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Central Bank of IrelandQuarterly Bulletin 03 / July 15© Central Bank of Ireland 2015


ContentsSection 1Forecast Summary Table 6Comment 7The Domestic Economy 9Box A: Ireland and the Macroeconomic Imbalance Procedure – An Update 21An Timpeallacht Gheilleagrach 23Financing Developments in the Irish Economy 25Box A: SMEs Cost of Bank Funding 27Box B: Investment funds debt security holdings in a low yield environment 32Developments in the Euro Area Economy 35Box A: US Monetary Policy: Looking Beyond Headline Unemployment 39Box B: Monetary Policy Rates and Shadow Short Rates 42Section 2Data Gaps and Shadow Banking: Profiling Special Purpose Vehicles’ Activitiesin Ireland 48Brian Godfrey, Neill Killeen and Kitty MoloneyThe Expanded Asset Purchase Programme – What, Why and How of Euro Area QE61Peter Dunne, Mary Everett and Rebecca StuartLabour Cost Adjustment during the Crisis: Firm-level Evidence 73Suzanne Linehan, Reamonn Lydon and John ScallySection 3Statistical Appendix


Notes1. The permission of the Government has been obtained for the use in this Bulletin of certainmaterial compiled by the Central Statistics Office and Government Departments. The Bulletinalso contains material which has been made available by the courtesy of licensed banks andother financial institutions.2. Unless otherwise stated, statistics refer to the State, i.e., Ireland exclusive of Northern Ireland.3. In some cases, owing to the rounding of figures, components do not add to the totals shown.4. The method of seasonal adjustment used in the Bank is that of the US Bureau of theCensus X-11 variant.5. Annual rates of change are annual extrapolations of specific period-to-period percentagechanges.6. The following symbols are used:e estimatedp provisionalr revisedq quartern.a. not available. . no figure to be expected– nil or negligiblef forecast7. Data on euro exchange rates are available on our website at www.centralbank.ie and bytelephone at 353 1 2246380.Designed by: Essentra plc.Cover Photograph: Stuart BradfieldEnquiries relating to this Bulletin should be addressed to:Central Bank of Ireland (Publications),P.O. Box No. 559, Dame Street, Dublin 2.Phone 353 1 2246278; Fax 6716561www.centralbank.ieEmail: Publications@centralbank.ieISSN 0332-2645


Section 1Quarterly Bulletin 03 / July 155


6Forecast Summary Table2012 2013 2014 2015 f 2016 fReal Economic Activity(% change)Personal consumer expenditure -1.2 -0.8 1.1 2.3 2.3Public consumption -2.1 1.4 0.1 0.5 0.9Gross fixed capital formation 5.0 -2.4 11.3 11.0 10.4of which: Building and construction -1.3 14.1 8.9 10.4 13.6Machinery and equipment -2.1 1.8 31.0 16.8 9.8Exports of goods and services 4.7 1.1 12.6 5.8 6.0Imports of goods and services 6.9 0.6 13.2 5.9 6.1Gross Domestic Product (GDP) -0.3 0.2 4.8 4.1 4.2Gross National Product (GNP) 1.1 3.3 5.2 4.2 3.8External Trade and PaymentsBalance-of-Payments Current Account (€ million) 2,698 7,634 11,469 11,211 11,413Current Account (% of GDP) 1.6 4.4 6.2 5.7 5.4Prices, Costs and Competitiveness(% change)Harmonised Index of Consumer Prices (HICP) 1.9 0.5 0.3 0.5 1.7of which: Goods 1.9 -0.4 -1.7 -2.7 0.4Services 1.9 1.6 2.4 3.6 3.0HICP excluding energy 0.9 0.6 0.5 1.3 1.5Consumer Price Index (CPI) 1.7 0.5 0.2 0.4 1.6Nominal Harmonised Competitiveness Indicator-4.0 3.1 0.2 n.a. n.a.(Nominal HCI) 1Compensation per Employee 0.7 2.0 3.8 2.2 2.3Labour Market(% change year-on-year)Total employment -0.6 2.2 1.9 2.3 2.3Labour force -0.6 0.4 -0.3 0.5 1.0Unemployment rate (ILO) 14.6 13.1 11.2 9.7 8.5Technical Assumptions 2EUR/USD exchange rate 1.28 1.33 1.33 1.11 1.10EUR/GBP exchange rate 0.81 0.85 0.81 0.72 0.71Oil price ($ per barrel) 111.57 108.58 98.52 59.25 66.44Interbank market – Euribor 3 (3-month fixed) 0.57 0.23 0.21 -0.01 0.021 Based upon the annual change in the average nominal HCI.2 The technical assumption made is that exchange rates remain unchanged at their average levels in mid-June. Oil prices and interestrates are assumed to move in line with the futures market.3 Euribor is the rate at which euro interbank term deposits are offered by one prime bank to another, within the euro area. Daily datafrom 30 December 1998 are available from www.euribor.org.


7CommentFollowing GDP growth of 4.8 per cent last year, the strong recovery of the Irisheconomy has continued in the first half of 2015. While the initial strengtheningof activity in 2014 was driven by net export growth, the recovery over the pastyear has become more balanced, with domestic drivers increasingly playinga more prominent role. Although the absence of National Accounts data forthe first quarter of 2015 reduces the detail and quality of information availableon the performance of the economy in early 2015, the signs emerging from abroad range of other data and indicators point to an increase in the pace ofdomestic demand growth in the first-half of this year.While the rebound in domestic demandwas initially driven by investment spending,consumer spending is now playing a moreprominent role. Moreover, the recovery inconsumption, while still modest, appears tobe gradually strengthening. Consumption hasbenefitted from continuing solid growth inemployment, particularly full-time employment,which is helping to boost incomes. The ongoingstrength of the labour market in 2015,as evidenced by both labour market and taxdata, supports the view that the economy hascontinued to expand solidly in the first-half ofthis year and corroborates the signal from highfrequency retail sales data that the recovery inconsumption is gradually strengthening.On the external side, the high rates of growthin exports and imports in the monthly tradedata suggest that some of the impact ofcontract manufacturing may have carriedover into the early part of 2015. Our workingassumption continues to be that thisrepresents a step increase in the level ofexports and imports and not a lasting upwardshift in their growth rates. Looking ahead it isassumed that exports will return to growingbroadly in line with projected growth in externaldemand. Helped by Ireland’s trade links withthe US and UK markets and the improvementin the outlook for the euro area economy, thisshould continue to generate a strong rate ofgrowth for exports this year and next.On the domestic side, the momentum ofrecovery has strengthened and the outlook isnow more favourable than at the time of ourlast published forecasts. Further increases inemployment, rising real disposable incomesand gradually strengthening consumerconfidence are projected to support a pick-upin the growth of consumer spending over theremainder of 2015 and 2016. However, despiterecent declines, the high level of householdindebtedness remains a headwind to anystrong recovery in consumption. In addition,growth in investment spending, abstractingfrom the volatile aircraft component, is forecastto strengthen further, helping investment,including construction investment, to continueto rebound following a prolonged period ofweakness.These developments suggest a strongeroutlook for growth in 2015 and 2016, ascompared to the forecasts in the previousBulletin. Reflecting a more favourable outlookfor consumer and investment spending,GDP growth of 4.1 per cent is now forecastfor 2015, an upward revision of 0.3 percent relative to the previous projection. In2016, again supported mainly by a furtherstrengthening of domestic demand, GDP isforecast to grow by 4.2 per cent, which is0.5 per cent higher than the previous Bulletinforecast. We would caveat these forecastsby noting that the inclusion of aircraft ownedby Irish resident leasing companies in bothinvestment and imports in the NationalAccounts places significant upside risk toour forecasts for both these components.Consequently, there may be upside risk tothe projected outlook for domestic demand,though this may be broadly offset by downside


8CommentQuarterly Bulletin 03 / July 15risk to the projection for net exports, leavingoverall risks to the forecast broadly balanced.Turning to policy issues, the challenge remainsto ensure that the strengthening economicrecovery which is underway transitions intoa sustainable return to steady growth. Whilemuch progress has been made, high publicand private indebtedness persists. In somekey areas, policy needs to focus on reducingremaining vulnerabilities and strengtheningresilience in order to minimise future risks toeconomic, fiscal and financial stability.With respect to the public finances, reflectingthe stronger economic performance,Exchequer data have been favourable. Taxrevenues have grown ahead of target andexpenditure has been lower than profile in thefirst half of the year. Against this background,the General Government Deficit is likely tocome in below target in 2015 and Irelandis on course to come out of the ExcessiveDeficit Procedure by the end-year deadline.Looking ahead, the strong growth outlookimplies that there is no need for fiscal policyto support economic activity and, importantly,also provides an opportunity to move aheadwith fiscal consolidation and debt reductionin favourable circumstances. Indeed, withstrong growth in prospect, it is importantthat the fiscal stance does not exacerbatecyclical pressures. Ireland’s past experiencedemonstrates the damage that can becaused by pro-cyclicality in policy and of theimportance of resisting the temptation toconsume unanticipated surplus revenues.Given the continuing high level and burdenof public debt, it would be best to use suchrevenues to accelerate debt reduction, leavingthe public finances better positioned toaddress future challenges.In the banking sector, favourable financialmarket conditions and the improving economicenvironment have helped banks reduce theirfunding costs, which together with reducedimpairment charges, has led to a return toprofitability. Encouragingly, the stock of nonperformingloans continues to fall. Still, theoverall level of NPLs remains high and longtermmortgage arrears of greater than 720days are still growing, although the paceof increase has reduced significantly. It isnotable that, for those banks subject to themortgage arrears resolution targets (MART),there has been a small decline in the numberof accounts in this arrears segment. In termsof the operation of MART, the Central Bankrecently announced a shift from commonquarterly solution targets across all banks toa bank-specific approach with more granularmonitoring of specific cohorts of distressedborrowers where progress has been slower.While challenging, progress is being made and,gradually, the balance sheets of banks andtheir borrowers are being repaired.


