||Central Bank Of Barbados
While there can be differences in the details,
the basic anatomy of financial crises is generally the same. This is according
to Dr. Patrick Honohan, a former Governor of the Central Bank of Ireland who is
the Central Bank of Barbados’ 4th Distinguished Visiting Fellow.
Speaking to officials from the private sector
during a presentation on the topic “Recovering from Crisis: Lessons from
Europe”, Honohan asserted that financial crises are usually the result of one
or more of three factors: prodigious borrowing by the private sector,
especially at times when interest rates are low; excessive borrowing by the
public sector; and a loss of competitiveness for the country due to high wages or
Using Europe as an example, Honohan identified
countries where each of these factors was principally responsible for a
financial crisis. He cited Italy as a country whose challenges were largely the
result of a lack of competitiveness, and Greece as one where excessive
government played a significant role. Exuberant spending by the private sector,
he explained, was the source of Ireland’s troubles.
According to Honohan, financial crises begin with
what he termed a “sudden stop”, an abrupt change in the government’s ability to
obtain external funding, or to do so quickly. The government then needs to make
adjustments in its spending, which potentially has an impact on the country’s level
of output and can also necessitate layoffs. Increased unemployment often results
in loan defaults, and the general uncertainty about the economic situation can lead
members of the public, even those not currently affected, to spend and borrow
less. This in turn leads to reduced tax revenue for the government compounded
by increased pressure to provide social safety nets for those citizens who are
suffering due to the economic downturn. This creates a feedback loop where the
effects of the crisis actually compound the crisis.
Honohan maintained that it is possible to
recover from crisis, however, and he outlined five strategies that worked in
Europe, and Ireland in particular.
He emphasised that early acknowledgement of the
depth of the crisis was essential. This allowed the Irish government to act
immediately, which allowed it to restore some measure of confidence among
creditors. Beyond taking early action, it was important to have coherent
medium-term goals, five-year and 10-year plans, that provided direction and
further motivation for the country to follow through on the necessary corrective
action. He added that seeking assistance from partner countries within the
European Union was also important.
Honohan also stressed that having credible
forecasting was important as this allowed countries to better monitor their
progress. He contrasted the accuracy of Ireland’s forecast when checked against
its actual economic performance with the significant deviation between Greece’s
five-year performance and what had been projected.
A fifth – and key – component to Ireland’s
recovery, Honohan revealed, was its policy of maintaining open communication
with the public. During Ireland’s financial crisis, unemployment rose to 15%,
public servants’ salaries were cut by an average of 14%, taxes increased (VAT
was 23%), and social services were reduced. The Irish public was angry, he admintted,
but they were also worldly people who had seen financial crises play out
elsewhere and knew that tough measures were necessary. “Adjustments are always
painful, but if the public understands them, they might accept them.”
Honohan maintained throughout the session by
saying that recovery is a lengthy and difficult process, one that requires
governments to make hard decisions and to have the discipline to see them
through. As for what does not work, Honohan mentioned three behaviours:
procrastination, threats and grandstanding, and rigidity.