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Joint Committee on European Union Affairs debate -
Thursday, 21 Feb 2013

Future of Ireland and the European Union: Discussion

We have received apologies from Deputy Seán Crowe.

The first item on the agenda is a discussion of the future of Ireland and the European Union. On behalf of the joint committee, I am pleased to welcome Mr. Seamus Coffey of the UCC school of economics, and Mr. Nat O'Connor and Mr. Tom McDonnell from the think tank TASC. This is the first of a series of meetings as part of a debate on the future of Ireland and the European Union. The session will focus on the implications for Ireland of an evolving European Union in terms of the proposed completion of economic and monetary union and the necessary steps to bolster democratic accountability and legitimacy. Mr. Coffey addressed the committee last year during the debate on the fiscal compact. Members will remember those days in March and April. Representatives of TASC have also been before the committee in the past. TASC describes itself as an independent think tank dedicated to addressing Ireland's high level of economic inequality. We all look forward to hearing the perspectives of both organisations on the future of Ireland and the European Union.

Before we begin, I remind members 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 that he or she can be easily identified. By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they give to the committee.

If a witness is directed by the committee to cease giving evidence in relation to a particular matter and the witness continues to so do, the witness is entitled thereafter only to a qualified privilege in respect of his or her evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and witnesses are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise nor make charges against any person or persons or entity by name or in such a way as to make him, her or it identifiable.

Members are reminded of the long-standing parliamentary practice that they should not comment on, criticise or make charges against a person outside the House or an official by name in such a way as to make him or her identifiable.

I invite Mr. Nat O'Connor to make his presentation.

Mr. Nat O'Connor

I thank the Chairman and the committee for the invitation to attend today's meeting. I welcome the launch of a national debate on the future of the EU and Ireland's place in it. TASC is an independent progressive think tank whose core focus is economic equality and democratic accountability. Both of those concerns come together in the question of how we and our European partners are to govern the European economy through treaties, institutions and growing harmonisation of economic and social policy. The structure of the economic and monetary union is at the heart of that question.

I will ask our economist, Mr. Tom McDonnell, to make a short presentation on some of the immediate issues to do with economic and monetary union, which is at the heart of the current debate about where Europe is going and Ireland's place in Europe.

Mr. Tom McDonnell

It is very important to consider the implications for Ireland of increasing financial, budgetary, and economic policy integration within the European Union. The question is the composition of this integration. The answer to that question depends on the changing structure of the economic and monetary union. We know the EMU as constructed was fragile, incomplete, and highly flawed. There was no centralised authority responsible for the supervision, regulation and, if necessary, resolution, of financial institutions; there was no fiscal transfer mechanism to deal with asymmetric shocks; no automatic stabilisers at eurozone level to replace those lost at domestic level, and no mechanism for offsetting competitive imbalances or for preventing them in the first place; there was no lender of last resort for member states and therefore no circuit breaker to protect against negative feedback loops of spiralling borrowing costs. Member states were at the whim of massive and destabilising credit inflows and outflows. The long-term viability of the European Union’s EMU depends on correct diagnosis and resolution of its design flaws, and the ending of the three interlocking crises - the sovereign debt crisis, the banking crisis, and the real economy crisis of low growth, high unemployment and high private over-indebtedness.

To understand what the EMU will look like in ten years’ time we must understand what may be the different solutions to these problems. We have already seen a number of official policy responses and changes, or proposed changes, to the EMU in recent months. These include European Central Bank interventions in the secondary bond markets through the securities market programme, SMP, and the new outright monetary transactions, OMT, initiative, or perhaps interventions in the future. In other words, the ECB has been indirectly buying government bonds through the SMP and has agreed to do whatever it takes through the OMT. Special purpose vehicles have been created in the form of the EFSF and ESM to preserve the stability of the euro by providing emergency funding lines to sovereigns. That was the stated purpose of those special purpose vehicles. Numerous initiatives, including bank recapitalisations and cheap liquidity through long-term refinancing operations, have sought to stabilise the European banking system. The parameters of a single supervisory mechanism have been agreed, and from the start of 2014 the ECB will, supposedly, be legally responsible for supervising 6,000 banks.

Responses to the sovereign debt crisis have thus far been somewhat insufficient. For example, the structure of the ESM is inherently fragile. Nevertheless, the ESM is an important crisis stopgap. It is often forgotten that the historical rationale for a central bank was not to stabilise prices by controlling inflation, but to stabilise the entire economic system by providing backstop or last-resort liquidity to banks and sovereigns. The OMT initiative was therefore a crucial step and reflects the critical need for the eurozone to have a lender of last resort for sovereigns, for that is precisely what the OMT represents. The announcement and formulation of the OMT in August and September 2012 was when the euro was existentially saved. The detail of how each measure is implemented will be very important. There are potential criticisms in respect of the OMT. Arguably, this set of measures remains critically incomplete. Little has been done to ease the growth and employment crisis, and pro-cyclical policies of internal devaluation have taken hold in the periphery. These policies were undertaken to deal with fiscal and competitiveness imbalances but have not been matched by countervailing measures in the eurozone core. The overall effect has been deflationary, causing economies to contract rather than grow. This does not necessarily mean there are alternatives in the periphery but it certainly means there are alternatives within the core. This has exacerbated and elongated the jobs and growth crisis in Europe.

In the medium term, a permanent mechanism is needed so that the so-called multiple equilibria problem of sovereign borrowing costs spiralling out of control is eliminated for any state showing a willingness to pursue a sustainable fiscal path. Different versions of eurobonds have become fashionable as an idea, but moral hazard concerns mean they are not the solution. A better solution would be to assign a banking licence to a special purpose vehicle such as the ESM, and then to use this vehicle as a de facto conditional lender of last resort for sovereigns. I am happy to elaborate on this point. This would be a key institutional development.