9The Domestic EconomyOverviewChart 1: Contributions to GDPnGDP is now expected to expand by 4.1 and4.2 per cent in 2015 and 2016, respectively.This upward revision to the forecast relative tothe previous Bulletin (0.3 and 0.5 percentagepoints) is driven by a stronger contribution fromdomestic demand while the outlook for externaldemand remains broadly unchanged. Similarly,GNP growth is expected to be marginallystronger than previously forecast this year andnext, at 4.2 and 3.8 per cent.86420-2-4Percentage changenIn the absence of National Accounts datafor the first quarter of 2015 at the time ofwriting, higher frequency indicators pointtowards an increase in the pace of domesticdemand growth so far this year. It is expectedthat personal consumption and investmentexpenditure will remain robust over the forecasthorizon.-6-8-102006 2007 2008 2009ConsumptionNet Exports2010 2011 2012 2013Gov ConsumptionInventories2014e 2015f 2016fInvestmentGDPnnnImproving labour market conditions, reflectingboth numbers in employment and increasingrates of pay, a mildly expansionary fiscalstance and further improvements in consumersentiment should underpin the strongerincrease in personal consumption forecast inthis Bulletin of 2.3 per cent both this year andnext.In terms of investment, the outlook for buildingand construction, and the related trends innon-aircraft machinery and equipment outlays,is increasingly positive. This drives doubledigitinvestment growth over the forecasthorizon, alongside slightly stronger intangiblesinvestment and a continued expansion inhousing investment. Forthcoming changes tothe treatment of aircraft owned by Irish residentleasing companies in the National Accounts arelikely to have a significant impact on headlineinvestment.The impact of the contract manufacturingissue on the rates of growth in Irish exportsand imports is likely to have carried over to thefirst quarter of 2015, but are assumed to havepassed by the middle of the year. Consequentlyit is envisaged that through to 2016 exports willgrow more in line with demand in Ireland’s maintrading partners, which is broadly unchangedsince the last Bulletin. Import growth isexpected to remain robust given the improvingdomestic demand situation. There is upsiderisk to import growth due to the forthcomingchanges in terms of trade in aircraft in theNational Accounts.Source: CSO and Central Bank of Ireland.nThe labour market has continued to improveand it is expected that employment will increaseby 2.3 per cent this year and next. This shouldsee the unemployment rate averaging 9.7 percent in 2015, with a decline to 8.5 per centexpected for 2016. The employment outlookis supported by the increasingly positivecontribution to growth arising from domesticsources.n Inflation is expected to remain muted in 2015,with the HICP averaging 0.5 per cent, as thedrag on consumer prices from weak energyprices continues to offset the, so far, marginalimpact of euro depreciation. The HICP isexpected to rise by 1.7 per cent in 2016, drivenmostly by base effects and strengtheningdomestic demand.nRisks to the forecasts are deemed to be broadlybalanced. The outturn for domestic demandmay be stronger than envisaged in this Bulletin,but there remains a particularly high degree ofuncertainty around the investment forecast.The net export contribution could be higheror lower depending on both the impact of theforthcoming methodological changes in theNational Accounts and the robustness of thegrowth in the euro area.


10The Domestic EconomyQuarterly Bulletin 03 / July 15DemandDomestic Demand OverviewDomestic demand is expected to becomethe main driver of growth over the forecasthorizon with average annual volume increasesof 3.8 per cent; this reflects a robust outlookfor personal consumption and investmentexpenditure. This would mark the strongestrate of growth in domestic demand since2007.ConsumptionPersonal consumption expenditure is forecastto grow by 2.3 per cent in both 2015 and2016, on a year-on-year basis. This outlook ispredicated on a continuation of the momentumevident in indicators of consumer spendingin the first half of this year. Furthermore, theoutlook for the labour market and specificallyreal disposable incomes should supportconsumer spending in the short-term.Retail sales were up 9.3 per cent in the first fivemonths of 2015 driven in part by strong carsales. Core retail sales have also been robust,increasing for a 19th consecutive month (by5.7 per cent) in the year to May. This has beenhelped by strong increases in spending onhousehold goods and electrical equipment.The apparent strength in consumer spendinghas also been evident in monthly Exchequerdata and specifically VAT receipts, whichare up 7.9 per cent in the first half of 2015.Survey indicators also point to a continuingimprovement in consumer confidence.InvestmentThe high degree of uncertainty usuallyaccompanying investment forecasts - due topurchases of aircraft by Irish headquarteredairlines - has been amplified by a forthcomingmethodological change in the treatment ofaircraft leasing in the National Accounts.Investment forecasts should therefore betreated with a higher degree of caution thanusual. With this in mind, spending on the121086420-2-4-6-8-10-12-14-16-18-20-22Chart 2: Index of Volume of Retail Sales% Change Year-on-Year 3 Month Moving AverageJ A J O J A J O J A J O J A J O J A J O J A J O J A J O J A2008 2009 2010 2011 2012 2013 2014 2015All BusinessesSource: CSO.Core (excluding Motor Trades)economy’s capital stock (mainly building andconstruction, machinery and equipment and,lately, research and development assets) isforecast to increase by 11 per cent this yearand 10.4 per cent in 2016, as the recovery ininvestment following the recession continues.Building and construction activity is forecastto increase by 10.4 and 13.6 per cent in2015 and 2016, respectively. Survey evidenceindicates that all sectors are reportingincreased activity. On the residential side,indicators signal that new house building isexpected to increase, with approximately13,000 units expected in 2015 and 15,000units in 2016. Non-residential constructioninvestment is expected to gather pace this yearand next with a healthy pipeline of projectsand a positive outlook for incoming foreigninvestment.Following two years of strong growth,machinery and equipment investment is alsoforecast to contribute further to investmentspending this year and next. The other maincategory of investment spending, intangibles,registered a small decline in 2014. This


The Domestic EconomyQuarterly Bulletin 03 / July 1511Table 1: Expenditure on Gross National Product 2014, 2015 f and 2016 f2014 %change in2015 f %change in2016 fEUR volume price EURmillionsmillionsvolume price EURmillionsPersonal Consumption Expenditure 85,618 2.3 1.4 88,813 2.3 1.9 92,582Public Net Current Expenditure 25,966 0.5 1.6 26,496 0.9 0.8 26,926Gross Domestic Fixed Capital Formation 30,399 11.0 2.8 34,690 10.4 3.1 39,507Building and Construction 12,789 10.4 6.1 14,907 13.6 6.2 17,866Machinery and Equipment 8,927 16.8 0.9 10,510 9.8 1.3 11,686Value of Physical Changes in Stocks 1,850 1,850 1,850TOTAL DOMESTIC DEMAND 143,833 3.8 1.7 151,850 3.9 2.0 160,865Exports of Goods & Services 207,791 5.8 1.7 223,638 6.0 1.7 240,992FINAL DEMAND 351,624 5.0 1.7 375,488 5.1 1.8 401,857Imports of Goods & Services -168,082 5.9 -1.0 -179,826 6.1 -1.4 -193,433Statistical Discrepancy 1,868 1,868 1,868GROSS DOMESTIC PRODUCT 185,410 4.1 2.4 197,530 4.2 2.2 210,292Net Factor Income from Rest of the World -26,974 3.3 1.7 -28,351 6.3 1.7 -30,646GROSS NATIONAL PRODUCT 158,436 4.2 2.5 169,179 3.8 2.3 179,646includes research and development (R&D)investment expenditure. For the forecastperiod, it is expected R&D related investmentwill grow broadly in line with the output of themultinational sector.Given the uncertainty surrounding some of thecategories of investment spending, namelythe new treatment relating to aircraft leasing(included in machinery and equipment) andintangibles investment, it is useful to considerthe outlook for business investment, classifiedhere as overall investment less intangiblesand transport equipment. This sub-categoryof investment spending is forecast to grow by11.4 per cent in 2015 and 12.6 per cent in2016. By the end of the forecast horizon, theinvestment to GDP ratio should be close to itslong run average of approximately 20 per centof GDP. Risks to these forecasts are generallyon the upside given the prolonged period ofunder-investment during the recession andthe low base from which it is coming. Potentialbottlenecks remain, however, mainly on thefunding, planning and resource requirementsfronts.Government ConsumptionThe volume of government consumption isforecast to increase by 0.5 per cent in 2015and by just less than 1 per cent in 2016. Thisoutlook takes account of recent developments,particularly the Lansdowne Road Agreement.


12The Domestic EconomyQuarterly Bulletin 03 / July 15External Demand and theBalance of PaymentsExports and ImportsOn the external side, higher frequencyindicators suggest that exports continued togrow strongly in early 2015, following a riseof 12.6 per cent in 2014. With import growthalso strengthening through last year, reflectingthe rise in exports and domestic demand,net exports contributed slightly less thanhalf of overall GDP growth in 2014 (Chart 1).Projections in this Bulletin for 2015 and 2016imply a weaker contribution from net exports toGDP growth over the forecast horizon.Growth in goods exports in 2014 wasparticularly strong, showing 17.2 per centannual growth, driving the overall growthin exports. Changes in the structure ofmultinational enterprises led to an increase inactivity contracted out to foreign manufacturingplants and this appears to be the maincontributor to export growth over the pastyear. 2 This development became evident in Q22014, and it has been assumed that it reflecteda level shift as opposed to a fundamentalchange in the trajectory of export growth.Therefore as the base effect of the rise inQ2 2014 passes it is anticipated that exportgrowth, expected to be strong in Q1 2015, willease somewhat in the second half of the yearand reflect to a greater extent the underlyingdemand in our main trading partners. Whilethis outlook is highly uncertain, monthlyIndustrial Production & Turnover data availableup to May 2015 are tentatively supportive ofit, indicating a slowdown in output in morerecent months. This is particularly evident inthe Chemicals and Pharmaceuticals sector,which has been the most affected by thecontracted manufacturing issue and accountsfor approximately 30 per cent of total exports.Sentiment indicators for both manufacturingand services industries continue to be positivein their outlook for exports. The outlook for2520151050-5-10-15-20Chart 3: Volume of Exports% Change Year-on-YearQ1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q42007 2008 2009 2010 2011 2012 2013 2014GoodsServicesSource: CSO Quarterly National Accounts.demand in Ireland's major trading partnersbased on the most recent external demandassumptions from the ECB is marginally lesspositive than in the previous Bulletin for 2015and somewhat stronger for 2016. This is dueto a slightly slower growth in imports in theUnited States assumed for 2015, being offsetby rising demand for Irish goods and servicesfrom other euro area countries as the widereuro area economy recovery continues.With these factors in mind, the latest projectionis for overall export growth of 5.8 per centfor 2015 in volume terms, and 6 per centin 2016. Goods exports are expected togrow at a faster pace than services over theforecast horizon. Aside from the uncertaintyrelated to the assumption on the contractedmanufacturing effect, there is also a highdegree of uncertainty around the outlook forexternal demand, with risks slightly to theupside for extra-euro area demand and to thedownside for euro area demand.The outlook for domestic demand implies astrengthening of imports over the forecast2 Due to the more widespread application of the economic ownership concept in the National Accounts, these goods owned by anIrish entity that are processed in and shipped from a foreign country on their sale are classified as Irish up until the time that they aresold, irrespective of whether the processing of those goods from their components to the final product for sale takes place in Irelandor not. While the activity is tracked in the Industrial Production series as Irish manufacturing, it does not involve goods moving intoand out of the State, and consequently is not recorded in the monthly CSO Goods Exports and Imports release. The CSO havereleased a technical note on this topic in their Quarterly National Accounts series, which can be accessed on http://www.cso.ie.


