred to the debt ratio reducing from 119% to 118% in 2014. Strictly speaking, the debt rule would suggest there has to be a bigger reduction in the debt in 2014, and probably 2015, than has been forecast.

There are different ways to reduce the debt. Deficit reduction excludes once-off or temporary factors. That is not excluded from reducing debt. For example, if there was privatisation or asset sales it would reduce the debt. By timing them properly they could hit in 2014 and 2015, reduce the debt by an extra two percentage points and it would work out. It becomes less of a problem as one goes further. Given where our balance will be and that growth is forecast, the debt ratio would reduce by two percentage points in any event. The problem is created in the short term. There may be ways of getting around it.

Deputy O'Donnell referred to promissory notes. There is a lot of confusion about them, which I understand because people look at the interest rates, which range up to 8.5%, and conclude that it is like the NTMA issuing a debt instrument on which we are paying a very high interest rate. That is not the way it works and is confusing the nature of debt instruments. The Government, at the time Anglo Irish Bank was recapitalised, did not borrow from the markets at high interest rates. Instead, it promised Anglo Irish Bank that, over time, it would give it cash. The promise is the promissory note, which is in writing and carries a notional interest rate.

Deputy Kieran O’Donnell

It is the general Government balance.

Dr. Alan Ahearne

I will refer to Government accounting in a minute. It carries an interest rate but that is ultimately transferable between one arm of the State and the other. The really critical point about the promissory notes is that they allow the recapitalisation of Anglo Irish Bank to be done at a very low financing cost, ultimately at 1%. It cannot get cheaper than that. Instead of putting cash in up-front, the payments have been stretched out. If one stretches out payments on a loan with a given interest rate, it is better. That does not mean there cannot be improvements and that there could not be further stretching. If one stretches even further, one can make even more savings.

Deputy Kieran O’Donnell

To clarify, my point is-----

Chairman

I will let the Deputy in later.

Deputy Kieran O’Donnell

I just want to make a specific point and will be brief. The interest charge on the promissory note, which is a notional charge, is having a real impact on people's lives because our general Government deficit must not exceed 8.6% of GDP this year and 7.5% next year. Am I correct in contending that €1.9 billion of the notional interest charged to Anglo Irish Bank is included in that?

Dr. Alan Ahearne

Yes.

Deputy Kieran O’Donnell

This is an artificial product and the money does come back, but in terms of real people's lives next year, it will have an impact.

Dr. Alan Ahearne

I understand, but the real benefit to reducing the cost is that it allows one to try to stretch things out. The mechanism was set up as a very cheap way of injecting capital into Anglo Irish Bank. It becomes more expensive over time because the cheap funding gets replaced by more expensive funding as the promissory note is paid off. If one can come up with an arrangement that keeps in place the current, very cheap funding for a longer time, it will mean savings for the State.

I was asked whether austerity and the pact will work. As I stated, it is not a solution to the crisis. In my opening statement, I tried to differentiate between "euro area level" and "country level". If there are countries with very large structural deficits, those deficits need to be reduced. A structural deficit, by definition, is one that will not go away even if the economy is growing normally. It can only be reduced through discretionary actions. Countries with very large structural deficits must reduce them. Quite a few of the peripheral countries are in this category. I agree that, in trying to reduce the deficits, it is very difficult if the external environment is not good, that is, if the euro area as a whole is not growing. There are significant risks to the euro area economy and it appears that it may go into recession in the first half of this year. This recession could be prolonged. That is why I suggested in my opening statements that there be a two-pronged approach. The first is that countries with big budget deficits need to stick to austerity or fiscal consolidation. At euro area level, where there is more scope for counter-cyclical policy, the stimulus should be applied.

Professor Karl Whelan

There are many questions and I do not know which to spend time on. The question on paying one twentieth of the overall sum goes back to Zeno's paradox. If one closes one twentieth of the gap every year, one will never close the gap. We can work out what kind of adjustment is required in the short term but it is not the way to proceed.

On the general question on austerity, which is worthy of debate, the pact, applied across Europe, will lead to more austerity on average than is required. However, we are starting where we are starting. The issues go well beyond what Irish politicians really have to debate in regard to this issue. We can say we do not like the treaty, as I do, but, on balance, our national interest requires that we sign it. That is an unfortunate compromise to have to take. I take the greater point on there being too much emphasis on deficit reduction around Europe and perhaps around the world, but that may be a discussion for another day.

The speed with which we will lower the ratio of debt to GDP relies every bit as much on the denominator, GDP, as it relies on the numerator. It is very difficult to get into questions as to how much deficit reduction is required to lower the ratio because every point of GDP growth is just as effective in lowering the ratio as deficits. Without a return to steady GDP growth, it will be very difficult to make any kind of decent progress on lowering the ratio.

With regard to my favourite topic – promissory notes, ELA, etc. – it may be worth having a committee meeting dedicated to this subject. I could give a quick answer now but it could trigger five questions, after which we would be talking about something else. To use an economists' term, I completely agree with Dr. Ahearne on "long-run neutrality" of the interest payments on the promissory notes. They go from one arm of the State to another. Largely, the money is used to pay off the ELA that came from the Central Bank. Deputy O'Donnell asked whether it came from the ECB. I am well aware that the Department of Finance is briefing people regularly that this money came from the ECB but it did not because the ECB does not print any money. The money printed in the euro system is printed by national central banks. Therefore, it was printed by the Central Bank of Ireland.

A long, complicated issue arises over what occurs next. In general, the money is printed by the Central Bank of Ireland and placed in a reserve account to which Anglo Irish Bank had access. Anglo Irish Bank wrote cheques based on the reserve account to pay off bondholders and depositors and this led to the money going out of Ireland to other countries. Part of the process involves the Central Bank of Ireland then incurring what is called an inter-euro system liability, also known as a Target2 liability. The Central Bank of Ireland pays an interest rate of 1% per year thereon. If the funding has an ultimate cost, it is 1%. That is the 1% that Dr. Ahearne was referring to.

The State is paying 1% for the funding. If it is salting extra money away inside Anglo Irish Bank, at some point when Anglo Irish Bank has paid off all its liabilities, it will have cash left. At some point in 2025, for example, there will be a big dividend that Anglo Irish Bank can return to the State. That is the way the note is structured. In the short term, there are interest payments going into Anglo Irish Bank which for now, are being counted on the debt. When Anglo Irish Bank returns the money later, EUROSTAT would then see the debt being reduced.

Deputy Kieran O’Donnell

How will the interest charge affect people's lives?

Professor Karl Whelan

I take that question very seriously. With regard to people's lives, the note involves the paying of €3.1 billion every year. In 2014, it will not pay more or less. Therefore, the only issue that would affect real people's lives would arise if we continued with the current accounting treatment that has been agreed with EUROSTAT. Anglo Irish Bank has a debt of €31 billion. If we were to put in €3.1 billion every year, one might say the debt would be paid off in ten years. One might then say the note is supposed to attract interest based on a decision to that effect and assume as a consequence that there would be extra payments up to 2030. The IBRC debt to the Central Bank is a low interest rate debt, at 1% plus some margin. In reality, as I described earlier, it can be wound down faster, after about 11 or 12 years. The interest rate on the note has really been calculated based on all these payments that are supposed to happen in 2025 and 2026 but they will never actually happen. In a sense, the 8% interest rate is fictional. However, this is a fiction that the Government has agreed with EUROSTAT which has some timetable whereby it decides each year some part of the €3.1 billion is principal and some part of it is interest. We have negotiated with EUROSTAT about this issue once before and asked it not to count it as interest for a couple of years. In terms of the impact on the lives of people, I would suggest we go back and talk again.

Chairman

I suspect Dr. Ahearne is correct, that this subject could very well take up a whole meeting on its own. We might discuss it later when in private session and arrange a meeting. We will have to discuss the matter with the finance committee to ensure we are not moving into its territory. I thank Dr. Ahearne for those comments.

Mr. Tom McDonnell

It is important to add to the discussion of the promissory notes that the €30.6 billion is equivalent to 19% of GDP. If that debt had not been socialised, if the private losses had not been imposed upon the good people of Ireland, then our debt to GDP ratio in 2013 would be closer to 101% which would mean we would have to reduce the debt to GDP ratio by 2% each year from that point on, rather than 3%. That additional 1% is the equivalent of €1.6 billion. That is another very important effect.