The question is how we can break the link between sovereigns and banks. The next few years will see the gradual construction of a banking union for the eurozone and this will have major implications for the EU as a whole. A centralised banking union is a necessary component of any viable monetary union in the long term. In practice, this means independent centralised supervision, regulation and, critically, resolution of financial institutions at the eurozone level. This will have major implications for member states. In addition, protecting taxpayers and depositors in the future, while also dealing with issues of capital flight, particularly from the eurozone periphery, will require some form of centralised deposit insurance scheme modelled along the lines of the Federal Deposit Insurance Corporation in the United States. This would end the differentiation between banks in the periphery and the core and help to create a genuine banking union. There is the prospect of further integration in the form of a eurozone banking union and possibly the creation of a eurozone lender of last resort.

A more fundamental question is whether eurozone member states can align monetary and fiscal policies to the goals of employment and growth. The answer to that question is "Yes", but only at the level of the eurozone itself. The broad framework required involves intergovernmental co-ordination of policies to prevent competitiveness and domestic fiscal imbalances from growing too large. An example of this is the new European semester. In order to help offset regional recessions and asymmetric shocks, such a framework will require a centralised fiscal fund. This is because member states have lost much of their power to use their own budgets as a counter-cyclical automatic stabiliser, while also losing control over other macroeconomic policy levers such as exchange rate policy and monetary policy. These lost policy tools need to be replaced in some form.

Safeguarding democratic legitimacy and accountability within a full fiscal union would require a fundamental overhaul of the treaties and far greater power for the European Parliament and its committees. However, what I have described is very far from a complete fiscal union. While greater integration and co-ordination between EU member states is inevitable under EMU, full fiscal union is unnecessary. It is important to note that in parallel to the formal development of the EMU, other more ad hoc forms of integration will occur. A good example is the financial transaction tax - also called the Tobin tax or Robin Hood tax – which has been signed by 11 eurozone member states, but not by Ireland. The European Commission tabled its proposals on 14 February of this year, confirming a levy of 0.1% for shares and bonds and 0.01% for derivatives. The FTT is an example of the enhanced co-operation procedure permitted under the existing EU treaties. These types of procedure may become more common in the future as it becomes increasingly difficult to reach agreement between the soon-to-be 28 EU member states. However, they also represent the risk of a fragmentation of economic policy across the EU, with multilateral agreements replacing common EU-wide policies.

The attitude and position of the United Kingdom within the EU is of great economic significance for Ireland. It seems unlikely that the UK will actually leave the EU, but this is a political question perhaps better answered by my colleague. I am limiting my response to the likely consequences of particular outcomes rather than speculating on the future of the UK’s relationship with the rest of Europe.

In summary, this is a critical decade for the European project. Catastrophic errors were made in the design of the EMU, and economic history and theory were both somewhat ignored. I have sketched a brief outline of the types of policy needed to create a durable EMU. There are, of course, other issues to consider. We are happy to take questions.

Mr. Seamus Coffey

I thank the Chairman and the committee for the invitation to attend today's meeting. The agenda will be driven by questions and contributions from members. EU economic and monetary policy is given a lot of attention, but it can be relatively easily understood. For those interested in studying the treaties, economic policy is dealt with in just five pages, while monetary policy is dealt with in just three pages.

However, they seem to have a major influence across different areas. From an economist's perspective, there is perhaps something more than just economic and monetary policy. I refer, for example to the workings of the Internal Market, the importance of competition policy, agriculture and fisheries policy, implications in terms of taxation, employment policy and consumer protection. These all feed in to economic behaviour. At the macro level, economic and monetary policy would be where it is at.

In the context of what the EU sets out as what it tries to achieve by means of its economic policy, the top priority is stable prices and this is followed by sound public finances and monetary conditions and then a sustainable balance of payments. Given the current economic environment in which we find ourselves, all of these bar stable prices have been achieved. Perhaps price stability has been achieved at the cost of other priorities. To a certain extent, EU economic policy is somewhat limited. Ireland is in the middle of an EU-IMF rescue programme but what can actually be forced upon it is relatively limited. We have certain targets to meet from a fiscal perspective. However, as is now widely accepted, how we achieve these is largely our responsibility. The policy itself is not being imposed. It is more a case of focusing on achieving the targets. Overall, EU economic policy largely involves monitoring, surveying, compiling reports and holding meetings rather than actually imposing specific policies on member states.

The EU currently comprises quite a broad spectrum of 27 countries and this is soon to increase to 28. The policies must hold in countries with completely different systems and approaches. For example, certain countries might have higher levels of social protection or public provision while states such as Ireland like to claim that theirs are lower-tax and lower-spend economies or that they are moving in this direction. EU policies must fit and must not involve the imposition of large numbers of restrictions on member states. They can, therefore, be quite broad.

For the first decade of the euro, much of the focus from a European perspective was on fiscal policy. As we know, the currency tended to be quite weak. There were rules in place by which countries were supposed to abide but these were largely ignored. This was generally caused by the larger member states tending to ignore the rules at the beginning of the previous decade. The smaller countries then took the view that if these larger states were not going to be pursued for ignoring the rules, they would not be too concerned about them either. At the same time, the Stability and Growth Pact, which emerged from an Irish Presidency in the 1990s, largely fell apart. Much of the past three to four years has involved, in a sense, fixing the Stability and Growth Pact. There have been various additions to EU treaties and new rules have been introduced. I refer here to the introduction of the six-pack in 2011 and the recent agreement on the two-pack. We can discuss some of the issues which emerged there. It is only really in the past 12 to 18 months that we seemed to get a sense of speed in the context of trying to fix the monetary side of things. The fiscal side has attracted a great deal of attention but it is clear that EMU rules have always been broken.