The Domestic EconomyQuarterly Bulletin 03 / July 1513Table 2: Goods and Services Trade 2014, 2015 f , 2016 f2014 %change inEURmillionsvolume price EURmillions2015 f %change in2016 fvolume price EURmillionsExports 207,791 5.8 1.7 223,638 6.0 1.7 240,992Goods 106,819 5.9 1.7 115,046 6.0 1.5 123,797Services 100,972 5.7 1.7 108,592 5.9 1.9 117,195Imports 168,082 5.9 1.0 179,826 6.1 1.4 193,433Goods 60,924 6.5 0.8 65,398 6.3 1.2 70,347Services 107,158 5.6 1.1 114,428 6.0 1.5 123,086horizon. Alongside this, the import content ofIrish exports is also relatively high. With exportgrowth being driven by high-tech sectorswith a reliance on imported royalties andlicenses as well as a higher tendency to importmanufacturing services, this also supportsa rising import profile. Consequently, a 5.9per cent increase in the volume of imports isexpected in 2015 followed by 6.1 per cent in2016. The import content of domestic demandwill be fundamentally higher given the inclusionof aircraft owned by Irish resident leasingcompanies in gross fixed capital formationin the forthcoming National Accounts, andthis puts significant upside risk to our importforecast.Combined with the export outlook this impliesa lower net export contribution to overall GDPthis year and next compared with 2014. Areasonable degree of uncertainty surrounds thenet export projections at present as a result ofthe sector specific issues noted above and thechanges in how some of them are reflected inthe forthcoming National Accounts.Net Trade, Factor Incomes andInternational TransfersThe trade surplus widened in 2014 as anincrease in net goods exports offset a declinein net services exports. The addition of thephysical trade in aircraft owned by Irishresident leasing companies in the forthcomingNational Accounts is likely to reduce the overalltrade balance in a number of years. The overalltrade balance for 2014 was €39.7 billion, anincrease of 9.2 per cent over the year.Net factor income flows have been marginallyless negative in recent years. This in partreflects lower multinational profits due toa higher tendency for these companies toimport royalties and licenses, as well asdevelopments in the IFSC. As a benchmark fornet factor income forecasts, it is possible toconsider the debt and equity composition ofthe net international investment position of theeconomy and the flows on that position givenassumptions on prevailing interest rates andother returns on capital. The lower interest ratepath assumed in this Bulletin implies a slightlymore negative net factor income position whencompared with that in the previous forecast.Given the scale of factor income flows andthe uncertainty of their timing, small changesin outflows or inflows could have a significantimpact on balance of payments projections inthis Bulletin. Similarly the outlook for the tradebalance is uncertain given the forthcomingchanges in the National Accounts on tradein aircraft. Taking this into account, theprojections imply that the current account willremain in surplus, averaging 5.6 per cent ofGDP in 2015 and 2016.


14The Domestic EconomyQuarterly Bulletin 03 / July 15Table 3: Balance of Payments 2014, 2015 f , 2016 f€ million 2014 2015 f 2016 fTrade Balance 39,711 43,812 47,559Goods 45,895 49,648 53,450Services -6,184 -5,836 -5,891Net Factor Income from the Rest of the World -25,991 -28,288 -30,646Current International Transfers -2,251 -2,251 -2,251Balance on Current Account 11,469 11,211 11,413(% of GDP) 6.2 5.7 5.4SupplyOn the supply side, higher frequency indicatorsfrom the monthly Industrial Production seriespoint towards a continued expansion inindustrial output in the first half of the year, withthe pace of increase easing into the secondquarter. The volume of industrial productionin the first five months of the year was 14 percent higher than the same period in 2014.Data for May however indicate that it was7.8 per cent lower compared with April andhad decreased by 4.4 per cent on an annualbasis. The output of the modern sectors,driven by the Chemicals and Pharmaceuticalssector, was 13.2 per cent lower over the yearin May. This likely reflects the base effect ofthe strong increase in output in Q2 2014 dueto contracted manufacturing. The output ofthe traditional sectors continues to expandrobustly and is 10.5 per cent higher in the firstfive months of 2015 compared with the sameperiod last year (Chart 4).A recovery in domestic demand and highertourism exports has supported strong growthin the services sector so far in 2015. Data fromthe CSO Monthly Services Index indicate thevalue of output in the non-financial servicessectors grew by 6 per cent in the first fivemonths of the year compared with thesame period in 2014. This was particularlyevident in the Wholesale and Retail Tradeand Accommodation and Food Servicessectors. With services consumer price inflationaveraging 3.2 per cent in early 2015, this lends403020100-10-20Q1Chart 4: Volume of Industrial Production% Change Year-on-YearQ2Q3Q4Q1Q2Q3Q4Q1itself to the view that the volume of output inthe non-financial services sector has expandedso far this year.Meanwhile sentiment surveys for bothmanufacturing and services sectors pointtoward continued expansion in output andemployment. The most recent Services PMI,at 63.3, is the thirty-fifth successive month ofexpansion. Similarly the Manufacturing PMI hasbeen above 50, which indicates growth in thesector, for twenty-five successive months up toJune 2015Q22011 2012 2013 2014 2015Manufacturing IndustriesTraditional SectorSource: CSO.Q3Q4Q1Q2Modern SectorQ3Q4Q1


The Domestic EconomyQuarterly Bulletin 03 / July 1515Table 4: Employment, Labour Force and Unemployment 2013, 2014, 2015 f and 2016 f2013 2014 2015 f 2016 fAgriculture 107 109 111 112Industry (including construction) 343 348 362 380Services 1,430 1,458 1,486 1,512Total Employment 1,880 1,916 1,959 2,005Unemployment 284 241 209 186Labour Force 2,163 2,157 2,168 2,191Unemployment Rate (%) 13.1 11.2 9.7 8.5Note: Figures may not sum due to rounding.The Labour MarketEmployment growth is expected to average2.3 per cent per annum in 2015 and 2016.This should see the number of persons inemployment reaching the two million markover the forecast horizon – the last time thisthreshold was reached was in 2008. Withaverage annual labour force growth of 0.8 percent envisaged over the forecast horizon, theunemployment rate is projected to average9.7 per cent in 2015 and 8.5 per cent in 2016.The labour market has been improving for anumber of quarters now and the rebalancingin growth away from net exports to domesticdemand should further stimulate employmentgrowth this year and next.Employment increased on an annual basis by41,300 persons (+2.2 per cent) in the first threemonths of the year based on the most recentQuarterly National Household Survey (QNHS).This growth was once again broadly based,with 10 out of 14 economic sectors recordinggains. The largest increases in employmentwere recorded in construction and financial(including real estate) sectors which accountedfor just over half of all jobs created. As well asthe broad based nature of the recovery, growthin employment is now predominantly beingrecorded in full-time jobs (reversing the patternof the early stages of the recovery).More recent data from the Live Registerconfirms the on-going recovery in the labourmarket; numbers on the Register declined to344,900 persons in June, down from 363,700at end-2014, marking a 36th consecutivemonth of decline. Furthermore, the seasonallyadjusted unemployment rate was 9.7 percent in June (down from 11.4 per cent a yearpreviously).The number of persons in the labour forcedeclined marginally (by 0.2 per cent) in the firstquarter of the year to just over 2.1 million. Thisreflects an on-going decline in younger cohortsin the labour force and a falling participationrate. For the year as a whole however, it isexpected that the labour force will grow by 0.5per cent.PayCompensation per employee is forecast toincrease by 2.2 per cent in 2015 and by 2.3per cent in 2016. As labour market conditionstighten and inflationary pressures pick up, therecould be some upside potential to this outlook.The latest Earnings and Labour CostSurvey reported a 0.4 per cent rise in hourlyearnings in the first quarter of 2015. The risein earnings was again driven by the privatesector with seven of the thirteen sectorsreporting increases in earnings. 3 The largestincrease was recorded in the Informationand Communication sector (+5.8 per cent inthe year). Public sector earnings growth hasbeen negative in recent years but the recentlyannounced Lansdowne Road Agreement3 Hourly earnings in the private sector increased by 0.6 per cent in the first quarter of the year, whereas a decline of 0.4 per cent wasrecorded in the public sector.


16The Domestic EconomyQuarterly Bulletin 03 / July 15Chart 5: Consumer PricesChart 6: Services Sector Inflation6% Change Year-on-Year7% Change Year-on-Year5463521403-12-2-31-40-5-6-1-7J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A-22008 2009 2010 2011 2012 2013 2014 2015J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A2008 2009 2010 2011 2012 2013 2014 2015Ireland: Consumer Price IndexIreland: Harmonised Index of Consumer Prices (HICP)EA-17: Monetary Union Index of Consumer Prices (MUICP)HICP Services (Overall)HICP Core ServicesNote: Core Services equals HICP services excludingtelecommunications, alcohol and administered services.Source: CSO.Source: CSO.should result in positive earnings growth from2016.Other data sources also point to strongerearnings growth. In particular, income taxreceipts and social security contributions haveincreased markedly in the first half of the yearby 6.1 and 9.3 per cent, respectively.InflationThe latest available consumer price datapoints to a tentative upward trend in headlineHICP inflation over recent months. Havingturned positive in May for the first time sinceNovember 2014, HICP inflation rose furtherto 0.4 per cent in year-on-year terms in June,up from its most recent low of -0.4 per centin April. Much of this upturn may be attributedto a less pronounced negative annual rate ofchange in the energy component of the HICP,driven by the recovery in the price of oil ineuro terms relative to the six-year low reachedin January. A somewhat more broad-basedrecovery, beyond the energy component,appears to have also taken effect over recentmonths, as evidenced by the fact that theHICP, excluding energy and unprocessedfood, rose to 1.3 per cent year-on-year inJune, having remained within a reasonablytight range of 0.6 per cent to 1.1 per centsince January 2013. Owing to downwardpressure from mortgage interest rates, whichare included in the CPI and not the HICP, theCPI remained negative on a year-on-year basisin June, albeit on an upward trajectory, rising to-0.1 per cent.On the basis of currently available informationand prevailing oil futures prices, HICP inflationis expected to remain low until the latter partof this year as the impact of past falls in energyprices and to a lesser extent, food pricesremain in year-on-year comparisons. Whilethe boost to consumer price inflation arisingfrom the depreciation of the euro since mid-2014 has, to date, been slightly muted, it isanticipated that this will increase somewhatover the second half of this year. In addition,the noticeably stronger HICP services outturnsof recent months, due largely to one-off factorssuch as the introduction of water chargesand sewage costs into the HICP basket areexpected to persist during the remainder of


