Economy Watch: the view from Dublin
Perhaps the greatest failing of economists internationally and in Ireland before 2007 was a blindness to how big an impact the financial system has on the real economy.
While this failing is now well recognised, economists are still in the early days of designing policies to limit the damage finance can do. Increased financial regulation plays a role for all but the most ideological of free market types, but more proactive measures are needed too.
In addition to stricter rules on all aspects of finance, a new buzzword has emerged — “macroprudential”.
These are non-interest rate levers that can be pulled to stop asset price bubbles inflating. These macroprudential tools include the kind of measures the Irish Central Bank has recently introduced which are aimed at reducing the risks of another property bubble.
They include ceilings on loan-to-value and loan-to-incomes ratios. Because those ceilings can be lowered if the market looks to be overheating they have a “dynamic” element that standard financial regulation lacks.
While the Central Bank was right to put these measures in place (and should have done so a few years ago when political resistance would have been much less), there remains a real issue in deciding when overheating is taking place.
Reflective of the more humble nature of macroeconomists, another former US treasury secretary at a Washington meeting entitled Rethinking Macro Policy III: Progress or Confusion? said: “We were not very good at telling when times were exuberant rather than normal.”
That observation remains true.