As to whether it is required to get down to 60% in 20 years' time, the short answer is "No"; it is simply required to maintain the ratio which becomes less onerous year on year. That is fine in 2025 or 2030 but where it really harms us is in the two or three years following our leaving of the official EU-IMF programme which will either be in 2013 or 2015, if a second bailout is required which, in itself, would be a function of the interest rates which we will be required to pay on the sovereign debt market. That is an open question and it will be very challenging. As to the difficulty and likelihood of achieving high levels of growth, Irish domestic demand will be very highly constrained for the next half decade because of the high level of deleveraging which is ongoing in the Irish economy. Historically it takes between five and nine years for a country to deleverage from a severe banking crisis and we are about halfway through that process now. Domestic consumption is likely to be quite low in the years ahead. Obviously there will be the ongoing fiscal contraction itself which contracts growth. There are diminishing expectations as regards exports over the next few years as the crisis deepens among our major trading partners. Whether the debt reduction is achievable depends upon the interest rate and on growth rates and also on the primary deficit. The likelihood is that it would be automatically triggered in 2014 or 2016 when we are leaving an additional €2 billion to €3 billion of consolidation in those years.

Deputy O' Donnell spoke about the implications for real people and the real economy. These implications will include increased taxation, reduced public services, fewer jobs and unemployment. It is a procyclical effect so the recession will worsen and deepen in the peripheral economies. As to what we can do about it, we can achieve low interest rates on borrowings which requires a backstop in all likelihood and which will be about either a second or a third programme. I would support actively seeking out a second programme as it is not a shame to do so and it is better to get official borrowing at 3% than market borrowing at 5%, 6%, 7% or 8%.

There also needs to be increased spending in the countries which have not been damaged to the same extent in order to counteract the procyclical effects and procyclical policy that is required in the peripheral countries. In the longer term, there are implications as to whether monetary union is at all achievable without some form of fiscal union and much of the academic theory would suggest it is not possible but this view also has major associated implications. There is not much to add on the promissory notes as Professor Karl Whelan is probably the global expert on the issue of the IBRC-----

Dr. Alan Ahearne

A sad thing to be.

Mr. Tom McDonnell

-----promissory notes. Last Friday, Professor Whelan called for a deferral on the payments and he has done so consistently over the past six months to a year and I wholly support his view, including the changing of the interest rate schedule which has an impact on the deficit year on year.

The debt deflationary cycle is already occurring and it will be very difficult to emerge from that by the use of procyclical policy. As Dr. Ahearne pointed out we have a large structural deficit which is completely unsustainable and this makes it very difficult for us to engage in any other policy. Nevertheless, at European level, there is space for fiscal expansion which would have an impact on our net exports and help in that regard.

Professor John McHale

Most points have been covered by my colleagues. Deputy Keaveney and others have pointed out it is a one twentieth rule and not a 20-year rule. The Fiscal Council has done simulations of the various rules and based on our simulations - even though certain assumptions have to be made in any simulations - the one twentieth rule would not be the binding constraint, not the thing that would force more fiscal adjustment. The really binding constraint is the structural deficit target of 0.5% of GDP or better. This leads to Deputy O'Donnell's question and I refer to my statement. There are really no new rules at all in this treaty, including the 0.5% of GDP structural deficit target to which we have already signed up. The bad news is that it is actually worse in that this is a maximum structural deficit which one is supposed to run over the longer term and each country has its own specific medium-term objective based on country considerations. Based on current calculations it looks as if Ireland could be forced to run a small structural surplus. This is of concern and is the real constraint in the system. However, it is not from this treaty and it is important to realise what this treaty is adding, which is additional enforcement using these national mechanisms.

On the promissory notes, for what it is worth, I strongly endorse Professor Whelan's proposals in that regard. The reason it is so important, in my view, is that the promissory notes are essentially unfunded; to pay out this €3.1 billion, the State will have to borrow and these payments are continuing in the near term to put a lot of extra funding pressures on the State. To the extent that we are making progress in getting into a situation where we can get back into the markets, it will be made much more difficult if we have these big additional funding needs. Anything that can ease those funding needs really improves our chances of getting back in the markets and the restructuring of the promissory notes is very important in that regard.

As Professor Whelan and the other speakers have said, looking at the consolidated accounts of the Government as a whole, the interest rate paid on the promissory notes is largely irrelevant. However, the Deputy has raised a very important point which is actually very relevant to what we are discussing. We now face these targets for the general government deficit under the programme and under the rules and as he pointed out the State is paying these interest payments to Anglo. As those interest rates are very high, it raises the general Government deficit making it harder to hit those targets, forcing potentially additional fiscal adjustment which has the effect on people's lives the Deputy mentioned. Professor Whelan is right that it is really an accounting issue, but it is an important accounting issue and it does matter.

Senator Reilly asked important questions about the effects of fiscal adjustment and whether it is working. There is no doubt that fiscal adjustment slows the economy, destroys jobs and creates additional hardship. Unfortunately we face this horrible trade-off. On the one hand, when we have an economy that is slumping we would like to support it as best we can and the last thing we want to hit it with is additional fiscal adjustment. On the other hand, we face great vulnerabilities relating to debt sustainability, being able to finance the very large deficit and debt roll-over that we face, and even vulnerabilities in terms of access to official funding in the future. We know that with the euro crisis official funding is in flux. So that very difficult trade-off determines what the right fiscal policy will be and there is really no easy answer.

It is wrong to think it is just the fiscal austerity that is leading to disappointing growth performance in the Irish economy. Unfortunately other factors are also slowing the economy. As Deputy Mathews has pointed out on many occasions, the debt burdens with the associated debt deleveraging are another source of significant contraction in the economy. One needs to be careful in just pointing to the disappointing growth and automatically concluding that the fiscal adjustment is not working. Some people claim that the fiscal adjustment is self-defeating in its own terms in the sense of not reducing the deficit but the evidence does not support that. The right measure to look at is the non-interest component of the deficit. Even though it is coming down slowly, part of the reason for that is that we have these other drags on growth in the economy.

The big question - the Fiscal Council is looking at this at the moment - is what the right response would be if there are even further negative growth shocks. The problem is that it makes the dilemma even more difficult. On the one hand, the economy is in even worse shape so that last thing we want to do is to hit it with big fiscal adjustments. On the other hand, debt sustainability is even more precarious. The IMF has done some very interesting international comparative work on this. One thing it emphasises is the importance of planning in advance in terms of figuring out what the response would be if a country has these negative growth shocks. A country should not wait for them to happen but should figure out what its response would be and this should also be negotiated into programmes. It is then much easier to retain credibility even if it must slow the fiscal adjustment when hit with negative growth if it has planned for it in advance. That is important to keep in mind.

One beneficial result of having a set of fiscal rules - a fiscal framework that makes it more credible that a country will get its fiscal accounts under control over the longer term - is that it can actually give it some more flexibility in the short term in dealing with adverse shocks. It gives credibility potentially with official funders and also potential credibility with the markets. So even though a system of fiscal rules has come in for considerable criticism here, there are some important benefits in having this sort of foundation to a country's fiscal policy that those rules can give.

Professor Karl Whelan

I disagree with Professor McHale slightly about what is new or not new in the pact. I will not say anything with which Professor McHale disagrees in terms of facts, only in terms of emphasis. So what is new in the pact? To my mind what is new is not that the figure of 0.5% has suddenly just come out of nowhere because it is in the six-pack. What is new is that the 0.5% and the 1% below 60% will be introduced into every country that signs into permanent and binding - preferably constitutional as we now know - law. However, most people missed the six-pack. The current fad, given the background of what is going on in Europe, is for responsible debt management. However, one could easily envisage a post-crisis Europe where the six-pack is revisited. For all the reasons I have pointed out, the 0.5% rule is not very sensible. One could imagine the European Commission drafting new six-pack proposals partly because these are so tight that they will probably be violated so often and will cause so much trouble that at some point they could be revised. However, once this treaty is passed and this is permanent and binding, it will be extremely difficult to change. In that sense what is new is that we will be stuck with this. Therefore, I think the treaty is more important than Professor McHale has emphasised.

Professor John McHale

I disagree only a little.

Deputy Colm Keaveney

Can I offer an observation? Three of the economists have American accents and I would be interested to establish whether their economic philosophy comes from Harvard or Chicago.

Deputy Timmy Dooley

That is personal.

Deputy Colm Keaveney

It is not personal. I know Mr. McDonnell does not have that American accent, but three of them do. Before they comment any further, because it is good to see on the other hand-----

Deputy Peter Mathews

Mr. Mario Draghi is Italian and Mr. José Manuel Barroso is Portuguese. Does it matter?

Deputy Colm Keaveney

I wish to know where they received their qualifications.

Deputy Timmy Dooley

Perhaps Deputy Keaveney and Senator Healy Eames will sing off the same hymn sheets based on their accents.

Deputy Colm Keaveney

There is a mirror behind the Deputy.

Chairman

I ask Professor McHale to respond briefly to Professor Whelan's comments and then we can take questions from the members.