The Domestic EconomyQuarterly Bulletin 03 / July 1517Table 5: Inflation Measures - Annual Averages, Per CentMeasureHICPHICP excludingEnergy Services a Goods a CPI2011 1.2 0.0 0.8 1.5 2.62012 1.9 0.9 1.9 1.9 1.72013 0.5 0.6 1.6 -0.4 0.52014 0.3 0.5 2.4 -1.7 0.22015 f 0.5 1.3 3.6 -2.7 0.42016 f 1.7 1.5 3.0 0.4 1.6a Goods and services inflation refers to the HICP goods and services components.3020100-10-20-30Chart 7: Residential Property Price Indices% Change Year-on-YearQ2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q22007 2008 2009 2010 2011 2012 2013 2014 2015out of year-on-year comparisons. A recoveryin HICP goods inflation seems set to be furthersupported by the impact of the lower euroexchange rate. In contrast, some decelerationin the rate of services inflation is anticipated in2016 due to downward base effects from theimpact of the introduction of water and sewagecharges into the HICP basket of goods andservices dropping out of annual comparisonsfrom January. Reflecting such a combinationof developments, HICP inflation is projectedto rise sharply next year, to average 1.7 percent, with a corresponding CPI inflation rateof 1.6 per cent. The projected profile for bothheadline HICP and CPI inflation is largelyunchanged relative to the previous Bulletin.National – All Residential PropertiesNational Excluding Dublin – All Residential PropertiesDublin – All Residential PropertiesSource: CSO.this year. As a result, HICP inflation is expectedto recover further during the second half of2015 to average 0.5 per cent in annual terms;on a CPI basis, an annual average rate of 0.4per cent is currently projected.Looking ahead to 2016, a pronounced pickupin headline HICP inflation is envisageddriven solely by a recovery in the goodscomponent. The single most prominent driverof the projected recovery in goods inflation isexpected to be energy as upward base effectsarising from previous energy price declines fallResidential PropertyResidential property prices increased by 13.8per cent in year-on-year terms in May 2015.The pace of growth is somewhat faster in theDublin region, where prices are 15.2 per centhigher on a year-on-year basis, though therate of increase has decelerated over the lastnumber of months. Outside Dublin, pricesgrew by 11.9 per cent in year-on-year terms inMay.On the supply side, there were 2,629 housecompletions in the first quarter of 2015, 25 percent more than in the same quarter of 2014while planning permission was granted for2,514 housing units and 641 apartment unitsin the first quarter of 2015. A further rise inhouse building is anticipated over the forecasthorizon.


18The Domestic EconomyQuarterly Bulletin 03 / July 15Commercial PropertyThe latest data (Q1 2015) from the Societyof Chartered Surveyors/Investment PropertyDatabank show that commercial propertyprices continued to grow strongly. The paceof growth in both retail and office capitalvalues, at 22.3 and 32.9 per cent on a yearon-yearbasis respectively, eased during Q1compared with the final quarter of 2014.Growth in industrial property prices continuedto accelerate with a year-on-year increase of 9per cent. The Bank’s Macro-Financial Review(June 2015) contains a detailed overviewof recent developments in the commercialproperty market.CompetitivenessWhile the euro weakened substantially againstboth the dollar and sterling in the openingmonths of 2015, it fluctuated within a relativelynarrow band (+/- 5 per cent) against bothcurrencies in the second quarter of 2015. Thepound sterling oscillated around £0.72 forthe second quarter of 2015 and the US dollarwas reasonably stable around $1.10. The twocurrencies have moved almost in tandem sincethe start of the year. There was some renewedweakness at the time of writing as uncertaintiesaround Greece weighed on the euro.The latest Harmonised CompetitivenessIndex (HCI) data for June 2015 show that thenominal HCI depreciated by approximately 6per cent in the first quarter of the year beforereversing this decline partially while the HCIwas 7 per cent lower year-on-year. Whendeflated by consumer and producer prices,the real HCI decreased by 8 per cent and 9per cent, respectively, over the same period.These HCI developments suggest that theIrish economy has made gains in terms of itscompetitive stance against its trading partners,with the bulk of this improvement due to thenominal exchange rate changes but alsopartly due to more favourable relative pricedevelopments.On the basis of the conventional GDP perworker measure, productivity increased by2.8 per cent in 2014. This followed from a403020100-10-20-30-40-50Q1Chart 8: SCS/IPD Irish Commercial Property Index% Change in Capital Values Year-on-YearQ3Q1Q3decline of 2 per cent in 2013. Developmentsin both years are mainly due to divergentcompositional effects in labour marketdynamics and GDP growth. Employmentgrowth slowed in 2014, while the drag onGDP growth of sector specific issues inpharmaceutical and ICT enterprises wasreversed significantly in 2014. Looking ahead,average annual productivity growth in GDPper worker of 1.8 per cent is forecast for both2015 and 2016.Factoring in the projected increases incompensation of employees over the forecasthorizon, unit labour costs are expected torise by 0.5 per cent in 2015 and 0.8 per centin 2016. The relatively small changes in unitlabour costs are attributable to the change inproductivity being matched by similar growth inaverage compensation per employee.The Public FinancesOverviewQ1Q3Q1Q3The latest Government Finance Statisticsindicate that the general government balancecontinued to improve last year. The deficitoutturn of 4.1 per cent of GDP was downQ12007 2008 2009 2010 2011 2012 2013 2014 2015Q3Q1Office Retail IndustrialSource: SCS/IPD.Q3Q1Q3Q1Q3Q1


The Domestic EconomyQuarterly Bulletin 03 / July 1519Chart 9: Harmonised Competitiveness IndicatorsChart 10: Divergence of Tax Heads from Profile1301251201151101051009590Base: Quarter 1, 1999=1001400120010008006004002000-20085JAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJAJANJA2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 ‘15-400Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun2014 2015Nominal HCI Consumer Price Deflated HCIProducer Price Deflated HCISource: Central Bank of Ireland and ECB.Income TaxCorporation Tax VATLocal Property TaxTotalExcise Duties Stamps OtherSource: Department of Finance.significantly from a deficit of 5.8 per centrecorded in 2013 and once again ensured thatthe Excessive Deficit Procedure (EDP) targetwas successfully achieved.With regard to this year, exchequer returnsfigures for the first six months have beenencouraging; with tax revenues coming inmore than €800 million ahead of Departmentof Finance expectations and governmentspending lower than profile. As a result, itappears that this year’s EDP requirementof a deficit under 3 per cent of GDP will bemet by a comfortable margin and Ireland willsuccessfully exit the corrective arm of theStability and Growth pact on schedule.Having reached a peak in 2013, gross generalgovernment debt declined to 109.7 per cent ofGDP in 2014. The improving budget position,robust GDP growth and a run down in cashbalances are expected to support a gradualdecline in the debt ratio in the coming years.Exchequer ReturnsThe latest data indicate that the Exchequer rana deficit of €292 million in the first six monthsof the year, a decrease of €4.6 billion fromthe corresponding period of 2014 (see Table6). While an improvement over the periodwas anticipated, revenue developments wereeven stronger than expected and currentexpenditure was lower than profile.A number of one off transactions alsocontributed to the improvement in theExchequer balance. Tax revenue in the first halfof 2015 was up 11.7 per cent year-on-yearand was €805 million ahead of profile. Thisreflected better than expected developmentsin three of the ‘big four’ tax heads – incometax, VAT and most notably corporate tax.Corporation tax receipts were €606 millionhigher than profile in the six months to Juneand increased significantly in annual termsreflecting on-going improvements in thebroader economy.Non-tax revenues were also higher overthe same period, mainly due to positivedevelopments in Central Bank surplus income,which increased by almost €500 million yearon-year.Revenue generated from capitalresources were also significantly higher inthe first six months of 2015, up €1.6 billion


20The Domestic EconomyQuarterly Bulletin 03 / July 15Table 6: Analytical Exchequer Statement for June 2015 (€ millions)Jan-June2014€mJan-June2015€mAnnualChangeOutturnvsProfileRevenue 25,877 27,961 8.1% 3.8%– Tax revenue 18,467 20,622 11.7% 4.1%– Appropriations-in-aid 5,429 5,318 -2.0% 3.0%– Other Revenue 1,981 2,021 +2.0% 3.6%Expenditure 31,516 31,159 -1.1% -1.1%– Current Primary Expenditure 26,253 25,841 -1.6% -0.3%– Capital Expenditure 967 1,135 +17.4% -3.4%– Interest on National Debt 4,297 4,183 -2.6% -5.6%Transactions with no General Government Impact 701 2,906 314.5% 1,121.4%Exchequer Balance -4,938 -292 94.1% 93.3%Source:Department of Financecompared with the same period last year. Thesubstantial increase was driven by a transferfrom the NPRF to the Exchequer following thesale of Bank of Ireland shares and the sale ofthe PTSB contingent capital note.Turning to the expenditure side, total currentspending and total capital spending weredown by 2.9 per cent and 8.7 per centrespectively, from last year. A contributionto the sinking fund in 2014 which was notrepeated this year partly explained the lowercurrent expenditure figures, as did lowerHealth spending. Meanwhile, a reduction inshort-term loans to the Social Insurance Fundwas a key driver of the lower capital spendingfigures in the first six months of 2015, as wellas the absence of a capital contribution tothe European Stability Mechanism that tookplace during the same period in 2014. Interestpayments on the national debt also declinedyear-on-year, largely reflecting the impactof early repayments to the IMF. Comparedto expectations, voted current and capitalspending and debt servicing costs were alllower than profile in the first half of the year.Funding and Other DevelopmentsThe National Treasury Management Agency(NTMA) raised a further €2.5 billion through theauction of 30-year, 7-year and 15-year bondsin March, May and June, respectively. As aresult, the agency has now raised more than80 per cent of the €13.5 billion funding that ithad planned for the year as a whole. In June,the NTMA also cancelled €500 million of theJune 2038 Irish Floating Rate Treasury Bond,which was issued in connection with the IrishBank Resolution Corporation Act 2013. Thebonds were purchased from the Central Bankof Ireland.Ireland’s long-term sovereign credit rating wasupgraded by Standard & Poor’s in June 2015to A+ (from A) with a stable outlook. This isthe third upgrade by Standard & Poor’s in thepast 12 months and is the latest in a seriesof upward reviews by the leading credit ratingagencies reflecting a more positive assessmentof Ireland’s performance and outlook.The deficit in the first six months of the yearwas financed by borrowing €3.5 billion,primarily in the form of Irish Government Bondsand Short Term Paper, while more than €9billion of IMF loans were repaid. Governmentcash balances increased by €3.2 billion overthe period.