I disagree with Mr. McDonnell to some extent in that I believe many of the failures related to design flaws that were intentional. The EU faces an issue of encouraging closer integration while also trying to protect sovereignty. There is no doubt that the weaknesses of the euro were identified at the time. Various authors and commentators stated that certain things should have been included in the structures relating to the currency but these were left out. Much of the power was left with individual member states. The regulation and supervision of banks, for example, remained at national level. Moving to a fully integrated monetary union in one jump might have been too much and it has taken ten to 12 years for the problems to emerge. Now, however, there appears to be a willingness to address these and to put in place the type of integration a fully functioning monetary union actually requires. This will take time. Estimates to the effect that a European-wide system of bank regulation could be established within 12 to 18 months are way too optimistic. At least the problem has been identified but it will take a while to get there. Ireland will be considering the implications of the fiscal rules and the impact these will have when we emerge from the current programme, under which our targets are explicitly set. When we move out of the programme, we are going to have to decide how we will abide by these rules during the next five to ten years. We must examine whether these rules can fix EMU and whether they will lead to the development of a euro currency that will not be beset by its current difficulties.

If there are any issues which members wish to raise, I hope we will be able to shed some light on them.

What are our guests' views on the two-pack, particularly in the context of the proposed redemption fund? The proposal in this regard is that where the debts of countries exceed 60% of GDP, they will be pooled and dealt with at a later date. What are their views on the proposed fiscal transfers countries between countries in order to correct structural weaknesses within economies and to counterbalance any cyclical economic downturns? How will these transfers work?

Mr. McDonnell stated that one of the reactions to the crisis included the securities market programme and Mr. Coffey wrote about this matter recently in the context of the number of bonds purchased by the ECB under that programme. I understand that almost €20 billion worth of Irish bonds were bought at distressed prices by the ECB in the second half of 2011. Some of these bonds were purchased for €70 and they are now trading at over €100. The ECB has, therefore, made a significant profit on the bonds it purchased. The ECB agreed to return the profits it made on the purchase of Greek bonds to the Government of Greece. Those profits amounted to several billions of euro. Should Ireland be seeking a return of the profits made on the bonds purchased and sold on by the ECB? The figures indicate that the ECB made between €3 billion to €5 billion from purchasing Irish bonds that were in a distressed state in 2011 and then selling them on at a profit.

I thank our guests for their presentations. One of the concerns regarding economic and monetary union is that it created specific difficulties for smaller member states. In the context of monetary policy, interest rates were set with the economic performance of large member states in mind. During the early years of the euro when the German economy was sluggish, ECB interest rates were kept low in an attempt to stimulate investment. While this made sense in the case of Germany, it created perverse incentives in the context of smaller economies such as that of Ireland which were performing strongly at the time. The cheap money on offer incentivised reckless borrowing. Now that the debate has moved on to the possibility of a closer fiscal union, there is a concern that similar problems will arise. Fiscal harmonisation or greater centralisation of macroeconomic policy at European level could have the consequences of decisions once more being made in the interests of larger member states with big economies. This, in turn, could have the potential to create more negative consequences for smaller member states and reduce the number of policy tools governments might choose to use in times of crisis. There is no doubt that such states require greater levels of flexibility in times of crisis.

Do our guests foresee the emergence of potential problems - similar to those which arose in the context of monetary union - for smaller member states such as Ireland as a result of greater fiscal and economic union? If so, are they of the view that such problems could be avoided? Will our guests also comment on the negotiations relating to the development of a banking union and the impact which slow progress in this regard may have in the context of any deal relating to the State accessing ESM funds to directly recapitalise the pillar banks? How do they assess the state of play on this front? From an economist's point of view, what would constitute a good deal at the end of the legacy bank debt deal negotiations? Mr. McDonnell stated that "In order to help offset regional recessions and asymmetric shocks, such a framework will require a centralised fiscal fund". Will he elaborate on how such a fiscal fund would work in the context of offsetting such recessions and shocks?

I welcome our guests. I missed the beginning of Mr. McDonnell's presentation but I have read it in its entirety. Senator Reilly referred to further fiscal and economic integration. I am clear on what further economic integration would look like from a banking point of view and in the context of the ability of governments to finance their operations through eurobonds, etc. I am, however, less sure of what future fiscal integration will look like, particularly as we move beyond where the stand at present.

I can see how it could develop in the area of tax harmonisation. That has been on the table and a policy pressure point for quite a while. Beyond that and bearing in mind the two-pack and six-pack and the fact that we will be emerging from a programme, what will the position be? When a state emerges from a programme, further oversight mechanisms are in place. What is the nature of the remaining aspects of fiscal integration which we can raise as good or bad? Is there really much more to be done in this regard, excluding harmonisation, which I understand?

I have two questions for Mr. Coffey. He stated one of the European Central Bank’s initial criteria.

As a vote has been called, I suggest the Deputy conclude, after which we will have to suspend the sitting.

That is no problem.

The third task the European Central Bank was charged with concerned the balance the payments. Is a core cause of the eurozone crisis that countries forgot about the balance of payments? Rather crudely, the balance of payments position is the test of whether a country will be solvent in the long run. There are countries running deficits left, right and centre, with no consequences. If a country had had its own currency, things would have happened to it that would have meant governments and central banks would have had to do something. However, since we did not have a national currency, people saw the balance of payments position as a phenomenon in which economists alone were interested and they believed it would not really have a great impact on them. This is because all the other warning signs were taken away.

How does Mr. Coffey envisage banking union evolving? With the inevitable pressures that have emerged as negotiations have begun, does he still envisage the ESM playing a role in the direct recapitalisation of future banks, leaving aside the issue about which Senator Kathryn Reilly talked? Will it be a credible component of banking union as opposed to what we would like to happen?