Professor John McHale

I think we agree on the rules that arise from the Stability and Growth Pact and the six-pack that was introduced last year. I do not disagree with Professor Whelan that the extent of enforcement here is what is really new. It makes them more significant in terms of the potential constraining effect they have on Irish fiscal policy. I would make one change to what he said. We need to distinguish what the treaty does in terms of the structural deficit target and the one twentieth rule. There is an additional enforcement mechanism in this treaty associated with the one twentieth rule, although there is this correction mechanism associated with the structural deficit target which would be very significant. It is perhaps just a difference in emphasis.

In terms of our accents, I think I can say for the three of us to whom the Deputy is alluding, that none of us is American.

Deputy Colm Keaveney

I was not talking about the accent.

Professor John McHale

All three of us completed our PhD studies in the US. In my case I did it at Harvard. I was in North America for almost 20 years in total - 11 in the US and eight in Canada before returning to Ireland two and a half years ago. I had hoped I had not picked up a North American accent but apparently I have, which is somewhat distressing, but-----

Deputy Colm Keaveney

There is a particular reason for asking.

Chairman

If we have time we might return to that.

Deputy Colm Keaveney

It was asked in terms of the economic philosophy emerging.

Chairman

Many members are indicating and I know that Deputy Mathews needs to be in the Chair in the House at 1 o'clock. I will call a batch of four members - Deputies Dooley, Mac Lochlainn and Mathews, and Senator Healy Eames.

Deputy Timmy Dooley

I welcome the participants and thank them for their presentations. I was getting concerned there was such a consensus of views coming forward. The thought of four economists spending so much time together and agreeing was starting to undermine their profession. I was pleased to see the two professors finding some views on which they did not quite share consensus.

There is considerable talk about the structural deficit target of 0.5% of GDP, which will be required to be reached beyond 2015. That is of concern to all, particularly given that the timeframe will be set by the Commission and will therefore be outside the control of the Heads of Government.

We are projecting an overall deficit of 3% by 2015. I know it is a fluid situation which is difficult to pin down. Can the witnesses give us any idea what percentage of the 3% will be a structural deficit at 2015? This would assist us in terms of trying to work that through.

Although it created some level of debate, all of the speakers identified that there is nothing particularly new about greater oversight, governance, sanctions and enforcement. However, if we go back a couple of months to the market situation that effectively drove the political process in Europe to seek a solution to protect or save the euro, because we were all having conversations three or four months ago as to whether the euro would survive, it was out of that situation that this process began. Much of the time, in political circles, a debate starts, then something happens, the debate moves on and people forget about where they started. The question is whether the markets will forget about where this started.

There is an expectation among the markets, and among those who would target the euro or not, that the political process had kicked into action and was putting in place a series of measures to create the necessary fiscal discipline and look towards a more effective method of protecting the euro and, in tandem with this, putting in place the necessary measures to generate growth. In order to do that, on the other side of the balance sheet, there was an expectation that part of the solution would see an equalisation of debt, the emergence of eurobonds and the emergence of the ECB as a lender of last resort. That was very much part of the thinking and of the presentation that seemed to suggest the markets would ease up on the euro when it emerged, but also that we could not have this without greater oversight, governance and enforcement. That point seems to have been lost in all of this.

I heard a colleague of the witnesses present talk in recent days about the introduction of eurobonds and the emergence of the ECB as the lender of last resort happening within the next five to ten years. While I am no market expert, I talked to people who work in that sector and that was not their expectation, and it will not be appropriate if the attack on the euro or the lack of confidence in the euro is to be prevented from returning after we have this situation agreed. It cannot just be an achievement at a political level, or a case of "We got the agreement, it is signed and delivered, and we are now into the machinations of whether there is going to be a referendum or not." We have lost the focus of where all of this started. I would like to hear the witnesses' views on that point.

Deputy Peter Mathews

I thank the delegation and apologise as I must leave shortly to take the Chair in the Dáil. During our visit to Germany with the finance committee, a couple of points needed to be appreciated by our counterparts on the budgetary committee and the finance committee of the Bundestag, of which they were not aware, as far as I could make out. The first is that the losses that occurred in the banking sector here, which are admitted at approximately €70 billion and in my view could be €100 billion, are an awful lot of our national income, over 50%. I told our German counterparts that if their economy had to bear losses of 50% of GDP, which is about €2.4 trillion, that would mean socialising €1.2 trillion of debt across their economy. That is the scale of our problem. I would like the witnesses to appreciate this in the context of a fiscal compact.

I am picking up on Deputy Dooley's point, namely, that the 2,000 lb gorilla in the room, to use Deputy Pádraig Mac Lochlainn's analogy from the other day, is in fact the loan losses which are emerging, embedded and not yet acknowledged in the banking and financial system across the eurozone, and even spreading outside the eurozone into US dollars and so on, depending on the interlinkages with banks. Furthermore, in addition to the normal balance sheet fragility, I pointed out to the Germans that as Deutsche Bank has a balance sheet of €1.85 trillion, if 10% of its assets are dodgy, that puts a €185 billion hole in its capital and reserves. This is the big problem that needs to be addressed.

This again echoes Deputy Dooley's point, which is that we need to address courageously across the eurozone and EU what are the likely provisioning losses that need to be recognised and then create a fund. My guess is that such a fund would probably approach €2 trillion, rather than the €1 trillion Ms Lagarde thinks it should be, and there would want to be another €1.5 trillion of reserve or standby capacity. Sooner rather than later, we would want to put in place the idea of eurobonds. We are in a 500 million person continent, with more than 300 million in the eurozone, and this is what is needed in order to get the financial cardiovascular system properly repaired.

I also reminded the Germans that in the 1951 London debt agreement there was serious restructuring and write-down of debts, which helped the German recovery. To ignore this in a country like Ireland is just plain wrong. I come back also to a point raised by Professor McHale, which is a theme of mine, namely, we have private household and business debt that is at present disproportionately and scale-wise far higher than any other country, including Greece. That is the starting point of our marathon. We are in a marathon. To have our counterparts in Europe saying, "Well done. You are a success story. The troika boxes are all being ticked", is like saying to somebody after the first half mile of a marathon, "Well done. You are a success story and you are going to get there." That is my tuppence worth.

Deputy Pádraig Mac Lochlainn

Deputy Peter Mathews's intervention was very important but also very depressing, although much of what we are talking about is deeply depressing. There are two core issues for us, as parliamentarians, to consider. First, we are discussing macroeconomics but we are not just running an economy; we are also running a society, and we have to consider the social consequences of the decisions that have been taken, many of which are out of our people's hands at this point.

I draw attention to a particular sentence from Dr. Alan Ahearne's contribution, "Closer fiscal integration, indeed, most likely some form of fiscal federalism, is required in Europe for the single currency to survive." I have heard this view from many commentators. The difficulty with it - perhaps it is a fundamental problem of monetary union - is that, clearly, this is not politically attainable. If one looks to the European constitutional push in 2005, the people of France and the Netherlands rejected that drive and, of course, the people of Ireland then rejected the Lisbon treaty, although, under significant economic duress, we voted for it the second time. Of course, we know what happened with the promises in that regard.

Sinn Féin's approach to Europe is sometimes deeply misunderstood. It is very sad that there is a growing euroscepticism. The potential of Europe as a block of countries that have been through deep conflict but which can now work together as a beacon of hope, for example, in human rights and the developing world or as a project that can demonstrate to the wider world the benefits of conflict resolution and developing common economic strategies, can be a good thing. Most important is the idea of social Europe. There have been immense advances in terms of social Europe in regard to worker's rights, women's rights, environmental issues and so on. It is a deeply important project. Ireland cannot function on its own and we have to engage with the wider world. I say all of that as a caveat to what I am about to say.

In terms of the great economic debates, I do not know what side the witnesses fall on with regard to Hayek v. John Maynard Keynes. Perhaps they do not believe either of them are appropriate to the modern era. It is clear to me that Hayek’s philosophy, which was famously embraced by Thatcher and Reagan throughout that era and continues right up to the present day, has catastrophically failed in terms of a lack of regulation and the international financial markets going bonkers, with all of these different vehicles, including derivatives and so on, with paper money leaving no trails, and with no proper stress testing taking place. The victims of all of this are the 23 million people out of work across Europe. Half of the young people in Spain are out of work. One third of our young people are out of work and we have seen devastating levels of emigration.