The Domestic EconomyQuarterly Bulletin 03 / July 1521Box A: Ireland and the Macroeconomic Imbalance Procedure – An UpdateBy Linda Kane 4The Macroeconomic Imbalance Procedure (MIP) was introduced in late 2011 as one of the keycomponents of the reformed European economic governance framework. The goal of the MIPis to ensure that macroeconomic imbalances do not develop as a threat to economic stabilityas they did in the previous decade and it is part of a strengthened EU economic surveillanceframework designed to complement the revised Stability and Growth Pact. 5 Following Ireland’sexit from its Economic Adjustment Programme in December 2013 it has been subject to tworounds of the MIP.The MIP is based on a set of measurable national macroeconomic indicators grouped in ascoreboard, each of which has a threshold that should not be breached (see Box A Table 1).The first step in the MIP is the publication by the European Commission of the Alert MechanismReport (AMR), which assesses countries using the above mentioned scoreboard to identify whichof them warrant more detailed analysis to determine if imbalances exist or not. The latest AMRwas published in November 2014 and Ireland was identified as one of 16 countries that requiredmore detailed analysis, 6 with Irish imbalances deemed in need of “specific monitoring and decisivepolicy action”. The second stage of the MIP involves the European Commission undertaking In-Depth Reviews (IDRs) of the countries identified in the AMR as requiring more substantial analysis.Ireland’s IDR was published in June 2015 7 and the analysis is based on data up to 2013. 8Ireland experienced a large increase in macroeconomic imbalances in the years leading up to,and during, the financial crisis and these will take time to unwind. The report found that Irelandhas made some progress in addressing the country-specific recommendations the EuropeanCommission issued in 2014, although further work remains to be done in areas such ashealthcare, SME financing and the low work intensity of households. According to the IDR, fourindicators remained beyond their threshold in 2013, down from a peak of eight in 2011.Turning first to external imbalances and competitiveness; Ireland’s current account positionimproved as the domestic economy contracted and foreign trade once again became thedriving force behind growth. The three-year average balance turned positive in 2013 and isexpected to improve further in 2014. Ireland has made significant gains in competitivenesssince the beginning of the financial crisis and this is reflected through the indicators for the realeffective exchange rate, export market shares and nominal unit labour costs all coming in undertheir respective thresholds in 2013. While preliminary data for export market shares in 2014appears to suggest deterioration in this indicator, this is due to a base effect in the historicaldata, with export market shares expected to improve more than 15 per cent on an annual basis.Ireland’s net international investment position (NIIP) remains highly negative and developmentsare complicated by funding activities of the large multinational sector and the presence of theIFSC. In recent years, however, it has mainly been official funding related to the EconomicAdjustment Programme that has been responsible for the rise in the NIIP to its current very highlevel. This reduces concerns about its magnitude somewhat. 94 Irish Economic Analysis Division.5 See Hickey and Kane (2014): Ireland and the Macroeconomic Imbalance Procedure, Central Bank of Ireland Quarterly BulletinNo.3 2014.6 The other countries identified were Belgium, Bulgaria, Germany, Spain, France, Italy, Croatia, Hungary, the Netherlands,Portugal, Slovenia, Finland, Romania, Sweden and the United Kingdom.7 European Commission (2015): Macroeconomic Imbalances Country Report – Ireland 2015, Occasional Papers 215, June2015.8 Box A Table 1 contains preliminary data for 2014 taken from the Eurostat MIP database. However not all of this data wasavailable or part of the European Commission’s official assessment.9 For a more detailed discussion of measurement issues relating to the Irish NIIP see Lane, P (2011), ‘The Dynamics of Ireland’sNet External Position’, Journal of the Statistical and Social Inquiry Society of Ireland Vol. XLI, November 2011.


22The Domestic EconomyQuarterly Bulletin 03 / July 15Box A: Ireland and the Macroeconomic Imbalance Procedure – An UpdateBy Linda KaneAccording to the IDR, four indicators remained above their MIP thresholds in 2013, with this likelyto rise to five in 2014 as house prices begin to climb once again. Private sector debt and generalgovernment debt are likely to remain elevated over the coming years as the legacy of the financialcrisis will take time to unwind. However, both indicators have seen recent positive developmentsand are declining from their peaks. Meanwhile, the three-year average unemployment ratecontinues to breach the MIP threshold, however in annual terms unemployment has beenfalling steadily from its peak in early 2012 as the economy improves. Following the bursting ofthe housing market bubble in 2007, private sector deleveraging has been on-going with houseprices, financial sector liabilities and private sector credit no longer flashing as warnings on thescoreboard in 2013.In conclusion, there has been a continuing reduction in the scale of Irish imbalances since therecession. While internal imbalances are generally improving, some will take time to unwind fromtheir current high levels. External imbalances, meanwhile, are currently not a significant concern.Ireland will continue to be subject to specific monitoring by the European Commission whichremains appropriate in order to ensure that the risks related to the current macroeconomicimbalances do not derail the on-going recovery.Box A Table 1: Macroeconomic Imbalance Scorecard - IrelandIndicator Threshold 2008 2009 2010 2011 2012 2013 2014 pExternal Imbalances& CompetitivenessCurrent Account^ (3-yr avg) -4%/+6% -8.1 -8.4 -6.4 -4.2 -1.5 1.1 4.1NIIP^ -35% -76 -92 -88 -112 -112 -105 -98REER* (3 yrs) ±5% 7.3 5.0 -5.4 -9.6 -12.2 -3.9 -3.5Export Market Share* (5 yrs) -6% -21.2 -5.3 -13.0 -13.1 -14.3 -4.9 -6.4Nominal ULC* (3 yrs) +9% 17.0 10.1 -3.2 -12.8 -10.0 1.3 5.6Deflated House Prices* +6% -8.5 -12.7 -10.4 -15.3 -11.9 0.3 12.2Private Sector Credit Flow^ 14% 22.4 -5.0 2.6 16.3 -1.8 -5.7 n/aInternalImbalancesPrivate Sector Debt^ 133% 237 259 261 278 282 266 n/aGeneral Government Debt^ 60% 42.6 62.2 87.4 111.1 121.7 123.3 109.7Unemployment Rate^ (3-yravg)10% 5.2 7.7 10.8 13.5 14.4 14.2 13.0Financial Sector Liabilities^ 16.5% 6.2 3.5 6.3 -2.4 -1.5 1.0 n/aSource: Official 2008-2013 data - European Commission. Preliminary 2014 data - Eurostat MIP Database;^ as % of GDP; * % change (year-on-year unless otherwise stated);Note: Shaded data represent indicator that has surpassed its threshold.


23An Timpeallacht GheilleagrachI ndiaidh fhás 4.8 faoin gcéad ar OTI anuraidh, lean an téarnamh láidir argheilleagar na hÉireann sa chéad leath de 2015. Cé go raibh an neartú tosaighar ghníomhaíocht in 2015 á spreagadh ag an bhfás ar ghlan-onnmhairí, táan téarnamh ar an ngeilleagar níos cothroime le bliain anuas agus tá ról níossuntasaí de réir a chéile ag spreagthaí intíre. In éagmais na sonraí CuntasNáisiúnta don chéad ráithe de 2015, laghdaítear mionghné agus cáilíocht nafaisnéise atá ar fáil maidir le feidhmíocht an gheilleagair sa chéad chuid de2015, ach tugtar le tuiscint ó na comharthaí atá le feiceáil ó raon leathan sonraíagus táscairí eile gur tháinig méadú ar luas an fháis ar an éileamh intíre sachéad leath den bhliain seo.Cé go raibh an t-aisphreabadh á spreagadh idtús báire ag caiteachas infheistíochta, tá rólníos suntasaí anois ag caiteachas tomhaltóirí.Thairis sin, is cosúil go bhfuil an téarnamh arthomhaltas ag neartú de réir a chéile, cé gobhfuil an téarnamh sin neamhthoirtéiseachi gcónaí. Thairbhigh tomhaltas d'fhás laidirleanúnach ar fhostaíocht, go háirithe arfhostaíocht lánaimseartha, rud a chuidíonnle hioncaim a mhéadú. Le neart leanúnachmhargadh an tsaothair in 2015, arna bhfianúle sonraí mhargadh an tsaothair agus le sonraícánach, tacaítear leis an dearcadh gur leanan dlúthleathnú ar an ngeilleagar sa chéadleath den bhliain agus comhthacaítear leisan gcomhartha ó shonraí ardmhinicíochtamiondíolacháin go bhfuil an téarnamh arthomhaltas ag neartú de réir a chéile.Maidir leis an taobh seachtrach, tugtar letuiscint leis na rátaí arda fáis ar onnmhairí agusallmhairí sna sonraí trádála míosúla go raibhcuid d'iarmhairt na monaraíochta ar conradh lebrath sa chéad chuid de 2015. Is é ár mbonntuisceana i gcónaí gurb ionann é seo agusméadú céime ar leibhéal na n-onnmhairí agusna n-allmhairí seachas treocht leanúnach aníosar a gcuid rátaí fáis. Ag féachaint romhainn,meastar go dtosóidh onnmhairí de bheith agfás athuair i gcomhréir, tríd is tríd, leis an bhfásréamh-mheasta ar an éileamh seachtrach. Ibhfianaise naisc thrádála na hÉireann le margaíSA agus RA agus i bhfianaise an fheabhaisar an ionchas do gheilleagar an limistéir euro,ba cheart go nginfeadh sé seo ráta láidir fáisd'onnmhairí i mbliana agus an bhliain seochugainn.Maidir leis an taobh intíre, tá neartú tagtha arfhuinneamh an téarnaimh agus tá an t-ionchasníos fabhraí anois ná mar a bhí nuair a foilsíodhár gcuid réamhaisnéisí deireanacha. Ba cheartgo dtacódh méaduithe breise ar fhostaíocht,treocht in airde ar ioncam indiúscartha agus anneartú de réir a chéile ar mhuinín tomhaltóirí lefeabhas ar an bhfás ar chaiteachas tomhaltóirísa chuid eile de 2015 agus in 2016. D’ainneoinlaghduithe le déanaí, tá an léibhéal ardféichiúnais ina bhac go fóill ar aon téarnamhláidir ar thomhaltas. De bhreis air sin, meastargo dtiocfaidh neartú breise ar an bhfás archaiteachas infheistíochta, cé is moite deghné luaineach na n-aerárthaí. Cuideoidh sésin le haisphreabadh na hinfheistíochta, lenan-áirítear infheistíocht foirgníochta, i ndiaidhtréimhse fada laige.Tugann na forbairtí sin le tuiscint go mbeidhan t-ionchas fáis in 2015 agus 2016 níosfearr ná mar a tuaradh san Fhaisnéis Ráithiúildheireanach. Léirítear ionchas níos fabhraí dochaiteachas tomhaltóirí agus infheistíochtasa mhéid go meastar go mbeidh méadú 4.1faoin gcéad ar OTI in 2015, is ionann é sinagus athbhreithniú 0.3 faoin gcéad aníos igcoibhneas leis an meastachán roimhe seo. In2016, meastar go dtiocfaidh méadú 4.2 faoingcéad ar OTI, is é sin 0.5 faoin gcéad níosairde ná mar a tuaradh san Fhaisnéis Ráithiúildheireanach. Beidh neartú breise ar an éileamhintíre mar thaca ag an méadú sin. Tá caveatag gabháil leis na réamhaisnéisí seo sa mhéidgo mbaineann riosca suntasach ar an taobhthuas leo toisc go ndéantar aerárthaí atá arúinéireacht ag cuideachtaí atá lonnaithe inÉirinn a áireamh in infheistíocht agus in allmhairí


