Credit Crunch

Overview

• Current crisis is more than a credit crunch in Ireland

• 4 Aspects or causes with effect on AD– Asset market Bubble: I– Government Budget: G– Banks: C+I– International Credit Crunch: C+I, NX

• Solutions– General: shift in AD– Special: unusual aspects of current crisis

Bubbles• Bubbles can occur in asset markets in general

– US, UK, Ireland have housing market bubble

• Examine evidence to prove this– Obvious now but clear signs before: Not just a price

increase– Soft landing

• Psychology– Shiller “Irrational Exuberance”– Makay “Madness of Crowds”

• Consequence was huge Investment (20% GDP)– GDP Boom– Inv cut-off: huge shock to AD

Budget• We have already seen how budget went

from surplus to deficit

• Bubble generated boom covered up a huge underlying deficit– Evidence of the structural position

• A fiscal contraction now makes things worse– Shift AD to left– EFC?

Government expenditure (G)

GNP1

AB

GNP2

C

Nominal GNP

NT

GNP

€ billions

Discretionary changes in taxes and expenditure

G, NT

*

Natural GNP

NT

NT

1

2

3

Leddin and Walsh Macroeconomy of the Eurozone, 2003

Banks• Massive amounts of foreign borrowing

– Through banks to housing market

• Weakens banks– Highly leveraged: lots of assets, lots of

liabilities; small cushion– Asian currency crisis: Iceland vs Ireland– US: Shadow banks

• Banking crisis is another shock to economy– Shortage of funds (controversial)

Credit Crunch• Originated in the US not Ireland• Direct Consequnces

– Hit directly two major markets for our exports (NX)– Rise in interest rates (C+I)– Would have burst bubble anyway

• Makes dealings with with our banks more difficult– Government guarantee– Borrow for deficit– Borrow for banks– Fear of upsetting bond markets

Overview of the Overview

ForeignBorrowing Banks Inv

costs

budget

NX