Sitting suspended at 2.35 p.m. and resumed at 2.50 p.m.

We can resume. We have had a number of questions for the witnesses and I am unsure who wishes to reply first. I do not mind whether it is Mr. Coffey, Mr. O'Connor or Mr. McDonnell but they should bear in mind there will be further questions and perhaps they could limit their comments to five minutes each at this point. In that way, we will have a chance to go back for more questions.

In fairness, if the answers are to be given in the absence of the two questioners-----

They will be in the record. We decided to resume at 2.50 p.m. I have been back in the committee room for five minutes and there is no reason for anyone else not to be back here either. We must move on, as we all have engagements.

That is fair enough. I was going to suggest the Chairman take more questions from members.

Let us do it that way. Would Deputy Byrne like to begin?

Why not? At the outset, I must state I am quite intimidated by the quality of the questions that have been asked. Unfortunately, I must ask a couple of questions that probably are like those asked in babies' class in school as against the academic questions posed to the witnesses earlier, which were very intellectually strong and powerful economic questions. Mr. McDonnell mentioned the example of the financial transaction tax and how 11 countries have signed up to it. My simple question is, what is his opinion of Ireland opting out? Is this a positive or negative position according to his intellectual analysis?

We will take questions from Deputy Durkan, followed by Deputy O'Reilly.

I again thank the witnesses for their presentations and their focus in particular. A couple of questions come to mind. The comment, "Responses to the sovereign debt crisis have, thus far, been somewhat insufficient" is an understatement but of course, there are a number of reasons for that. They have been both insufficient and late and the lateness of the hour has been the biggest single factor. I will ask the witnesses a question I have asked a number of times. During the boom, we repeatedly heard that we could not control the economy in Ireland because interest rates were controlled from Europe and, as a result, they could not be varied and nothing at all could be done about that. All of this now seemingly falls flat because there are varying interest rates throughout the eurozone. This raises the question as to the reason we locked ourselves in on the basis that we had no control over our own interest rates and could not control inflation or whatever.

My next question is also an answer but I will pose the question. I have held the view for a long time that there will never be satisfactory economic, monetary, social and political cohesion in Europe until such time as there is a single currency right throughout the European Union. My case for so stating is the United States and asking how successful it would be if 20 different currencies circulated there. I believe it would not be in any way successful and could not succeed.

The final point I wish to raise relates to the financial transaction tax, Tobin tax or whatever one might call it. My view is that were all countries worldwide where financial services and trading takes place to adopt such a policy, that would be fine. However, if that is not done, the countries that do not adopt such tax obviously will have a distinct advantage over those which do. In the same way, countries that stay outside the eurozone but are within the European Union can have an advantage over their colleagues by adjusting their own currencies in respect of the euro. This has been done repeatedly and is being done in some countries even as we speak. Possibly this is even being done by some countries within the eurozone.

Deputy Eric Byrne has given me the courage to ask simple questions as well and I thank him for that. It took someone to give leadership on this matter.

We both were intimidated by the academics sitting to my right.

I thank him for that. My first question concerns something that is still only a possible hypothesis. However, it could happen and there are many strands to suggest it will happen, although I acknowledge Mr. McDonnell stated he thought it might not. Can the witnesses provide a further discourse on the implications for Ireland and the European Union, were the United Kingdom to leave? How do they think we would be fixed if that happened?

Mr. McDonnell's presentation included a section on aligning monetary and fiscal policies to the goals of employment creation and on having a special fund. He should talk a little more about that and on what steps he thinks the European Union can take of a practical nature for job stimulus. Those of us who believe in some of the present policies would argue that by creating the right broad financial conditions, the private sector will then create the jobs. Mr. McDonnell should comment on what particular stimuli or measures can be taken, apart from the youth guarantee which is very important, by creating a separate fund, etc., to create jobs. Mr. McDonnell also indicated in his presentation that he does not think eurobonds will work. Perhaps he will explain this a little more to me or to Deputy Byrne.

I do not need that explained to me.

Deputy Byrne does not require an explanation. He is aware there are gradations between us and I am a worse case again. Mr. McDonnell should explain this point. There is even a hierarchy between members.

As we have some time available, the witnesses might take up to ten minutes. I will tell them when the time has expired and perhaps they can then conclude. We may then have some time for a back and forth session. I invite Mr. O'Connor to respond first.

Mr. Nat O'Connor

I might talk about the political and institutional end before getting into the economic detail. One issue with Europe is the question of cohesion on the one hand and fragmentation on the other hand and both the economic and wider political policies speak to that. At present, we have something of a mixture. We have the core eurozone of 17 members out of 27. The economic and monetary union, EMU, policies under discussion are about how the European economy will work but in particular about the eurozone. At the same time, there are countries like United Kingdom which have a permanent opt-out from the euro, as do Denmark and Sweden. Even within the 17 eurozone members, there is the question of whether all 17 are going in the same direction with regard to EMU policies or whether there is beginning to be something of a division. In Ireland in particular, we find ourselves to be a country that is both small and peripheral. There of course are small countries which are closer to the centre and which have advantages in terms of infrastructure and closeness to other economies. Ireland is both peripheral and small, even though it is within the euro and close to the centre in that sense.

A number of issues exist in this regard and in addition, there also are countries such as Norway, which is in the European Economic Area but is not in the European Union itself, and Switzerland, which has close economic ties but is in neither in the European Union nor the European Economic Area. In the short term, we have the problem of whether we can get 27 and soon to be 28 countries to agree EMU policies that make sense for all of us and which must have the flexibility to take into account questions such as the core versus periphery and so on, while at the same time controlling fragmentation.