What has happened in response to that ideological breakdown and failure? We need to embrace more Hayek and write Keynes out of the story. We need to write out the historic advice about the role of the Government and the public sector in a time of recession that we counter the cycle by stimulating the economy and restoring confidence. All of that has been thrown in the bin in the proposition before us. One must ask what is the logic of that. None of the four witnesses present, for whom I have huge respect and I have read all their publications in recent years because we have all had to become amateur economists to try to make sense of this crisis, has said this is a solution to our crisis or that this is the way forward for Europe. We have heard from Professor Whelan, for whom I have huge respect, that for pragmatic reasons we might have to accept it. It is a bit of a gun to our head situation. If we want to avail of the future bailout moneys, we will have to suck up this, so to speak. It is an awful position in which to put our people. It must be remembered that we have to run a society. That is the message we send to our people and it is the way we promote the European brand. This is a very bad time.

Two Nobel prize-winning economists who obviously are advocates of Keynes, Paul Krugman and Joseph Stiglitz, have been arch critics of the approach being taken in Europe. I have yet to hear a comprehensive rebuttal of their view. Sadly, in Davos our Taoiseach described Joseph Stiglitz as a commentator and said that commentators commentate. I was furious when I heard that. This was an open door where one of the most eminent economists in the world gave an analysis that was to bolster the Irish people's case at this time and our Taoiseach dismissed it.

I will now put my questions which get to the core of the issue. Do the witnesses agree there are a number of core elements to this crisis, the first being a lack of growth in jobs and an absence of hope, which is a very dangerous thing? We have an investment crisis, a banking crisis and a sovereign debt crisis. In terms of the investment crisis, I have not heard anyone outline the role of the European Investment Bank. Does it have a role in this crisis? Ireland has the National Pension Reserve Fund in which there is still €5.3 billion. The Sinn Féin Party teased out that with the troika when we met it in terms of utilising the resources of the National Pension Reserve Fund in partnership with the European Investment Bank. The European Investment Bank has a track record of prudent investment and return. Could we utilise this to stimulate our economy, to invest, for example, in next generation broadband? That is the first point in terms of investment.

The second point relates to banking. When will the global financial system take ownership of this crisis? When will rigorous stress tests of the core banks in Europe be done? When can we start to see the paper trail? When can we start to examine, and have the full facts on, all the different vehicles, derivatives and other things in which we have been involved because until we get to the heart of this banking crisis, I do not see how we can move on? The way we will restore confidence is for those at the top who have catastrophically failed us and caused this crisis to pay the price.

The third element relates to sovereign debt. Deputy Peter Mathews's contribution is critical in that regard because the problem is wider than sovereign debt. There are three or four different types of debt, and Professor Ahearne mentioned that. I do not think anybody believes Ireland, or in a more extreme case in terms of sovereign debt, Greece, can work its way out of this crisis, without devastating social consequences. It will mean a lost decade for us, for example. The witnesses are economists and I have huge respect for their analysis but how do we, as parliamentarians, protect our society? How do we prevent the flow of our brightest and best out of our country again? The point was made about American accents. There will be many more American, Australian and British twangs among our people in the future and our challenge is to prevent that. What is the witnesses' proposition in terms of investment, banking and manageable debt? I presume they do not present this intergovernmental agreement as any kind of panacea. Those are my questions and I thank the witnesses for their patience

Senator Fidelma Healy Eames

I welcome the panel. It is good to have them here together.

My concerns are not dissimilar to those of the previous speaker. I am concerned about the economic health of our nation and how we position ourselves within Europe but particularly the harsh effects this is having on our people. Mr. Tom McDonnell has put it in clear terms to us. We have made many mistakes. Private debt has been socialised, and he outlined the harsh effects that managing this debt will have on our people in the future. It is depressing but I appreciate the truth.

Growth is obviously key. From where do each of the witnesses see growth coming? Our relationship with Britain is also key. How will Ireland position itself between Britain and the EU, remembering that Britain is our single largest trading partner and given that it has opted out of the treaty? We saw Nick Clegg in Dublin recently, reinforcing our relationship. How will Ireland manage the relationship between Britain on the one side and Europe on the other, while trying to keep in with both? Where else should we be looking for growth now? Are we too focused on the EU? What about the BRIC countries? What about China? What are the views of the witnesses in that regard? They might comment briefly on the relationship between Europe and the BRIC countries? What avenues do they consider we should pursue to achieve growth for our people? We are incurring a great deal of austerity at the most basic level in terms of home care packages and rural schools. We are compromising the education of our young people as a result of the terrible decisions of lack of regulation and previous bad Government decisions. What solutions do the witnesses propose?

Hypothetically, if the treaty were put to a referendum and rejected by the people - which I doubt because Irish people do not like to be left out - what do the witnesses envisage would be the consequences for Ireland and for the EU?

Chairman

While we have a lot of time, I am conscious that other speakers would like to contribute. I ask the witnesses, therefore, to limit their responses to three or four minutes each on this batch of questions.

Deputy Pádraig Mac Lochlainn

Good luck with that.

A Speaker

I would never try that.

Chairman

Who would like to speak first, Professor Whelan?

A Speaker

To answer Deputy Pádraig Mac Lochlainn's questions in three minutes is a challenge.

Professor Karl Whelan

We will select a number of issues, and if members consider a matter has not been addressed, they can put up their hands.

The first question I wish address, which was raised by a few members, relates to the big solution of the euro bonds, fiscal federalism and so on. The optimistic answer on this is that Rome was not built in a day. The optimists among us may want to say that this treaty, imperfect and all as it is, is a valuable first step. For instance, if it turns out to be the case that Italy, Spain and various other countries run into funding problems, perhaps the ECB would be more likely to intervene given that it could say that a fiscal compact is in place so it does not think this will be the start of endless monetary financing of deficits that would prove to be inflationary.

I ended my comments by saying that the pact is imperfect but we should sign it and look to produce a better outcome. We are still in the early days of trying to put a new infrastructure together. However, I am not one of the optimists among us so I think that fiscal federalism is probably politically impossible. The European Central Bank, by construction and the nature of German attitudes to monetary policy, is likely to prove to be extremely rigid and not to do some of the things that we want done. I am really not sure that this is a quid pro quo for something that will come down the tracks. I hope I am wrong.

On Keynesianism and the abandonment of it represented by the pact, I agree with everything Deputy Mac Lochlainn said. This is turning its back on what macroeconomists teach to undergraduates in textbooks. We do not know everything but we know more than we knew at the time of the Great Depression. We know that fiscal policy should be used as a valuable counter-cyclical tool. To a significant extent, this treaty cuts back on that. It is turning its back on macroeconomic best practice. I agree with the criticism of Krugman, Stiglitz et al.

Briefly, on banking and stress tests, one of the problems facing us currently is that the European banking system is weak but there is no political will for another round of bank bailouts. What politicians want Europe-wide is for the banks to go out and fund themselves. That is proving extremely difficult to get done. We have such mechanisms as the three year LTRO operation with the ECB in order to shove lots of cash at the banks. This is a nettle that we should grasp. We should put in place a fund to recapitalise banks but also procedures for winding down insolvent banks and seeing that creditors, including senior bondholders, lose out. I firmly believe that what happened with Anglo Irish Bank will not be repeated across Europe if the time comes and we have to accept that there is a systemic problem with banks. Therefore, it is extremely unfortunate that the taxpayers' money - this must be brought up again and again when discussing the promissory notes - has been used to bail out bondholders of Anglo Irish Bank. If one talks to people around Europe nobody thinks that is what should be done with failing banks. There needs to be burden sharing, including by bondholders but if one puts those procedures in place then the bank bond market will not be keen to come forward and lend to the banks and people want the banks to be able to be funded on their own. We are in a vicious circle right now that can only be broken with a new regime for bank resolution backed by a large fund to then see that banks are recapitalised and made solvent; after that things could work but there is no political appetite for it. I have used my four minutes but I have not addressed all of the questions.

Professor John McHale

I will also be selective given the time limits. On Deputy Dooley's question on whether the euro will survive, it is important not to forget the almost existential crisis the eurozone is facing, which was particularly evident late last year as yields on Italian and Spanish bonds began to move upwards. It was clear there had to be improvements in the lender of last resort and mutual insurance mechanisms for the eurozone to survive. It also became clear that politically, but not just politically - as to some extent one could see it also economically - the stronger countries of the eurozone would not provide that backstop or firewall unless there was a stronger commitment to share discipline. People say it is politics in Germany but that country faces a real choice; on the one hand there are potential massive liabilities if they provide the back-stop to the rest of the eurozone. On the other hand they really want to save the eurozone but not at any cost. Without the commitment to share discipline being in place eventually they may have come through and done what was necessary but it would always have been reluctantly and there was a danger of things spiralling out of control. What the treaty is about is allowing them, partly politically but partly substantively, to slowly, as Prof. Whelan said, provide the back-stop that is needed.

