Shock Exchange

CURRENCY:  We overpaid ourselves during the boom and gambled on the euro remaining weak. It didn't - but can Ireland avoid the worst consequences of a colossal error?, asks MICHAEL CASEY

PERHAPS NO country has an ideal currency regime. Over the years Ireland has not been particularly blessed by its currency arrangements. The fixed link to sterling was often a fraught one. Sterling was a reserve currency and was therefore subject to considerable volatility. When sterling went up we found it hard to export to third countries. When sterling went down we suffered from higher (imported) inflation.

Because of the latter we began, in the late 1970s, to cast around for a stronger arrangement, and for a while considered linking the Irish pound to a weighted basket of currencies. But then the revamped EMS exchange-rate mechanism came along and we joined in 1978, even though sterling stayed out.

From then on we had to become adept at riding two horses, ie staying in the mechanism which was dominated by the Deutsch Mark, but also trying not to move too far away from sterling. The strain told in 1992 when interest rates had to be increased to high levels to defend the Irish pound. But speculative attacks increased, some self-inflicted, and Ireland had to devalue in early 1993.

At present, the euro system is not doing us any favours. The euro is now equivalent to around $1.35 - about 50 per cent higher than its lowest point. The appreciation against sterling has been of a similar order of magnitude. Irish exporters are badly affected, while domestic producers are losing out to cheaper imports. In most monetary unions there would be automatic fiscal support for a member country which was in difficulty. In EMU there is no such support. (Historically, monetary unions without a fiscal dimension have not lasted very long.)

When we joined the euro it was recognised that we would lose two policy instruments: the interest rate and the exchange rate. It was readily apparent that overall economic policy would have to change to compensate. Throughout most of the Celtic Tiger period there was a risk that the exchange rate of the euro could move up against the dollar and sterling - both currencies tend to move together. It was essential to maintain competitiveness through other means.

While wage rates tended to rise by about 2 per cent a year in Europe and the US, in Ireland they rose by 4-5 per cent. Benchmarking was another act of myopic generosity that would return to haunt us. Over a 10-year period rapid wage growth compounded and ensured Ireland would lose competitiveness, even if the exchange-rate configuration remained favourable. But it didn't. The country took a huge gamble and lost.

When the government and social partners were busily dividing up the national cake and agreeing to high wages in the palatial surroundings of Government Buildings, there was little or no reference to exchange-rate risk. Not to communicate this risk to the social partners on a continuing basis was a colossal mistake.

Constant awareness of that risk should have been one of the main features of economic policy. But it got lost in the hype and self-congratulation of the boom years. Irish governments live in the short-term, and never look ahead or factor in risks.