I will give two examples. First, there is a longer game in play in terms of the treaty. Any country that now signs up to the European treaties must join the euro; it is not optional and a country cannot have an opt-out. In the longer term, there is certainly a vision of the European Union where, as Deputy Durkan stated, we all have membership of the same currency. That leaves a question as to whether the United Kingdom, Denmark and Sweden will eventually opt-in or find themselves in a second tier of the European Union. Of course, Ireland, being geographically on the other side of the United Kingdom, will find itself in a difficult position. We would be in a very bad position if the United Kingdom leaves the European Union or pulls away because we trade so much with the United Kingdom, and yet we have growing trade over the recent decades with the European Union. It would be a bad position for Ireland if the United Kingdom pulled away.

On the question of what a coherent EMU might look like, there is the question, that Deputy Donohoe raised, of how far might tax harmonisation go. One of the questions there is size. Currently, speaking relatively, the European Union budget takes a small percentage of member states' budgets and pools it. One of the tax harmonisation questions would be, not only what taxes we might harmonise but just how much tax. For example, if we were to move towards including social insurance as part of tax harmonisation and trying to have harmonisation of social insurance, that would be a major step towards a much larger European Union budget. It would also be a detailed harmonisation of social protection and social welfare systems which might make sense because it could work well with the integration of the European labour market. It would strengthen the social Europe dimension because there might be the development of a European-wide stronger social safety net. That is an example of how it would be a major step, in terms of the amount of money involved in the European Union and, therefore, a transfer of power from the national level to the European Union level. That then brings in the question of the European Union institutions - the role of the European Parliament, its mandate, its effectiveness in terms of its committee at holding the various European institutions to account, the division between the Commission and the European Central Bank, etc. All of that becomes an even more serious issue depending on how fast and how much we harmonise in the coming decades. That is what is at stake in terms of the issue of core.

Fragmentation is the other side of the coin. What I have described are some of the forces that might be involved in a more coherent larger European Union over the coming decades, and EMU is at the centre of that. With something like the financial transaction tax to which only 11 eurozone countries have signed up, the following is what we have seen in those who have not signed up. Finland is currently holding itself aloof, but the five other countries that have not joined the financial transaction tax all display similar features - these countries have larger financial sectors; while not being tax havens, have features of a tax haven; and are identified in various lists as countries to do with financial privacy, etc. Arguably, the financial sectors in those countries are against the financial transaction tax, and are persuasive or have arguments why they are staying out. Malta, Cyprus, Luxembourg, the Netherlands and Ireland are the five countries not in the financial transaction tax even though they are in the euro.

The risk of fragmentation on the political level is one which begins to get a complete incoherence of European policy. The central train is economic and monetary union where the eurozone countries are growing closer together and something such as the fragmentation we see in the financial transaction tax, could slow that down. That is really what is at stake. It is a matter of whether we can get the 28 countries to agree mechanisms whereby they can agree or there will be ever more situations where member states make multilateral agreements together with the enhanced co-operation procedure. The latter would slow down integration which, of course, would weaken the European economy in the global sense. If the European Union takes another 10, 20 or 30 years to sort out where we will combine policies and when we will have different policies, it will weaken the European Union in terms of global trade.

Mr. Seamus Coffey

I will take the issue of the ECB bondholdings first and, maybe, then move on to some subsequent issues.

The Chair has introduced a useful topic. The figures in this regard are unconfirmed, although a set of figures was presented to the Governor of the Central Bank, Professor Patrick Honohan, at the Joint Committee on Finance, Public Expenditure and Reform recently and he did not deny them. I think we can take it that they are in the ball park.

The ECB had what it calls the securities market programme where it bought Government bonds. It started in 2010. The programme ended in March of last year. The programme is now over but its legacy is substantial government bondholdings by the various national central banks in the eurozone which carried out the policy on behalf of the ECB. Most of the activity took place after the July 2011 European Council meeting that finally admitted that a Greek default was necessary but, perhaps, did not go far enough. Because private sector involvement was finally admitted in the case of Greece, to try to cushion some of the consequences for the other countries that were under pressure the ECB stepped in and really stepped up its bond buying over the coming months. Irish bonds formed part of that. It looks like they had somewhere in the region of €18 billion to €22 billion of Irish Government bonds bought in a fairly short period. Most of them focused on what we might call "the short end." These were bonds coming to maturity over a fairly short period - two, three or four years. Since then, there have been two sovereign bond maturities in Ireland. There was a November 2011 bond that matured and also a March 2012 one. Many of the bonds that were bought might have matured and been redeemed, but the figures would still have been quite large.

At a eurogroup meeting in February last it was agreed that the national central banks would recycle some of the profits they were making on these bonds back to Greece. As attempts were made to bring down their debt-to-GDP ratio, one approach taken was that there was this money flowing out of Greece and maybe they could get it to flow back in. In the main, as we now will be aware, when central banks make profits they return them back to their sovereign. In our case, we expect the Central Bank to make substantial profits on Government bonds, but these merely happen to be our own Government's bonds and we hope the Central Bank can hold on to them for as long as possible because the interest we pay on them to the Central Bank is then recycled back to the Exchequer. If there is a profit on any interest that is paid on the Irish bonds now held by the national central banks across Europe, it can be returned to the exchequer in those countries and we hope, perhaps, they will return it to us.

The issue is made up of two elements. The Chair spoke about the profit that the central banks will make. The profit is made up of the annual interest - coupon - they get every year and the capital appreciation. There is not too much we can do about the capital appreciation. The central banks will require a certain return for taking on the risk of buying Irish Government bonds, and this was particularly the case in the autumn of 2011 when sovereign bond markets were quite heated.