Even though we have focused on many negatives issues today, it does seem to be working. We are nowhere near out of the woods but one should look at what has happened to Irish bond yields since last summer. For instance, the two-year bond yield was pushing towards 25% last July. It has now dipped below 5%. That is an incredible turnaround. The nine to ten year bond yield has come down from approximately 14% to close to 7%. There are achievements and part of that is related to greater confidence that the back-stop will be provided. Certain changes to the ESM have helped this country in terms of creating confidence that if this country cannot get back into the markets that the funding will be there. That confidence is critical to getting back into the markets because investors do not want to lend unless they are reasonably confident there will be a source of funds to pay them back. The things that are happening as a result of the treaty are important and should not be forgotten.

In terms of the Hayek-Keynes debate, on which we academics love to focus, on the Fiscal Council we have been somewhat unfairly described as fiscal hawks, but we are very much Keynesians and believe in the importance of fiscal policy in terms of stabilising the economy. The problem is that Irish creditworthiness hangs in the balance. As I have just described, it is now moving in the right direction, partly as a result of the actions that have been taken to get our fiscal situation under control but one is restricted in what one can do in terms of using fiscal policy for demand management purposes when one is not creditworthy and one is dependent on others, as Morgan Kelly said, on the kindness of strangers to provide one with the money to fund that budget deficit. Unfortunately, when one is not creditworthy, that puts severe constraints on what one can do in terms of Keynesian-type policies to stimulate the economy.

This also relates to the Stiglitz-Krugman debate because, again, we would see those as Keynesian economists. I very much agree with them in terms of their global analysis. In terms of the policies they are recommending for the United States and Germany or the eurozone as a whole, as Dr. Ahearne said, there needs to be a move towards greater stimulus. However, when one turns to this country again, one runs into the unfortunate problem that this country is not creditworthy. We cannot go out and borrow ourselves to fund those programmes. That is a huge difference. One must make the distinction between the policies that are appropriate at a global level for countries that have bond yields of 2% and countries that are in IMF programmes.

I will respond to the questions from Senator Healy Eames. There were many good questions and I apologise that I must be selective. I will comment on the first point about the terrible and harsh effects of the austerity measures on people. We see a focus on different elements of this programme every day. It is heart-wrenching to see the effects of these policies on ordinary people. Unfortunately, however, it is not a question of having, or not having, austerity. If we were to allow the deficit to stay high, or to rise and have the debt spin out of control, we could suddenly be forced to adopt massive austerity. If we lost we would not have access to markets and could lose access to official funding as well. It is a real balancing act. Ultimately, the goal of fiscal policy - certainly in the way the fiscal council looks at it - is to try to get as gradual an adjustment as possible, trying to delay it as much as possible, so that these incredible burdens are not imposed on people. At the same time, however, one must recognise there is huge vulnerability to the financing of the Irish State and one must keep that in mind.

I really do not believe default is a way to reduce austerity. We see that with Greece. If a country defaults and still has a huge deficit, it will still need official funding. The question is whether it would get that funding. If it does, it would be on really tough terms. These would be more demanding in respect of the austerity that would typically be imposed, as we see with Greece. Unfortunately, therefore, there is not an option of low austerity, or at least not one which does not involve huge risks.

Chairman

Would Mr. McDonnell care to speak?

Mr. Tom McDonnell

I would echo much of what previous speakers have said but would have my own spin on it which can be quite different in terms of detail. Deputy Dooley asked what the structural deficit would be in 2015. It would be approximately 3.7% so one would be looking at another two years of austerity on top of that. In reality, 2017 becomes the time when one would begin to stop engaging in discretionary fiscal tightening. One is talking, therefore, about another five or six years under the current system.

Will the eurozone survive? A monetary union that is not supported by fiscal union is fundamentally incoherent. On top of that, we do not have banking union and it is for that reason the Anglo Irish Bank debts were enforced on 4 million people as opposed to 300 million people which would, of course, have been more manageable. It is very unlikely that Ireland will be able to go back to the markets in 2013. It is certainly possible but again much depends on what happens in Europe. I would agree with Professor Whelan in that I do not believe there is any appetite for fiscal federalism, or any kind of fiscal transfer mechanism. Deputy Mathews mentioned debt write-downs and eurobonds. Greece is already engaging in a process of debt write-downs. Politicians and analysts will always remain silent on this and will never admit they are considering a default until it actually happens. That is an entirely rational thing to do.

I refer to eurobonds, or using the ECB as a lender of last resort, or even the alternative of using the ESM or EFSF in the sense of giving either a banking licence and enabling it to buy sovereign bonds and using that as collateral. There are certainly solutions within the ECB. Deputy Dooley spoke of five or ten years in terms of using eurobonds as lender of last resort. There are legal issues involved there. Giving the ESM a banking licence would be a way of greatly expediting that and doing so legally. The alternative would be to do it through the IMF but I do not understand why one would choose to do that when one could simply give the ESM a banking licence.

On debt write-downs, clearly we must differentiate between the IBRC promissory notes and Ireland's sovereign debt. Again, if one were to achieve a debt write-down on something that is ultimately not our debt, although unfortunately it is ours right now, that would go a long way towards restoring our debt dynamics and sustainability. Our debt to GNP ratio in and around 2013 will exceed 140%, which is comparable to the Greek metrics. On top of that, of course, we have far higher levels of commercial and private debt which will dampen consumption investment from the private sector for the foreseeable future. It is within that context, therefore, that there may be a business case to give to the ECB for actually writing down the Anglo-related promissory notes. That would greatly help us. It would of course break the rules. It is the parachute drop analogy that Professor Whelan used on his blog but nevertheless the circumstances are clearly unusual.

As to Keynes and Hayek, I would certainly be a Keynesian in that I believe in counter-cyclical fiscal policy. I do not believe procyclical fiscal policy is good economic policy because it will exacerbate the recession-depression in Ireland. Nevertheless it is true that leakages are quite high in countries such as Ireland and the country has a very high structural deficit. Therefore, within a monetary union at the federal level there has to be a strong case for engaging in stimulus. There is certainly a strong case for using bodies such as the European Investment Bank or the eurozone equivalent of the EIB as a possible fiscal equivalent to the ECB. This might be funded through financial transaction tax, or imposing 1% on top of VAT in each country, and would act as a form of insurance vehicle so that when countries get caught in bad equilibriums or particularly severe recessions there is a fund that allows them to manage their way out of a recession without creating the horrific social consequences that Senator Healy Eames described.

As to where growth comes from, or where it can come from in the long run, one cannot just create it but one can create the environment that inculcates growth. In this respect one must ringfence and protect the factors that lead to growth. Human capital must be maintained to the greatest extent and this means education. The empirical evidence indicates that the earliest levels of education are the most important, namely, pre-primary and primary, followed by secondary and, finally, tertiary and fourth-level. We must also acknowledge that because of the construction boom and bust there is now a huge cohort of young people, men and women between the ages of 18 and 35, who do not have skills that are likely to be congruent with the future needs of the labour market. What we need to do, therefore, is engage in almost the equivalent of the GI Bill, and provide funding so that these people have opportunities to get back into education and ride out the storm. There could be a role for bodies at a European level in providing these opportunities. This also applies to research and development and to the provision of growth-enhancing or innovation spawning technologies. Historically, these were reading and writing and the steam engine. The modern equivalent is broadband standard Internet. There is great scope here for adding to innovation and the productive capacity of the economy because technologies like these actually increase the productivity of innovation. Ultimately, technological change is where growth principally arises.

There were a few other questions but I am sure I have gone well over my three minutes.

Chairman

Is Dr. Ahearne a Keynesian?

Dr. Alan Ahearne

I try to be pragmatic about these things. This is such a difficult crisis there is no real room for ideology. It is whatever works.

Deputy Dooley asked about the structural deficit. There is no precise measure of that and there is a very wide margin of error around it but with current forecasts it looks as if there will be a structural deficit in 2015 that is bigger than 0.5% and, therefore, further fiscal consolidation will be needed in 2015 and 2016. In the outer years, fiscal consolidation is easier because the forecast is that the economy will be growing at that stage. What has been so difficult in recent years is that we had to have fiscal consolidation at a time when the economy is contracting. It is easier to do fiscal consolidation when the economy is growing and people are getting wage increases. The Government may take some of this but at the end of the day people end up with more money in their pocket and do not feel it. In such years fiscal consolidation does not bite as much or feel quite as difficult.

Will the euro survive? If this treaty is the last of a set of actions it will not survive. That is why I said in my opening statements that I hope and assume this is just a stepping stone to something much more aggressive in terms of monetary policy, euro area fiscal policy and banking policy. More rigorous stress testing and more recapitalisation of banks is needed. We have done that quite aggressively in this country but it is needed right across the euro area.

