“The Celtic Tiger was the phrase most associated with Ireland since the 1990s, describing its dramatic growth from one of Europe's poorest states to one of its richest.” The government, thinking that the economy was growing, increased wages and pensions, extended the public sector. They used money that they didn’t own, as the growth they thought was real, was in fact a bubble. This led to a huge deficit in the Irish economy. Ireland was bailed out because the countries within the EU knew the extent of Ireland’s budget deficit. The EU was worried about the contagion effect, that if the Irish economy went bust, it would have a dramatic effect on the countries within the EU. Another reason for the bailout was that financial leaders believed that “the bail-out money a move to help restructure the banking sector.” “RBS and other companies have invested heavily in Ireland. RBS, which is partially state-owned, has £53billion exposure to Irish loans – of which more than £40billion are underwritten by British taxpayers.” Ireland needed to be bailed out as if it went bust RBS would lose its money and the British taxpayers would be heavily weighed down by this. If Ireland went bankrupt this would ruin the trade market between Britain and Ireland as “around 60% of Ireland’s imports are from the UK.” Bailing out the Irish was vital because if that didn’t happen, unemployment would have increased further and people would have migrated to Britain where there is an “already increased competition for jobs.” Although bailing Ireland out may not have the greatest consequences in the long run, it was a necessity to ensure that other countries didn’t suffer from Ireland going bust.
I would expect Ireland to reduce their government spending and to raise taxes. “A contractionary fiscal policy allows a government to reduce the growth of an economy by limiting the amount of government expenditures.” An increase in taxes, leads to a lower interest rates and a lower output. An increase in taxes also means that people have a lower disposable income and so their consumption also decreases. “The decrease in income reduces the demand for money, leading to a decrease in the interest rates.” To prevent the debt of the country growing the government has to increase the primary surplus, where the interest rate exceeds the average growth rate. “Large primary surpluses require high taxes which introduce distortions in the economy.” When the “r-g” increases, the government should increase the primary surplus by the same amount to keep the debt ratio constant. This means that the government would have to increase taxes which “generates even more political uncertainty and further increases the risk premium, and therefore the interest rates.” The increase in the interest rate “generates a deeper recession further reducing the rate of growth”. All this makes it extremely difficult to keep the debt ratio constant. The problem with very high public debt is that it is very hard to get rid of it as there is a vicious circle which just ends up getting the country in more debt. The best way would be to “repudiate the debt” as this leads to an almost instant decrease in taxes and the risk of vicious circles is also smaller, however in the long run it might have really bad effects on the economy like a decrease in consumption because people will see a decrease in their wealth.
3. If Ireland had its own currency it would have been able to respond to the crisis by using the monetary policy and fiscal policy to affect the exchange rate. The Irish banks could have increased government spending which would have in turn lead to an increase in output and interest rates, as well as an appreciation.
Ireland could also decrease the money supply, by using a contractionary monetary policy. This would lead to a decrease in output, an increase in the interest rates and an appreciation.
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