We can focus particularly on the annual interest, which might not grab as large a headline as focusing on the capital but which sums can be quite large. Here, the central banks are making a cheap and easy profit. The central banks get access to funds at a very cheap rate. They can get the funds at the ECB rate and they have bought these Irish Government bonds. They might have made a profit by buying them at 70 bps or 75 bps, but they are making that profit off somebody else. They are making that profit off the person who sold the bonds. That really is of little concern to us. We borrowed €100 whenever the bonds were issued, say, in 2006 or 2007, and we will pay back €100. The central banks themselves are not making a profit off us on that basis. What they are making a profit on will be the interest that we will now pay on an annual basis on those bonds. Perhaps we should target and try to get back the interest, which is the substance of the Greek deal where the interest that is paid on bonds is then recycled back to the Greek central bank which can return it to the Greek exchequer.

The sums have potential to be reasonably large. Given some of the redemptions, there could be - I merely pick a figure - €12 billion of these bonds still being held by the national central banks across Europe. At a rough 5% annual coupon, one is talking about €600 million of interest per year. We have a massive interest bill, approaching €8 billion. Some €600 million of that could be going to the national central banks of Europe. The money they are borrowing from the ECB for this facility could be costing them €100 million and, potentially, there is a €500 million per annum profit or income for the national central banks across Europe on their holdings of Irish Government bonds. The central banks will benefit because they got to buy them cheap but as of yet, there has been no benefit for Ireland. We were not in bond markets in July and August 2011 when these bonds were being bought. This was, apparently, done for our benefit. It was to try to stabilise European bond markets but as of yet, we have got no real benefit because it is only subsequently that we got back into markets. This potential €500 million is there and could be recycled back to the Central Bank of Ireland which would give it back to the Exchequer. It would be a welcome boost to the public finances.

Deputy Paschal Donohoe asked about the balance of payments and, to a large extent, answered his own question. When it comes to an individual country with its own currency, there will be a focus on the balance of payments because it is interested in the supply of its currency on international markets and how it influences the exchange rate. However, for countries in the eurozone, the balance of payments is less important as a mechanism for influencing the exchange rate because trade in the euro is not particularly influenced by what we do. We may be interested in the direction of the euro exchange rate, but we have little control over it. When we had the punt, a large balance of payments deficit, that is, punts flowing into the international market, it gave raise to concerns about whether people would try to sell or hold our currency. We have realised in recent years that while the balance of payments provides an indication of the health of an economy, it might not be the policy objective it previously was. If more money is flowing out than coming in, problems will arise eventually.

A number of countries are facing difficulties because of balance of payment deficits. It is a question of running a collective rather than an individual currency. The United States runs a huge balance of payments deficit but does not regard this as a significant problem because it controls its own currency and is interested in seeing its value fall. It is not concerned about hundreds of billions of dollars flowing into international markets if the value of the dollar is dragged down as a result because that will help the drive to increase exports. For several years there has been a closer focus on balance of payments and most of the struggling countries are improving in this regard. Our balance of payments has moved from a slight deficit to a surplus and while countries such as Spain and Greece remain in deficit, they are moving towards surpluses. This is something that does not receive much attention, but it is a sign of health and stability in an economy.

On the future of the ESM and the possibility of bailing out banks, I hope we will never have to bail out banks again. Some of the rules being put in place will ensure the call on the taxpayer will be reduced in the future. We know that the capital ratios for banks are going to be increased because they will need more money to absorb losses before somebody else is called on. The mechanism being put in place for bank resolution on an EU-wide basis will require bondholder bail-ins and, perhaps, large depositor bail-ins, depending on the nature of the losses for the banks concerned. The lack of a bank resolution mechanism on an EU-wide basis was a failure in the design of the euro. Most of the countries involved tended to ignore the issue, rather than put in place their own mechanisms for bank resolutions. This was something that could have been done in the run-up to the crisis and was done overnight in Ireland recently. The aim is to avoid taxpayer bailouts of banks. As the bondholders and depositors will only be bailed in to failed banks, it is unlikely that they will be bailed in if viable or functioning banks run into trouble . They will still get their money back, but as long as the bank remains alive, the possibility remains for the State to get its money back. We must avoid the bailouts for Anglo Irish Bank and Irish Nationwide Building Society, in respect of which the State invested money which it had no chance of recouping. In those instances a mechanism will be put in place to ensure there will be no call in the future. The ESM will not be called in for failing banks which will be allowed to fail. It may be called in for viable banks, but countries may also decide to act without the ESM to maintain control within their own jurisdiction if they decide there is value in doing so. The aim at all times is to reduce taxpayer involvement, although it is difficult to decide if that is achievable because they are still only at the design phase. It is badly wanted and I hope it will have an impact in the future.

Senator Kathryn Reilly asked about monetary policy. I slightly disagree that interest rates were set with larger countries in mind. Interest rates were set with inflation in mind. If inflation was low, interest rates were going to be low. The ECB takes note of policy conditions, but it is not going to respond with interest rate changes if they impact on its inflation rate target. Its prime objective is to control inflation. When inflation was low in the eurozone, interest rates tended to be low. They were unsuitable for Ireland at a time when the economic growth rate was high and inflation was higher. The question arises of what countries can do once their interest rates are set at a supranational level. We are seeing difficulties in terms of the ECB trying to reduce interest rates beyond already very low levels. Apart from Ireland, this does not have much of an impact on the ground. The reason ECB interest rates have such a large impact on Ireland is tracker mortgages. The ECB's low rate has not fostered cheaper lending in other countries or on bond markets. While the ECB rate and German bond yields are low, there has been little impact on Italy, Spain, etc.