24An Timpeallacht GheilleagrachQuarterly Bulletin 03 / July 15araon sna Cuntais Náisiúnta. Dá bhrí sin,féadfaidh go mbeidh riosca ar an taobh thuasdon ionchas réamh-mheasta maidir leis anéileamh intíre ach féadfaidh go ndéanfar é sina fhritháireamh le riosca ar an taobh thíos donionchas maidir leis an réamh-mheastachán doghlan-onnmhairí, rud a fhágann go mbeidh narioscaí foriomlána cothrom tríd is tríd.Maidir le saincheisteanna beartais, ní mór aáirithiú go ndéanfar an téarnamh eacnamaíochatá faoi lán seoil a fhorbairt tuilleadh sa chaoigur filleadh inmharthana ar fhás cothroma bheidh ann. Cé go bhfuil an-dul chuncinn déanta, tá féichiúnas ard poiblí aguspríobháideach ann i gcónaí. I bpríomhréimsíáirithe, ní mór beartas a dhíriú ar laghdúleochaileachtaí atá fós ar marthain agus arneartú stóinseachta chun go n-íoslaghdófarrioscaí don chobhsaíocht eacnamaíoch,fhioscach agus airgeadais amach anseo.Ó thaobh an airgeadais phoiblí, bhí na sonraímaidir leis an Státchiste fabhrach, rud a léiríonnfeidhmíocht láidir eacnamaíoch. Tá an t-ioncamcánach chun tosaigh ar an sprioc agus tá ancaiteachas níos ísle ná an phróifíl. I bhfianaisean méid sin go léir, is dócha go mbeidh antEasnamh Rialtais Ghinearálta faoi bhun nasprice in 2015 agus ba cheart go mbeadhÉire ábalta imeacht as an Nós Imeachta umEasnamh Iomarcach faoin spriocdháta agdeireadh na bliana. Ag féachaint romhainn,tugtar le tuiscint leis an ionchas láidir fáis nachbhfuil gá le beartas fioscach chun tacú legníomhaíocht eacnamaíoch agus, go háirithe,féadfar gluaiseacht ar aghaidh le comhdhlúthúfioscach agus le laghdú fiachais in imthoscafabhracha. Ó tharla go bhfuil fás láidir tuartha,tá sé tábhachtach nach ndéanfar brúannatimthriallacha a dhianú tríd an seasamhfioscach. Is léir ó thaithí na hÉireann gur féidirdamáiste a dhéanamh trí chomhchiogalacht imbeartas agus go bhfuil sé tábhachtach nachngéillfear don chathú chun ioncam barrachaisgan choinne a úsáid. I bhfianaise leibhéal agusualach ard an fhiachais phoiblí, bheadh sé níosfearr an t-ioncam sin a úsáid chun an laghdúar an bhfiachas a luathú, rud a fhágfaidh gombeidh riocht níos fearr ar an airgeadas poiblíchun dul i ngleic le haon dúshláin amachanseo.San earnáil baincéireachta, bhí imthoscafabhracha sa mhargadh airgeadais mar aonle timpeallacht fheabhsaithe eacnamaíochmar chuidiú do na bainc chun a gcostaiscistiúcháin a laghdú. I ngeall air sin agusar tháillí laghduithe i leith lagú, tá filleadhar bhrabúsacht le feiceáil. Is ábhardóchais é go leanann stoc na n-iasachtaíneamhthuillmheacha de bheith ag laghdú. Ara shon sin, tá leibhéal foriomlán na n-iasachtaíneamhthuillmheacha ard i gcónaí. Tá riaráistífadtéarmacha morgáiste os cionn 720 láag méadú i gcónaí ach tá moillú suntasachtagtha ar luas an mhéadaithe sin. I gcás nambanc sin atá faoi réir spriocanna réitigh doriaráistí morgáiste (SRRM), is díol suntais é gobhfuil laghdú beag tagtha ar líon na gcuntasatá sa deighleog riaráistí sin. I dtéarmaí oibriúSRRM, d'fhógair an Banc Ceannais le déanaígo mbeifear ag aistriú ó spriocanna coiteannaráithiúla réitigh do na bainc go léir go dtí curchuige a bheidh sonrach do bhainc ar leithagus go ndéanfar monatóireacht ghráinneachar ghrúpaí sonracha iasachtaithe anásta igcásanna ina mbeidh an dul chun cinn mall.Cé go bhfuil dúshláin ann, tá dul chun cinná dhéanamh agus tá cláir chomhardaithe nambanc agus a gcuid iasachtaithe á réiteach deréir a chéile.


25Financing Developmentsin the Irish EconomyOverviewFinancing conditions have generally improved for domestic banks, householdsand non-financial corporations (NFCs) during late 2014 to mid-2015. While theoverall macroeconomic environment remains challenging, there are tentativesigns that declining debt burden levels, improved economic growth andincreasingly favourable funding dynamics have all contributed to a somewhatmore positive outlook.Central Bank interest rates remain at historically low levels in the majority ofadvanced economies, including Ireland. However, the degree to which theserates have passed through to economic agents in terms of favourable loan anddeposit interest rates has been limited. There is tentative evidence that themore favourable economic background has improved the financial capacityof both households and NFCs, although this remains quite constrained.Households and NFCs have continued to reduce their respective debt levels,with repayments on existing debt exceeding new lending. In addition, the netfinancial worth of households has risen, reflecting rising property and financialasset values. Despite the unfavourable rates applicable to new businessdeposits, NFC overnight deposits have increased sharply, suggesting that nonfinancialinstitutions may be reducing their reliance on bank based funding andare increasingly relying on their own funds for working capital purposes. Thesigns of additional financial capacity in the domestic system bodes well forboth medium and long-term growth prospects. However, to date, the improvedfinancing conditions have largely manifested themselves through reductions inindebtedness, with increases in consumption and investment relatively muted.In conjunction with private-sector debt, government debt levels have also beenstabilising in nominal terms, leading to a moderation in the overall level of debtin the economy. Irish government bond yields fell to record lows in early 2015,reflecting the positive international sentiment towards the Irish recovery, albeitwith yields somewhat rising since due to the ongoing uncertainty surroundingthe Greek sovereign. Notwithstanding the situation in Greece, Irish yields haveremained stable relative to other euro peripheral countries. This resilience isreflected in the S&P announcement in June 2015, upgrading Ireland’s sovereigncredit rating to A+, with a stable outlook.HouseholdsHousehold indebtedness has continued todecline during the fourth quarter of 2014, falling1.6 per cent to €157bn or €34,069 per capita.Overall debt has fallen by some 22.9 per centsince its peak during Q3 2008. Mirroring thisdevelopment, indicators of debt sustainabilityhave continued to improve, with householddebt as a proportion of disposable income


26Financing DevelopmentsQuarterly Bulletin 03 / July 15in the Irish EconomyChart 1: Household Debt as a Percentage ofDisposable IncomeChart 2: Net Transactions of Loans for HousePurchase, 12-month moving sum220%1,500€ million2001,0005001800160-500-1,000140-1,500120-2,000-2,500100Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q42003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014-3,000JanMarMayJulSepNovJanMarMayJulSepNovJanMarMayJulSepNovJanMarMayJulSepNovJanMarMayJulSepNovJanMarMay2010 2011 2012 2013 2014 2015Debt to Disposable IncomeNet TransactionsSources: Quarterly Financial Accounts, Central Bank of Irelandand Quarterly National Accounts, Central Statistics Office.Source: Money and Banking Statistics, Central Bank of Ireland.declining by 3.7 percentage points to 169 percent during Q4 2014, representing the lowestratio since the fourth quarter of 2005 (seeChart 1). However, this ratio still remains highby international standards. The improvementin household finances had been largely drivenby the extent to which households’ repaymentson existing debt have exceeded new lending.Improving disposable income levels havesupported households’ ability to reduce overallindebtedness. In monetary terms, householdnet wealth rose to €601 billion in the fourthquarter, or €130,331 per capita, its highest levelsince Q4 2008. The increase observed overQ4 2014 was predominately driven by risingresidential property and financial asset prices.At end Q4 2014, household net wealth wassome 33 per cent higher than the lowest levelrecorded in Q2 2012 following the crisis.Reductions in household indebtedness wereparticularly strong in the case of loans forhouse purchase, where repayments exceededdrawdowns by circa €2 billion over the 12months to May 2015. Consumer and otherlending also recorded net repayments (Chart 2).In tandem with repayments of debt, householdsincreased their holdings of deposits by €1.5billion, or 1.6 per cent, over the 12 months toend-May 2015. Increased deposit holdingscontributed to the strong accumulation inhousehold savings over recent quarters.However, to date, there is limited evidenceof these savings translating into increasedconsumption.Household interest rates remain elevateddespite the historically low ECB benchmarkrates. The interest rate applicable to outstandingloans for house purchase was 2.7 per centat end-April 2015, over 35 basis pointshigher than the euro area average. This isdespite the inclusion of tracker mortgages(no longer offered by domestic banks), withweighted average interest rates of just over 1per cent. The weighted average rate on newfloating rate mortgages was just over 3.3 percent. However, when renegotiated loans areexcluded, the average rate stood at almost 4.2per cent. The high rates currently being charged