I agree with Deputy Mac Lochlainn it is very politically unlikely we will see full federal fiscalism but we do not need full federal fiscalism. A partially federal union would work. What we really need is a pot of money or fund at euro area level that can be used for counter-cyclical policy and to enact transfers. Part of it could be used, for example, as a resolution fund for the banking sector. If we had had this ten years ago, meeting the large cost of the bank rescue would not have fallen on the Irish State and it would have been spread out. We need the pot of money at the euro area level.

I disagree slightly with Professor Whelan on his characterisation of the ECB as extremely rigid. There is more room for monetary easing but I would not refer to the bank as extremely rigid given its recent actions. It has actually been more aggressive than many believed would be the case. Before Christmas, for example, there was considerable lending to European banks and we will probably see more of this later this month. The ECB is demonstrating more flexibility than people believed although there is room to go further.

Senator Healy Eames asked about growth. Mr. McDonnell spoke about long-term growth but I will focus on where growth will arise in the Irish economy in the next few years. One approach is to think of the different components of spending. Growth will hardly arise from consumer spending, as Deputy Mac Lochlainn stated. There is a lot of private household debt. Households are trying to reduce this rather than increase it. They will not go on a credit binge and, therefore, consumer spending will remain depressed. The growth will not come from another construction boom as there is already excess housing. It will not come from a traditional fiscal stimulus at national level. The Government's public finances simply do not allow for that. All that is left is exports. Fortunately, we have a very large export sector. If exports grow, it will assist the Irish economy. We have a quite strong export sector and have regained over recent years much of the competitiveness we lost during the boom years. Exports have been doing well. There are risks, however, and these emerge from the fact that the euro area potentially faces a recession. That is what is so worrying about what is happening in the euro area. This is partly why I emphasised in my opening remarks the importance of ensuring that at euro area level the current slowing of the economy will not be deep and prolonged.

Chairman

We need to conclude this section at 2 p.m. so we can go into private session. I ask the remaining speakers to confine their comments to approximately three or four minutes so we will have a chance to hear the responses of our visitors.

Senator Terry Leyden

I welcome the delegates and the members of the media who are present. There is a great turnout on the part of members. This is a most interesting and worthwhile discussion. Instead of depending on listening to debates on TV3 or RTE, we are having them here live.

My question is for Dr. Alan Ahearne. Although I must go to the Seanad, I do not want to leave without my question being answered. The Chairman has been quite accommodating to other members in this regard.

Chairman

If the question is not answered when the Senator is present, we will ensure that he receives a copy of the transcript.

Senator Terry Leyden

I will put the question in that case. Dr. Alan Ahearne was at the cutting edge with the late, great Brian Lenihan. He helped to carry the cross and was a tremendous support to the former Minister. While it was a shared burden, Mr. Brian Lenihan had to take full responsibility. He was a larger-than-life and great politician and he took enormously difficult decisions at a difficult time. Dr. Alan Ahearne was present to assist him.

Everything that is happening now is based on the events of 28 September 2008. Why was the decision taken to carry the private debt of Anglo Irish Bank and Irish Nationwide as sovereign debt? Why had we to take on the burden of the most irresponsible bankers this country has ever produced and some irresponsible borrowers? This is the biggest burden we have had. The bondholders, secured and unsecured, were risk takers and were receiving an enormous return from their investments in Anglo Irish Bank and Irish Nationwide. Why did they not know that their activity could not be sustained? Economists were advising them. They were greedy investors. The depositors should have been supported. The shareholders were burnt big-time, particularly in the case of Anglo Irish Bank. The €31 billion question concerns why we took on the private debt of private banks and greedy bankers as our sovereign debt. This has burdened the country down and has wrecked us. Perhaps Dr. Alan Ahearne has answered this many times before but I would like an answer now.

Chairman

When Dr. Ahearne responds, I will-----

Senator Terry Leyden

No. I intend to wait for an answer.

Chairman

Excellent. I will call Dr. Ahearne first after the remaining questions if he is happy to answer that specific question.

Deputy Paschal Donohoe

I welcome the delegates and apologise for being late. I am a member of the Committee of Public Accounts, a meeting of which began at exactly the same time as this one. I was due to ask some questions at the other committee meeting and had to attend it. Just as I was settling in to listen to the testimony of the delegates, I was called into the Dáil to speak on the HSE's action plan. I will read the entire testimony of everybody here this morning. It is an area in which I have a great interest. It is clear that there have been many good questions and answers. In recognition of how much I have missed, I will confine my remarks to one assumption and two questions, on which I would appreciate the delegates' perspective.

My assumption is that all the behaviour that falls within the framework of the new fiscal compact would have been engaged in by us in any case. I assume this because if I consider the quantity of public debt and the changes that are taking place in debt markets, such that risk will be priced in a way it has not been priced heretofore, I conclude that once we get beyond 2015 or 2016 we will be running primary budget surpluses to finance our current debt, regardless of its source. I would appreciate the delegates' perspective on whether this assumption is correct.

My assumption is that all the behaviour that falls within the framework of the new fiscal compact would have been engaged in by us in any case. I assume this because if I consider the quantity of public debt and the changes that are taking place in debt markets, such that risk will be priced in a way not been priced heretofore, I conclude that once we get beyond 2015 or 2016 we will be in a position of running primary budget surpluses to finance our current debt, regardless of its source. I would appreciate the delegates' perspective on whether this assumption is correct.

Let me ask my first question. If we are to engage in the aforementioned behaviour in respect of paying back our debt, would it not be more advantageous for us to be doing so inside the framework of the fiscal compact, on foot of which we would have a buttress of credibility in respect of our activity? Thus, if we were to borrow further or engage in any way with the financial markets, we would be doing so with broader support than we would have if we were operating on our own. This is the benefit the arrangement would offer.

My second question concerns a point touched on by Professor Whelan. Every country in the eurozone operates as if it were on its own. It makes a decision not realising it will have a spillover impact elsewhere, be it in respect of a country's bank or the activity of elected governments. We are now all coping with the spillover of all these effects. My main worry is that this lesson does not seem to have been taken on board in the design of the compact. If every country is to deal with its debt burden at a prescribed rate, many will be doing the same thing at the same time without recognising that their doing so will have an effect on other member states' economies. I, as an optimist by nature and conscious of the fact that people who are much smarter than me must also recognise this, realise there are tools available to member states beyond purely fiscal ones that would give other economies the ability to move forward and, I hope, generate the required demand.

I would appreciate the witnesses' perspective on whether my assumption is correct and on the aforementioned two questions. The first is that if Ireland must reduce its debt burden, is so doing inside an institutional framework such as this not an asset to it? The second question pertains to the risk and whether we really have learned from the fact that no man is an island.

Deputy Bernard J. Durkan

While one might think there is little left to say, I assure the Chairman I could say a lot but will refrain from so doing. Like many times in the past, I am confused. The Chairman will be glad to know I have been confused for most of my life but am more confused now than ever before.

Whenever I hear economic debates, I become increasingly confused as time goes by and I have seen and heard many such debates over the past four years in particular. Reference has been made to history, with particular reference made to the great depression. While that point is well made, the point also was made that economists have learned from the lessons of the great depression. This is not true and is the single thing that has not happened because what happened then has taken place again. For instance, the preliminaries happened, in that we again experienced the Roaring Twenties.

I first read about the great depression only about 25 years after it had happened. It is now considerably longer ago and revisionism appears to have taken over. After the Roaring Twenties came a deep and serious recession and a depression and it took a very long time to work out of it. The one lesson learned during that period is that while countless remedies were proposed both in the United States and in Europe, they did not work. The evidence is there for everyone to read. Moreover, despite the best intentions of those who made such proposals, they still did not work because there were so many other factors to be taken into account. Although many such factors were taken into account, they still had an impact on and impeded the recovery that was anticipated and that was necessary.

I note, when listening to this debate, that one point put forward continually concerns the need for stimulus. A certain amount of stimulation is taking place and it is seriously dangerous to go too far down that road, without there being considerable grounds for coming to that conclusion. For example, following two oil crises, this State opted for a stimulus package in 1977. I do not make a political point as this is an historical fact. The country went for a big stimulus package to spend more, put more money in people's pockets and create more jobs. Within two and a half years, the country was broke. Within two and a half years, the IMF was knocking on the door and had visited this city with the intention of doing something serious about it. That experiment was wrong and although plenty of economic experts at the time suggested, proposed and supported that experiment, it did not work.

I assure the witnesses that I am not an economist but I have read a lot about them and I mean no disrespect to those present who are. The fundamental lessons, for want of a better expression, to be learned from that era and everything that has happened subsequently are that there are basic fundamentals everywhere, including ratios to borrowing and spending and so on, as all members are aware. When those fundamentals go wrong or go off kilter, serious problems arise and one should not do something stupid afterwards. During the height of the boom, I can recall a Minister stating in the House that Ireland is a low-tax high-wage economy. At the time, I told myself this was a stupid crazy notion as were that to happen, we would become uncompetitive. Were we to pay ourselves above and beyond what everyone else was doing, we would be unable to compete on international markets. Moreover, I note we still have people who think this.