Closer fiscal union would benefit small countries. Fiscal union should allow countries to deal with macro shocks without putting public finances under pressure. We find ourselves in the midst of a large macroecnomic shock which, in theory, should be dealt with by easing back on the fiscal side, that is, spending more or cutting taxes. However, because we are also faced with a solvency problem in keeping the country afloat, we responded in exactly the opposite way, by cutting expenditure and increasing taxes. If there was fiscal union, perhaps unemployment benefit and other social welfare payments would have been ring-fenced at European level. The public finances might be in a mess, but social welfare levels would be maintained from a central fund and once we were back on track to growth, we would become a net contributor to the fund, rather than a beneficiary. We could thereby sort out the rest of the public finances while protecting social welfare expenditure. That approach would bring net benefits for small countries.

Mr. Tom McDonnell

A wide spectrum of questions were raised. I will try to touch on at least one issue mentioned by every member.

The issue of what was described as excessive influence over interest rate policy is a reflection of the size of economies and the weighting they are given over inflation policy. The larger the economy the closer the chosen interest rate to the correct rate for the country concerned. As smaller countries have a reduced weighting, they are likely to be more volatile and pro-cyclical in respect of the interest rates decided by the ECB. However, it is not a case of bias or undue influence per se.

Members asked a number of related questions about why eurobonds would not work, what fiscal integration would look like, whether it would make sense to have a single currency for the entire European Union and what direction banking integration was likely to take. One of the problems when the euro currency was introduced was that policies which may have been sensible individually ended up as a mess when taken collectively. I do not agree that the crisis was only discovered ten or 12 years later. There were massive credit inflows to certain countries from the very beginning, but they were not acknowledged as being part of a bubble. The crisis began when high levels of indebtedness began to form. They should have been identified earlier. The policy failures were imbedded from the outset.

Eurobonds will not work because the eurobond models that have been discussed to date give rise to moral hazard issues. Making EMU work and ensuring coherence in fiscal policy require us to deal with the moral hazard problem because we are members of a club and discipline is important alongside solidarity.

The question then is how does one do what one is supposed to do in terms of one's central bank and create a lender of last resort that can do what is supposed to, which is to stabilise the system, and reconcile that with the inability to provide unlimited funding to whichever country wants it, that is, it has be a conditional lender of last resort. The eurobond model, unfortunately, does not deal with the moral hazard issue. It only deals with one issue and even then it is problematic because anything in excess of 60% is suddenly a second type of debt. The first 60% might be safe and fine but bond traders will look at the remaining portion of the deb and they will isolate it as being different and will arguably regard it as even more toxic. Eurobonds, therefore, are not an answer.

A circuit breaker, which prevents sovereign bond yields going over a particular value, is required but, at the same time, mechanisms are needed to prevent countries abusing that and, for example, running a 15% deficit every year because they know they can borrow at an interest rate of 2% or 3%. Those goals have to be reconciled and that, ultimately, will become the problem that must be squared. There are a number of ways in which that could be done. The ECB is not allowed to be a lender of last resort for sovereigns because of the monetary financing prohibition and for other reasons and, therefore, another institution would have to do that, whether that is a special purpose vehicle created by eurozone members such as the ESM. I have written a paper on this which I would be happy to circulate. There are many moving parts but, ultimately, that question is very much core to resolving the long-term issues and making EMU sustainable and coherent but eurobonds are not the way to do it. There are no solutions there and that possibly answers the redemption question as well.

We were asked what fiscal integration looks like and both Mr. Coffey and Mr. O'Connor have articulated the concept of a stabiliser. There are two stabilisers within the system. The first is the lender of last resort, which prevents sovereign borrowing costs from accelerating to unsustainable levels. If there is a circuit breaker, that is prevented from happening. The other automatic stabiliser traditionally has been government budgets but, as we are aware, there is limited capacity there. We are in a new type of construct. Ireland is not like the US. There are not inter-regional transfers between Ireland and Austria in the same way there are between New York and Mississippi. In the US, for example, if there is what is known as a localised shock such as a hurricane, the federal government can step in and provide emergency funding but if a local industry collapses in Ireland or there is an earthquake in Greece or a massive banking crisis, which leads to instability, there is no mechanism in place to deal with that and if unchecked, that can lead to higher levels of long-term unemployment in the long run as hysteresis and other effects kick in. What a state wants to do is to prevent those long-term effects from occurring and some form of a limited central fund is needed, which runs a surplus in normal times and which can be automatically activated for specific purposes such as for social welfare under specific conditions. My own preference would be for education, retraining and upskilling, which would be particularly appropriate in the Irish context, given the vast majority of jobs were lost in the construction industry and many of them will never return. Those people will have to acquire different skills. It should be about human and physical capital, which is part of the process of restructuring economies and structural reform.

The question then is how does one create the fund without it being a full fiscal union. In all likelihood, the eurozone countries will have to come together in a similar fashion to the FTT proposal, which is currently being put in place, and hypothecate some form of taxation from within each country, which would probably be a consumption tax. This could also be an FTT, for example, but which in all likelihood would probably be 1% off VAT. This fund would simply build up and be used purely to respond to the asymmetric shocks that have been identified for 50 or 60 years. This also addresses the question of united states and whether we should all come together and have a single currency. However, there would be hypothecated fund of, say 1% off VAT, which goes to a central place and which is activated upon certain events occurring such as a banking crisis or another crisis that leads to a major recession in countries. That would then be used to ameliorate the recession and allow those countries to more easily manage their fiscal consolidation-austerity process without causing as much damage to society. Countries tend, when reducing public spending, to go for the capital budget because it is politically the easiest thing to do by far, even though in the long term it is probably the most damaging thing to do in the context of the growth potential of the economy. If the fund was in place and ring-fenced for those type of activities, that problem could be circumvented as well to a certain extent.