Financing Developmentsin the Irish EconomyQuarterly Bulletin 03 / July 1527means variable rate mortgage holders have anincreased incentive to seek out the best ratesavailable in the domestic market, by switchingtheir mortgage provider. However, recentCentral Bank research indicates very low levelsof switching activity. 1 Interest rates on termdeposits have continued to decline in Q1 2015.Rates on new term deposits have consistentlyfallen since mid-2008, standing at just 0.35per cent at end-April. There is clear evidencethat banks are improving their interest marginsas lending rates have not fallen in line with thelower cost of funding.in the number of longer-term arrears cases over720 days. However, the number of accounts inarrears over 720 days appears to be stabilisingas the increase of just 155 cases during Q12015, represents the smallest increase since thearrears statistics were introduced.The number of mortgages in arrears continuesto decline in line with the economic recoveryand an increasing volume of successfullyrestructured mortgages. By the end of Q12015, 74,395 mortgages, or 9.8 per cent of allmortgages, were in arrears for over 90 days.This represents the sixth consecutive quarterlydecline in the number of accounts in arrears,notwithstanding the fact that the volume ofoutstanding arrears cases remains high. Thedownward trend observed in arrears over 90days stands contrary to the stubborn increaseBox A: SMEs Cost of Bank FundingBy Martina Sherman 2While interest rates charged for mortgages have attracted significant media attention recently,there has been relatively little focus on rates charged to businesses, particularly SMEs.According to the Bank’s most recent Macro-Financial Review (MFR), SMEs are still facingchallenging financing conditions, which discourages investment and growth potential and hasnegative consequences for employment. The Review also highlights the growing divergencein new business SME interest rates between Ireland and the euro area, with Irish rates almosttwo percentage points above that of the euro area. This comparison is based on publishedECB interest rates on new lending to non-financial corporations for amounts up to €1 million,which are used as a proxy for SME bank funding costs. Additionally, the most recent RedC SME Credit Demand Survey 3 , finds that the interest rates on approved credit, althoughdeclining from 6.5 per cent to 5.2 per cent when compared to the previous survey, remainhigh. The Survey also indicates that SMEs are re-investing their own funds for working capitalpurposes rather than requesting bank funding, while those applying for bank credit are insteadapplying for larger amounts. Against this backdrop, this Box aims to enhance the dialogue onIrish SME interest rates by providing further analysis at an economic sector level.1 http://www.centralbank.ie/publications/documents/el_2015_8.pdf2 The author is an Economist in the Statistics Division of the Central Bank of Ireland.3 Covers the period October 2014 to March 2015.


28Financing DevelopmentsQuarterly Bulletin 03 / July 15in the Irish EconomyBox A: SMEs Cost of Bank FundingBy Martina ShermanRecent enhancements in the Central Bank’s data collection include the reporting of quarterlydata on SME interest rates by a representative sample of Irish resident banks. The data arereported at a NACE classification level, which provides a breakdown by economic sector, andrefer to both new business (drawdowns) and outstanding amounts. 4 While the ECB seriesallows for meaningful comparison across euro area countries due to its harmonised nature,no sector level detail is available. As such, it masks significant differences in rates acrosseconomic sectors in Ireland. 5Chart 1 shows the interest rate charged by Irish resident banks by sector, along with the totalvalue of drawdowns for new SME business. While the total weighted average interest ratecharged is around 5.2 per cent, large deviations exist across economic sectors. SME loansfor the service-related purposes attracted lower rates than the total weighted average rateover the 6-month period, while the converse was true for construction and transport/storagerelatedloan drawdrowns, which recorded rates of over 6 per cent. Over the six-month period,all sectors experienced marginal declines in interest rates, much in line with the Red C Survey.However, it is worth noting that the overall weighted average interest rates for some sectorsmay be impacted by low levels of new lending or high levels of outstanding indebtedness.Box A Chart 1: Irish SME new lending rates(6-month weighted average) and cumulativenew lending drawdowns (6-month sum)Box A Chart 2: Irish SME outstanding stocklending rates and outstanding volumes(Q1 2015)400Millionsper cent725,000Millionsper cent73506620,00030055250415,0004200150310,000310050215,000210000Primary IndustriesManufacturingConstructionWholesale/Retail TradeTransport and StorageHotels and RestaurantsInfo and CommsReal Estate activitiesBusiness and AdminElec and WaterOtherPrimary IndustriesManufacturingConstructionWholesale/Retail TradeTransport and StorageHotels and RestaurantsInfo and CommsReal Estate activitiesBusiness and AdminElec and WaterOtherVolumes (LHS)Total weighted average (RHS)Source: Central Bank of Ireland.Rates (RHS)Notes: Excludes Financial Intermediation sectors.Data refers to Q4 2014 and Q1 2015.Volumes (LHS)Rates (RHS)Total weighted average (RHS)Source: Central Bank of Ireland.Note: Excludes Financial Intermediation sectors.The data also highlight the gap between rates on existing SME loans and those on new loans.The rates on new drawdowns in Chart 1 are generally higher than those of Chart 2, whichdisplays the average rates on the stock of outstanding loans held at end-Q1 2015. The spreadin new drawdown rates across the economic sectors is also much greater than the spread ofrates on outstanding SME debt.4 The data was first presented as part of the Bank’s Retail Interest Rates release, and is comparable to the Business Credit andDeposits SME statistics.5 The SME interest rate statistics differ to the NFC series (SME proxy) as it excludes lending to other euro-area residents, covers allcurrencies and refers to a representative sample of banks.


Financing Developmentsin the Irish EconomyQuarterly Bulletin 03 / July 1529Box A: SMEs Cost of Bank FundingBy Martina ShermanThe largest differential between new rates and those on outstanding stock at end-2015,of almost 2.6 percentage points, was recorded for construction-related loans. These loanscurrently carry the highest average interest rates for new SME loans, although historically rateswere below average. In contrast, new loans to real estate SMEs were almost 2.5 percentagepoints lower than those for construction and were below the average charged, despite havinghistorically high rates. Real estate SMEs were the third largest recipients of new loans, but thisrepresented a low proportion of outstanding stock. 6SMEs in the primary industries sector (mainly agriculture), which have accounted for themajority of new drawdowns in recent quarters, attracted above average interest rates of 5.5per cent during Q1 2015. This was unchanged from Q4 2014 but almost a percentage pointabove historical rates. Given that typical loan amounts to the agriculture sector are generallylower than average but are highest in terms of number of loans issued 7 , this may indicate ahigh volume of unsecured or short-term lending with banks pricing in credit risk arising fromvolatility and uncertainty in agri-food markets.The hotel and restaurant sectors currently experience rates on new drawdowns approximately 1.5per cent higher than rates on outstanding amounts and are marginally below average. Rates forthe wholesale and retail sector are at average levels, but are likely to be impacted by the exclusionof some banks active in the motor trade industry from the reporting population.Chart 3 shows how rates charged by Irish-owned banks for SME lending compare with ratescharged by foreign-owned banks operating in the Irish market. Irish-banks’ rates are higher formost non-service sectors, with the differential for construction particularly marked. This is probablyindicative of a cautious approach given the huge losses sustained from property-related debt.It is interesting to note is that at end-Q1 2015, some sectors with above average interest ratesrecorded high deposits holdings with Irish banks. The same sectors also had a relatively lowproportion of total new drawdowns. Survey evidence from the Red C Survey suggests an increasein enterprises reporting the use of own-funds for working capital requirements rather than bankfunding. However, further research is required in this area.Box A Chart 3: Irish-owned banks' SME ratescompared to Foreign-owned bank rates(operating in the irish market)Primary IndustriesManufacturingConstructionWholesale/Retail TradeTransport and StorageHotels and RestaurantsInfo and CommsReal Estate activitiesBusiness and AdminElectricityEducationHuman HealthOther community-3.0 -2.5 -2.0 -1.5 -1 -0.5 0.0 0.5 1.0 1.5 2.0percentage pointsSource: Central Bank of Ireland.Note: A positive differential means Irish-owned bank ratesare higher, while a negative differential implies foreign-ownedbanks charge a higher rate.6 See Central Bank of Ireland Statistical Release: Trends in Business Credit and Deposits: Q1 2015.7 Menton, A and Sherman, M. (2014), ‘Analysis of the SME Market Using Micro-Data’, Central Bank of Ireland Conference Paper.


30Financing DevelopmentsQuarterly Bulletin 03 / July 15in the Irish EconomyCredit InstitutionsThe funding profile for Irish banks continued toimprove in 2015, reflecting improved economicconditions, widening interest margins,successful debt issuances and increasingstability in deposits. The outstanding stock ofIrish private-sector deposits with Irish banksincreased slightly by 0.2 per cent to circa €174billion in the year to May 2015, following asustained period of negative deposit growthrates stretching back to February 2014. Thenegative deposit growth in earlier months waswholly attributable to financial sector entities,in contrast to households and NFCs wherethe positive growth evident in recent monthshas continued. Recent developments indeposits funding is almost entirely driven bya sharp increase in overnight deposits, risingsome 15 per cent in May 2015 (Chart 3). Thegrowth rates of deposits with agreed maturitieshave fallen steeply over the same period.The increase in overnight deposits at quitelow interest rates, particularly for NFCs, mayindicate a reduced reliance on bank fundingfor these entities. The share of deposits in thebalance sheet of the domestic market groupof banks (i.e. those with retail operations inIreland) has increased to 67 per cent in May2015, compared to 65 per cent in Januaryof that year. In addition, credit institutions’borrowings from the Central Bank havedeclined by €1.5 billion in the month of May to€13.1 billion, down from €23.2 billion in May2014. These developments indicate that thedomestic banks are returning to a more stablefunding environment.Non-Financial CorporationsNon-financial corporations (NFCs) continuedto reduce their overall debt burden during Q42014, with NFC debt relative to GDP decliningby 1.6 per cent to 185 per cent. Developmentsin NFC indebtedness in Ireland are heavilyimpacted by the activities of multinationalfirms, which can lead to volatile quarterly debtdynamics for the sector. Domestic NFCs,and particularly small- and medium-sized100,00090,00080,00070,00060,00050,00040,00030,00020,00010,0000Chart 3: Private Sector Deposits with IrishResident Banks€ millionJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecJan Feb Mar Apr May2014 2015Households Non-financial corporationsInsurance corporations and pension funds/Other financial intermediariesSource: Money and Banking Statistics, Central Bank of Ireland.enterprises (SMEs), rely heavily on bankfinance compared to MNCs, which havegreater access to financial markets and otherfunding sources. SMEs 8 , which are particularlyimportant to the domestic economy in terms ofemployment levels, undertook new loans over€2.5 billion in the year to Q1 2015, comparedto almost €2 billion the previous year.Nevertheless, outstanding credit to SMEscontinued to decline in annual terms.In the year to May 2015, repayments onexisting debt exceeded new lending by €5.4billion for all NFCs, resulting in a decline of 8.2per cent in overall lending. NFCs have alsoincreased savings with net inflows of depositsto banks of €6 billion in the year to May 2015.The sharp growth in deposits, particularlyovernight deposits for NFCs would suggestthey are increasingly making use of their ownfunds for working capital purposes, rather thanrelying on bank funding. The rise in depositsmay indicate that NFCs and particularly SMEsare now somewhat less reliant on traditionalbank funding.8 Small- and Medium-sized Enterprises, excluding financial intermediation and property sectors.