I will come to a conclusion as quickly as I can but having waited for so long, I have a few words to say. I note that we then focused on the top tier of the economic sector. This was a good thing because so doing is necessary. However, we also must have a mixed economy and must be able to provide for a full comprehensive economic cycle. We must have high-paid middle-income and relatively lower-paid workers. We do not have this in our economy at present and I acknowledge that some of my friends sitting to my right would state it does not work that way. I can only state that during my time in public life, I have spent considerable time in trying to help out people who got into financial difficulty. I have fairly considerable experience in this area and basic fundamentals must be addressed in all such cases as unless they are addressed, one does not emerge from such difficulty. However, one can work oneself into a different and greater degree of depression and recession.

The proposals before members are not the first step but are the first realistic step and they at least recognise what must be done. One thing that must be done is we must recognise ourselves this problem is not going to go away without some degree of sacrifice. It will not go away overnight, we cannot wish it away and it will not go away otherwise. Moreover, we must demonstrate to others externally, in the eurozone and beyond, that we are capable of doing this. For example, would it be of benefit to Ireland were other European countries, within or without the eurozone, to decide they were not going to bother to stand up to this recession but were going to spend and go for a Shirley Valentine holiday? It does not and will not work that way. More serious damage could be done to our employment prospects and all other prospects unless we recognise this point.

My colleague, Deputy Mathews, correctly made comparisons with the German economic position. It will not be news to anyone but the people of Germany took an extremely serious hit in their standards of living over the last 20 years, when compared with the previous period. This is a fact and anyone in this room or elsewhere who believes this is not the case should compare Germany then with the new wider, reunited Germany of the present. I reiterate they have made huge sacrifices.

Another problem that worries me and makes me depressed is how each country appears to have different views as to what will be the resolution. I can understand the reason the German people are concerned about carrying the burden for so long. However, this does not mean to say they have the ultimate answer. Other European countries perceive the corporation profits tax rate in this country as a major obstacle to European progress. That is rubbish and has nothing to do with it at all. Others believe progress cannot be made without complete fiscal and economic unity and federalism. This also is rubbish and, as my colleagues would readily recognise, does not even prevail within the United States, where there are huge variations in taxation levels and in fiscal and economic policy. Moreover, such variations are necessary.

The point made regarding the target of 0.5% of GDP is well made. The degree to which one can move within a band in particular situations must be recognised at all times whenever one is dealing with an economic issue. I note this is the narrowest of bands yet to have been put forward and being restricted in the degree to which one can move within a band can create problems for individual countries. Within the past week, I made the point to a senior member of a certain major political party in Europe that none of these points matter unless the signatories adhere to the spirit and the letter because it will be a waste of time otherwise. The Growth and Stability Pact was ignored by those who wished to ignore it. When things were going well, everything was ignored by those who wished to so do.

Moreover, one should not forget that in addition to the international financial crisis that exists, Ireland also has a property crisis. Ireland has a cantilevered property overhang, which was overpriced but which is falling rapidly. Moreover, one should not forget what one was told by all commentators four or five years ago. One was told there would be no recession and there would be a soft landing. When one turned on the radio each morning, one heard there was nothing to worry about as there would be a soft landing. However, there was no soft landing and there is nothing easy about the problem we now face.

Members should do one thing, which is to resolve to tackle this problem. I acknowledge we will be obliged to change and modify as time passes but one does not start off by stating at the outset that one will not pay anything and will not do one's job. If one does something like that, no one will make an agreement with one.

Chairman

I thank the Deputy.

Deputy Joe O’Reilly

I welcome the four witnesses and I thank them for their thorough presentations. They have honoured the committee with expansive contributions, which are appreciated. A number of factors must be recognised. On every occasion we meet to discuss these issues, we must recognise yet again that enormous mistakes were made in banking and in the management of fiscal policy in countries. There was a break from the economic management that would have maintained the strength of the euro and kept it intact. There is no escaping the fact that those mistakes were made.

The banking issues must be resolved through regulation and recapitalisation in certain instances. Government debt must be solved nationally as well. Before we talk about stimulus and other issues, while everybody who lives in a civilised, progressive society wants to do the best for those in need and wants to have the best social and education policy, there has been enormous waste in public expenditure in Ireland and other countries for which there is anecdotal and other evidence. In many countries, a chunk of national budgets was allocated to "social expenditure" and "education" but it did not hit the spot. The spending did not address need and it did not necessarily address the needs of a person with a disability because there were layers of bureaucracy and waste. There was a great deal of waste in the entire apparatus of government and in bureaucracy. The bush needs to be pruned.

I take the point that the economies of member states or the economies of Europe collectively cannot be compared to household budgets but there are worthwhile areas of comparison. Initially, we need to prune the bush and get rid of wasteful expenditure. Nobody has suggested that we should get rid of proper social expenditure but we must get rid of waste. If we do that, we will get somewhere. Professor Whelan is correct that Ireland must accept the fiscal treaty on pragmatic grounds because we have to do the business anyway and it is in the country's short and medium-term interests to accept it. There is no other show in town since the country cannot do anything else.

However, the objectives of the fiscal compact to deal with government deficits and keep them under control are worthwhile. I spoke to a number of colleagues who visited Germany last week on a parliamentary trip. They said that all the taxi drivers, waitresses and ordinary Germans to whom they spoke said they could not go on carrying the debts of Europe and carrying our mismanagement on their backs. We cannot obliterate the reality of what they think from our minds. We are all aware of the misbehaviour of German banks but I am highlighting what ordinary Germans think and that cannot be denied.

As politicians, we have a duty to send the message that the treaty must be put in place. It is great that there is a good media presence at this meeting but it is important that we are unambiguous about the fact that the treaty must be carried, it is in the best interests of the country and the basic strategies in it are correct. While I have great respect for Deputy Mac Lochlainn on a personal level - I know him well having run in the European elections against him - he is not correct in that his analysis is predicated on ideal conditions and, unfortunately, we do not live in those conditions. We have to sort everything out.

A stimulus package is needed for jobs. The incentivisation of job creation is necessary but I take the point eloquently made by Deputy Durkan that a stimulus may facilitate spending on imported goods and foreign holidays, which will not help the economy. If a stimulus is provided, it will have to create jobs down the street, which will result in somebody coming off social welfare, thus saving the Exchequer €20,000 a year while also creating a tax revenue stream. What is the expert view on achieving the objective of a stimulus in Europe, which will not send us on a cruise outside of our spending zone?

The fiscal compact is welcome. It is a step in the right direction and it will steady the ship. Every member state must get its house in order and I am aware from travelling around Europe that there is enormous waste in a number of countries that has to be sorted. When that is addressed, countries can move on to creating jobs and learning the lessons of the past.

Deputy Paschal Donohoe

If every member state that says it will ratify the compact does so and Ireland does not, what would be the impact on Ireland?

Chairman

We will conclude shortly. Each of our guests has three minutes each to answer the questions and make final remarks.

Dr. Alan Ahearne

The first question was about the former Anglo Irish Bank. Senator Leyden is correct that the cost of that institution to the State has been unacceptably high. He brought this back to the night of the guarantee. I cannot help him on that. I was not working for Brian Lenihan at that stage. I did not join the Department of Finance until March 2009. As he pointed out, the cost to the State is expected to be €31 billion and he also correctly pointed out that the equity holders were wiped out. They absorbed some of the losses while the subordinated bondholders were also more or less wiped out. It is a pity there were not more equity holders and there was not greater capital in the bank because they would have absorbed more. It meant that the other losses in excess of capital fell on the State because depositors and other senior bondholders got all their money back.

If I recall correctly, there was approximately €11 billion of long-term senior bonds in the bank in September 2008. In theory, €11 billion of the losses could have been put on the senior bondholders. That would still have meant the State putting in €20 billion to protect the deposits, which the Senator said he favoured. It was going to be expensive either way. The problem was it was a big bank with bad loans and it had funded itself to a large degree by deposits. The previous and current Governments have tried to put some losses on to senior bondholders but the ECB has prevented that. Both Governments faced a cost benefit analysis on defying the ECB and both decided that it would not.