With regarding to the direction of banking union, it will happen but I am not convinced it is what we need. The main thing required in the context of such a union is proper resolution mechanisms. If resolution is to be at European level, that means supervision and regulation also has to be at that level. This may be more severe than is perhaps anticipated. It could mean regular stress tests for banks to a much greater extent than before. It will probably be a requirement under a proper banking union with proper resolution legislation in place that it will have to be fully independent. This is why it is not popular among nation-states. If a fully independent body can turn around overnight and shut a bank, that will create issues at local level. Perhaps the answer is to simply look at it as a European banking system.

As to whether we should move to a single currency at European level, that comes down to whether one believes Europe is an optimal currency area. The US is not necessarily an optimal currency area. What does this mean? The issue is whether the benefits of the single currency outweigh the costs of losing exchange rate policy and the ability to devalue a currency to restore competitiveness and boost economies at particular times. Israel, for example, strongly devalued its currency and got through the crisis fairly well. I do not say that is the panacea. However, fundamental surgery is still required to create a genuinely durable EMU. There are a number of different ways in which all these things can be done.

With regard to jobs and what can be done for weak countries, the answer is a centralised targeted fund, which could be used in that fashion. Unfortunately, there are no silver bullets when it comes to jobs. It is a long-term grind. The question is how long-term growth is generated. The answers to those questions are different and those type of structural reforms at root and branch level remain important.

The problem with the FTT is the costs and benefits for individual states are different and, as Mr. O'Connor said, what we are witnessing is countries opting out of the things they believe will be negative for them and, in the context of 28 states, it will be increasingly difficult to fully integrate at that level. There will be smaller clubs in different areas.

Mr. Seamus Coffey

From an economic perspective an FTT is sound. The purpose of the financial sector and finance in general is to allocate money from savers to borrowers and to allow us, to a certain extent, to engage in risk management. The problem is the financial sector has become much larger than that, part of which has been down to the ease of transactions that can now simply happen at a touch of a keyboard. Transactions that would previously have been quite complex can now be done in fractions of seconds. The financial sector in general is adding value as it circulates funds around and deals with risk, but the part of the financial sector that engages in this very high-volume transacting might not necessarily be. These small taxes can to a certain extent control that and also get a contribution from the financial sector to the broader economy. Much of what happens in the financial sector stays within the financial sector - they are dealing with each other rather than dealing with individuals and businesses which is where the real benefit of the sector comes from.

The concept of the FTT has been around for 40 or 50 years without being implemented. The difficulties that Mr. McDonnell highlighted of countries picking and choosing what they want reflects the difficulties in implementing it. From an Irish perspective, it is not so much the imposition the FTT would put on normal people - we do not engage in huge amounts of transactions with bonds, shares and derivatives - but that within Ireland a lot of it happens through the financial services sector that provides 20,000 or 25,000 jobs. We talk about the IFSC, but basically it is a financial services industry within Ireland. There are IFSC-type companies in Cork - they might not be in Dublin 1 but throughout the country companies are engaged in activities relating to that sector.

As has been highlighted it becomes very much a national issue as opposed to a broader issue. The benefits of such a tax have readily been proved and stand up, but then economic nationalism steps in and countries decide to step out. So Ireland has decided to step out on the basis that we do not want to be seen to be flexible in any fashion. We have established, what we might call, a business-friendly environment and even with issues such as corporation tax and financial transactions tax, we have drawn a line in the sand and said we would not change. It is not that these changes are negative but that we do not want to show any flexibility and want to provide certainty for foreign companies investing in Ireland, which looks locally rather than to the broader issues. It is possible to justify the decision to stay out of the FTT. I believe the economics of it stacks up and it would be a useful addition, but getting all the countries to come into it would be quite difficult.

Mr. Nat O'Connor

I wish to return to the issue of the short term versus the long term. In the short term as I have described, there is considerable fragmentation about who is in the eurozone and who is in the European Union. There are particular risks for Ireland because we are not only small but also peripheral. There is a question of whether our economic strategies as a country are compatible with the long-term direction of the European Union. In the short term we can have it both ways. We are in the eurozone and involved in the conversation about European monetary union and the various institutions there such as the ESM. We are also outside the FTT because it suits us regarding multinational FDI, particularly in our financial services industry. At the moment we can have it both ways, but as there are more countries in the eurozone sharing more of the same rules there is a question of whether we will find ourselves having to make a choice as to whether we are in or out regarding, for example, harmonisation of corporation tax. Rather than having a point ten or 15 years down the road where there is a break point and suddenly we are under massive pressure to change, we should really be looking at the longer-term strategic risk for Ireland of not having an economic policy here that is compatible with the direction of the core EU economy.

In that context, as both other speakers said, institutions matter as do the rules of the European Central Bank. The ECB explicitly does not look at employment and growth, as the Federal Reserve in America does. At the moment it only looks at interest rates in order to control inflation and price stability. It interprets that very narrowly as meaning 2% inflation but in fact a higher rate of inflation would suit Ireland now because of our high level of both private and public debt. The institutional detail matters of the ECB, ESM and other institutions should have the flexibility to benefit peripheral economies like Ireland as well as benefiting the core. That is where I would might a concern that Ireland is outside the FTT.

There is no doubt that our strategic interest is for the UK to remain in the EU and ultimately if every other country in the EU is going to be in the eurozone then we need the UK to be in the eurozone. Ireland has often been positioned as a broker between the UK and other European countries, particularly at a Brussels level. We should certainly be considering our strategic interest in how the UK can be persuaded to stay in the European Union as a central player and ultimately to move into the eurozone. It is unambiguous that is where our strategic interest lies.

I thank all three of our guests who have certainly given us food for thought. We will produce a report at the end of our meetings which should finish in June. That will be available on our website and we will also make sure that each of the witnesses gets a copy.

The joint committee went into private session at 3.35 p.m. and adjourned at 3.40 p.m. until 2 p.m. on Thursday, 28 February 2013.
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