Was the financial catastrophe that hit Ireland from 2008 on an accident or due to mistaken policies?
It is natural for economies to experience highs and lows during different periods, often being subject to a boom-bust cycle. The financial catastrophe that hit Ireland from 2008 on, however, was definitely not an accident. A global financial crisis ensued the same year, which would obviously have a negative impact on Ireland - it “contributed very significantly to the [Irish] economy’s current woes” (Fitzgerald, 2011). However, the policies undertaken by the Irish government, Central Bank and ECB are the main cause of the prolonged length and depth of the Irish recession.
The origin of the Irish recession stems from the monetary policy implemented by the Central Bank and the ECB, and from the introduction of the Euro in 1999. The integration of EU financial markets provided Irish banks with access to international market (wholesale) funding, allowing Ireland to borrow cross-border without the foreign exchange risks; as a result banks were able to expand their loan books to a great extent.
This new source of funding made it possible for Irish banks to lend well beyond their means of domestic deposits and equity. There was also potential for large profits, as Irish banks could borrow short term at a cheap interest rate and lend long term at a higher rate. The rate to customers was still relatively very cheap and, at a time when the economy was growing rapidly and incomes were rising, people took advantage of the cheap credit and borrowed excessively. The average household took out small loans and large mortgages alike; small and medium enterprises borrowed more for expansion and business purposes, and property developers took on massive (often risky) loans for construction projects.
As the demand for loans increased significantly, banks strove to increase supply, to gain higher profits and maintain their market share; the arrival of foreign banks in Ireland made the domestic credit market much more competitive (Regling and Watson, 2010). Between 2003 and 2007, AIB annually reported significant growth in the number of loans to customers, of about 25-30% a year. At the same time, they encountered much slower growth in customer accounts, between 11-19% (indicating a strong dependance on wholesale funding). Other banks, such as Anglo Irish and Bank of Ireland, experienced similar growth during the same period.
A credit bubble arose, which then fuelled the emerging property bubble of the late 1990’s and early 2000’s. The extent of the increase in lending can be seen from data from the World Bank: In 1994, the amount of credit lent by domestic Irish banks as a percentage of our GDP was only 51.2%, five years later this figure had doubled to 103% and by 2007 banks were lending almost four times our national income, at 195.3% of GDP.
This growth in the number of loans meant profits increased significantly and shareholders were pleased. In the...