Deputy Donohoe asked about the protection within the new framework. It is clear, as Professor Whelan mentioned, that if we do not have a financial back stop and potential access to the ESM, the economy would be in a terribly dangerous place because it is clear that potential borrowers will see a cliff at the end of 2013 when the programme ends. That cliff will come quickly and they will certainly not lend to us. We would then face that cliff. It also has implications for the financial sector. Over the past few years, the banks have lost many deposits. That, thankfully, has stabilised more recently but, again, if people are worried about the funding of the State after 2013, that presumably would give rise to increased uncertainties about the banking funding position. We may see increased outflows from the banks again. It would put us in an impossible position to have that cliff and, therefore, it is absolutely necessary that we have the potential to borrow from the ESM.

Senator Terry Leyden

I want to make a point. Dr. Ahearne had access to all the papers and the Minister.

Chairman

Senator Leyden, a question must be asked.

Senator Terry Leyden

If he had been there, they might have burned those bondholders.

(Interruptions).

Deputy Bernard J. Durkan

Nice one.

Deputy Paschal Donohoe

If all four of them had been there, they might have.

Deputy Joe O’Reilly

Or if Deputy Donohoe and I had been there.

Professor Karl Whelan

Senator Healy Eames asked earlier what happens if the treaty goes to a referendum and it fails. This question is going to come up a lot in the next several weeks. I will be disappointed if I hear the repeat claim that the Minister for Finance made in December about it being an in or out of the euro which will mean the people will vote "Yes". There is nothing in the treaty about being put out of the euro if one does not sign up to it.

It is a complicated matter which puts us back in Lisbon territory. Everyone was supposed to pass the Lisbon treaty which the whole EU was to sign. When Ireland did not pass it the first time, we had to do the referendum again. We should be careful in discussing it this way. For example, say the public is told Ireland will be out of the euro if the referendum is not passed and the opinion polls suggest two to one are against the treaty. People will wonder if their money in their bank account is safe and should they move it out. Such an approach could run the risk of triggering a bank run, even if one thinks such an approach may pass the referendum. Adopting a sort of bullying tone, as happened in the past, will not work in getting this referendum passed.

The treaty is not great but benefits stem from it. If we do not pass it, then we do not have access to ESM funds. As the chances of getting back into the financial markets are pretty slim, we are then potentially talking about a sovereign default scenario. That could be the ultimate scenario if Ireland does leave the euro as a consequence of not signing the treaty.

Deputy Paschal Donohoe

It might be quite a leap to see such a situation unfold where the referendum goes down and we leave the euro. However, it is not that big a leap seeing the referendum going down and Ireland then being in a default situation. That then has further consequences beyond our membership of the eurozone.

Professor Karl Whelan

It is not that great a leap. However, if the referendum were to fail, I suspect we might be in for a rerun of Lisbon. The public may think again if it becomes clear we are failing to get access to finance but we could get access to the ESM if we pass the treaty.

Deputy Bernard J. Durkan

On the possibility of leaving the euro, we are in dangerous territory. If it becomes a distinct possibility, the kind of difficulties we are in now will be 100 times worse. I have heard various economists putting forward the notion of coming out of the euro, voluntarily or involuntarily, as a means of resolution. It is not.

Professor Karl Whelan

The onus is on politicians, in particular the most senior one responsible for the country's economic policy, to be careful with their words about the implications of this treaty failing to pass.

Beyond that, having the treaty helps a bit in restoring credibility. If the economy does not return to growth, then it will be difficult to get the debt-to-GDP ratio down. One can have all the fancy treaties in the world but investors may look at a country and say, "At some point those guys are going to run out of road". We had the Stability and Growth Pact before, so there will be a healthy scepticism among investors. Portugal will and Greece might sign the treaty but investors are looking at their fiscal fundamentals rather than the treaty that protects them.

Mr. Tom McDonnell

I agree that leaving the euro would be a catastrophe and would not advocate it under any current conditions. Regarding the poisoned pill inserted in the treaty — a country that does not sign it will not have access to ESM funding — it is very significant. It will be challenging for Ireland to fund itself beyond 2013 and 2014 and the ESM will act as a de facto lender of last resort, providing funding at affordable rates. However, Greece, Portugal and Ireland will be essentially wards of the eurozone — Greece until the second half of this decade while it is more of an open question as to when Ireland and Portugal will be able to leave. We will be reliant upon that ESM funding, and access to that funding is conditional on passing the treaty.

That does not mean the treaty is a good development, however. The point made by Deputy Durkan about the policy failures of the past should warn us about the need for flexibility and not tying ourselves to rigid rules which bind our hands to a pro-cyclical policy which embeds recession and leads to stagnation.

On the point about Germans carrying the debts of the euro, the euro acts as a massive subsidy to Germany in the sense the currency is too weak for Germany if it were not tied to the other 16 eurozone members while it is too strong for Greece and Portugal. It is an open question for Ireland. German exporters are benefiting from the currency's weakness while it is actively damaging Portugal and Greece.

Regarding a successful stimulus package, one of the goals should be to minimise leakages out of the economy. One targets individuals with high marginal propensities to consume, that is people on low incomes who are consuming necessities and buying locally. One does not provide stimulus to people who can use that money to take foreign holidays or buy cars. This implies when the inevitable austerity discretionary decisions are being made in fiscal policy over the next three years, there should be an emphasis on protecting and ring-fencing people at the bottom, not overtargeting them. This is not just for moral reasons but also the leakages associated with their consumption are likely to be of a lower order than those on higher incomes.

Professor John McHale

I agree with Deputy Donohoe's assumption. One point we have learned in this economic crisis is how countries in a monetary union are structurally uncreditworthy largely because they do not have access to their own central bank which can essentially pay back creditors as a bank of last resort. Deputy Donohoe referred to the 60% target for debt to GDP and it is hard to see Ireland being sustainably creditworthy unless we get our debt substantially down towards targets in that range. With or without this treaty, we have little choice but to engage in a fairly sustained period of fiscal adjustment. Part of the goal would be to get debt down to a level in which we would have enough space if the economy were hit by recession for the Government to use countercyclical policies to deal with it and allow automatic stabilisers to work. That requires, unfortunately, that we get down to a much safer debt level.

The Deputy is correct on spillovers. If all countries are forced by these rules to engage in overly restrictive fiscal policies that have negative effects on one another, then what might be rational in an individual country's case could be worrisome in its consequences collectively. We are now seeing the importance of another type of spillover in that to have any chance of exiting the crisis, we must strengthen lender of last resort mechanisms such as the ESM and the ECB buying countries bonds and moving eventually, hopefully, to Ireland's bonds. That means that there are huge spillovers across countries and means they are taking responsibility for one another. We are seeing, as I have said before, that a willingness to take that responsibility will not exist unless there is a degree of shared discipline. Unfortunately, we see these rules that leads to the other kind of spillover spoken about. I am not sure that there is a good fiscal solution but we must use other policies. It is hoped that monetary policy could counteract, to a degree, the excessive tightness of fiscal policy. For instance, it would be fantastic if the ECB could adopt a higher inflation target that would allow for exchange rate adjustments that are necessary for countries, particularly on the periphery, to regain competitiveness. There is not much that can be done to deal with the spillover problem.

With regard to the last question, I partially agree with Professor Karl Whelan. We do not want to engage in scaremongering and have a stark "Yes" or "No" decision. That is probably not the right way to go. It is important that people understand the consequences of a decision. The worst scenario is where people are not informed of the consequences of a "No" decision and then bear with them afterwards. We need an informed debate but that requires understanding of, for instance, the link to the ESM. Some media commentary has said that the ESM link is not true and it is stated with great confidence that the ESM was decided last July. While the ESM was finalised on 23 January - and even though I have not been able to read a draft because it does not seem to be available for some reason - based on reports it is clear that one does not access the ESM unless we sign up to the treaty. That is a big deal. If we vote "No" in the treaty it may not be the end of the process, who knows, but one is taking a huge risk. There would be a great amount of uncertainty and the possibility again of spiralling bond deals and bank loans. It is important that people understand the consequences while not engaging in scaremongering. Even a claim of scaremongering can sometimes lead to people pulling back and being unwilling to outline facts because they do not want to be accused of that. It is important that people understand the potential consequences of the choice if it does go to a referendum.

Deputy Paschal Donohoe

We could be in a situation where we neither have access to the markets or a new bailout fund.

Professor John McHale

It is possible.

Senator Terry Leyden

That scenario will mean there will be an interesting referendum campaign.

Professor John McHale

Certainly if that is the case.

Deputy Bernard J. Durkan

Is it necessary to have a referendum?

Chairman

On behalf of the committee I thank the delegation for their informative presentation. We appreciate the time taken to attend, the detailed presentation and comprehensive answers provided. As I said, this is our first committee meeting since the publication of the draft fiscal compact. It has increased our understanding of the issues that the compact presents us with.

The joint committee went into private session at 2.15 p.m. and adjourned at 2.20 p.m. until 11 a.m. on Thursday, 16 February 2012.