Financing Developmentsin the Irish EconomyQuarterly Bulletin 03 / July 1531Chart 4: Government IndebtednessChart 5: Irish Government Ten-Year Bond Yields250€ billion € billion1805%160Greece misses deadlinefor payment to the IMF2001501001401201008060432ECB GoverningCouncil decidesthat interest rateswill remainunchangedS&P upgradesIreland'ssovereigncredit ratingto A (withstable outlook)ECB announcesExpanded AssetPurchaseProgrammeNTMA raises €4bnfrom sale of 30-yearbenchmark bond andcompletes secondtranche of earlyrepayment of IMFloan facilityECB's ExpandedAsset PurchaseProgrammecommencesNTMA sells €1bn of30 year benchmarkbond at auction andcompletes third andfinal tranche of earlyrepayment of IMloan facilityNTMA sells€750 millionof 7 year bondby auctionNTMA sell€750 millionof 15 year bondby auction500Q1 Q2 Q3 Q4Q1Q2 Q3 Q4Q1 Q2 Q3 Q4Q1Q2 Q3 Q4Q1 Q2 Q3 Q4Q2 Q3 Q42009 2010 2011 2012 2013 2014Q14020010NTMA completesfirst tranche ofearly repaymentof IMF loanfacilityGreek legislativeelections heldNTMA sells €500mof 15-Year Bondby auctionNov Dec Jan Feb Mar Apr May Jun Jul2014 2015S&P upgrades Ireland'ssovereign credit rating tA+ (with stable outlook)Gross General Government Debt (LHS)Source: Thomson Reuters Datastream.Net General Government Debt (RHS)Source: Central Statistics Office.Interest rates for NFCs remain relativelyunfavourable when compared to average euroarea rates. The interest rate on new NFCbusiness loans up to €1 million and up to oneyearfixation (often used as a proxy for lendingto SMEs) was nearly 5 per cent at end-April2015, having fallen slightly since the beginningof the year. The equivalent rate for the euroarea as a whole was significantly lower, at2.8 per cent. The cost of funding for SMEsand changes in the sectoral composition ofSME lending are further explored in Box A. Inconjunction with the unfavourable loan rates,new business NFC deposit rates are alsocurrently quite low, standing at just 0.16 percent at end-April 2015.GovernmentGross government debt, as measured for theExcessive Debt Procedure, continued to fallduring Q4 2014, decreasing by 2.3 per cent(Chart 4). This decline largely reflected the earlyrepayment of some IMF loans by the State.In contrast, net government debt rose furtherover the quarter, increasing by 1.1 per cent.Net debt when expressed as a percentage ofannualised GDP, however, declined from 90.2per cent in Q3 2014 to 89.2 per cent in Q42014, due to increased economic growth.Yields on long-term Irish government bondshad fallen to a record low of 0.6 per centduring April 2015, reflecting the positiveperception of the Irish economic recovery andthe low rates generally applicable to euro areasovereign debt at the time (Chart 5). However,more recently, yields have trended upward,reaching 1.6 per cent in mid-June, as marketsresponded to improved inflation expectationsand uncertainty surrounding the agreementof a new financial assistance programme forGreece. Despite the crisis in Greece, Irish bondyields have remained stable relative to otherperipheral euro area countries which haveexperienced higher increases in yields. Thepositive sentiment towards the Irish recoverywas reflected in S&P’s announcement of anupgrade in Ireland’s sovereign credit rating toA+, with a stable outlook, in early June 2015.


32Financing DevelopmentsQuarterly Bulletin 03 / July 15in the Irish EconomyIFSC – Investment Funds, MoneyMarket Funds and FinancialVehicle CorporationsIFSC non-bank entities benefitted from strongglobal financial markets in Q1 2015, whilesubstantial euro depreciation also boostedasset values. Investment funds (IFs), asmeasured by the value of their units/sharesin issue, rose to €1,451 billion in Q1 2015from €1,275 billion in the previous quarter,mainly driven by positive revaluations of€145.4 billion in debt securities and equitiesholdings. Investor inflows to IFs amountedto €30.9 billion, continuing a longer-termtrend of strong growth (Chart 6). Despite thestrong inflows, fund investment managers arefacing challenges arising from the very lowyields on debt securities. The response byfund managers to the low yield environmentis elaborated in Box B. Money market funds,also measured by unit/share valuations inissue, increased in value to €447.0 billion from€394.1 billion over the same period, partlydriven by increases in the value of short-termdebt security holdings.5550454035302520151050-5Chart 6: Value of Investment Funds Shares/Units€ billion € billionQ1Q2Q3Q4Q1Q2Q32012 2013 2014 2015Transaction Net Inflows (LHS)Q4Value of Investment Funds (RHS)Source: Investment Funds Statistics, Central Bank of Ireland.Note: The movement from Q4 2013 to Q1 2014 includes48 billion of investment funds that were reclassified as moneymarket funds.Q1Q2Q3Q4Q11,5001,4001,3001,2001,1001,0009008007006005004003002001000Box B: Investment funds debt security holdings in a low yield environmentBy Brian Golden 9Debt security yields have been low in historical terms for around the last five years and, in early2015, reached new record lows with, for example, Switzerland auctioning ten-year governmentbonds at a yield of -0.055 per cent on 8 April. This has posed a particular challenge forinvestment funds (IFs), as rising debt security prices boost net asset values while depressingyields. Prices close to their peak, combined with the low yields on offer, present challenges forbond fund investment managers, many of whom are constrained in the types of investmentsthey can undertake. One potential strategy is to take on somewhat more risk in order to achievehigher yields. Within debt securities, this can involve changing the country or economic sectorof the issuer, or the residual maturity of the security, or a combination of these measures, whichis the focus of this box. It is possible to change holdings without changing country, sector ormaturity, but the data does not facilitate this type of analysis. IFs have reacted to the challengeof the low yield environment in various ways.9 The author is a senior Economist in the Statistics Division of the Central Bank of Ireland.


Financing Developmentsin the Irish EconomyQuarterly Bulletin 03 / July 1533Box B: Investment funds debt security holdings in a low yield environmentBy Brian GoldenStrategies other than a search for yield are apparent in the IF industry. Some IFs appearto be operating a hunkering down strategy, which might be expected for IFs with markedlyconstrained investment strategies, such as passive funds that track an index or specific set ofsecurities. This is illustrated by the fact that as much as 5 per cent of debt security holdingsfor all IFs had negative yields at end-Q1 2015, albeit these negative yields were close tozero. One reason for holding negatively yielding bonds is an expectation of deflation, but thisrationale should not apply so much to IFs seeking to generate a return for unit holders in theshort-to-medium term. The normal market strategy of pre-emptive selling can also help tomitigate the potential impact of low yields and declining prices. For example, as quantitativeeasing in the US began to be scaled back, bond funds investors withdrew €19.1 billion inthe second half of 2013, causing debt security holdings in bond funds to decline by a similaramount. These movements occurred in advance of a substantial negative revaluation in debtsecurity holdings in Q1 2014, which indicates strategic pre-emptive selling by IFs.A search for yield is also quite apparent as an investment strategy within the industry, focusingon the year to end-Q1 2015. There has been a significant shift in the maturity profile of debtsecurity holdings into longer-term maturities, which have higher yields. For example, over thecourse of the year to end-Q1 2015, IFs net transaction flows into debt securities with residualmaturities of less than 5 years were 17 per cent of the closing stock in Q1 2014. At the sametime, net transaction inflows into debt securities with residual maturities of five to ten yearswere 33 per cent of Q1 2014 closing positions. IFs also showed a marked preference for UKdebt, where yields were higher than similarly rated euro area debt, reflecting differing stages inthe monetary policy cycle between the two areas. There was not much evidence in portfolioshifts between economic sectors to indicate that IFs were taking on more risk to achieve ahigher yield. There were strong net portfolio shifts into government debt, which is seen asrelatively safe, although inflows to bank debt were also substantial.Overall, IFs have reacted in different ways to the low interest rate environment, as can beexpected in such a diverse industry. Where IFs have sought out higher yields, the emphasisappears to have been on risk minimisation, with the focus on extending maturities andinvesting in UK debt. Nevertheless, a substantial short-term correction to current high debtsecurity prices could potentially lead to a sell-off by funds, which may exacerbate marketmovements.Total assets of Financial Vehicle Corporations(FVCs) expanded by €13.3 billion in Q12015 to €414.5 billion, primarily driven by anincrease in FVC reporting numbers to 779. Thisrepresented the second successive quarterof growth, breaking an extended period ofdecline, as investors return to the securitisationmarket seeking higher returns in the currentlow yield environment. Inflows were mainlydriven by increases of €3.7 billion, €3.2 billionand €2.5 billion in deposit and loan claims,securitised loans originated by non-euro arearesidents and other assets, respectively. Euroarea FVCs asset values did not mirror theIrish performance in Q1 2015, falling by €35billion to €1,827 billion, as securitised loansoriginated by euro area banks declined.


34Financing DevelopmentsQuarterly Bulletin 03 / July 15in the Irish EconomyFor detailed commentary on the latestdevelopments in financial statistics, please seethe following:• Monetary Financial InstitutionsMoney and Banking Statistics, May 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/releases.aspxSecurity Issues Statistics, May 2015http://www.centralbank.ie/polstats/stats/sis/Pages/releases.aspxLocational Banking Statistics, Q1 2015http://www.centralbank.ie/polstats/stats/locational/Pages/releases.aspxConsolidated Banking Statistics, Q1 2015http://www.centralbank.ie/polstats/stats/conbs/Pages/releases.aspx• Non-Financial Private SectorMoney and Banking Statistics, May 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/releases.aspxTrends in Personal Credit and Deposits,March 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/releases.aspxTrends in Business Credit and Deposits,March 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/releases.aspx• GovernmentQuarterly Financial Accounts, Q4 2014http://www.centralbank.ie/polstats/stats/qfaccounts/Pages/releases.aspxHolders of Irish Government Bonds, May2015http://www.centralbank.ie/polstats/stats/sis/Pages/releases.aspxGovernment Finance Statistics, CentralStatistics Office, Q4 2014http://www.cso.ie/en/releasesandpublications/nationalaccounts/governmentfinancestatistics/• Funds and Financial VehicleCorporationsI Investment Funds, March 2015http://www.centralbank.ie/polstats/stats/investfunds/Pages/default.aspxMoney Market Funds, June 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/MoneyMarketFunds.aspxFinancial Vehicle Corporations, Q1 2015http://www.centralbank.ie/polstats/stats/fvc/Pages/fvc.aspxFor up-to-date charts on the latest financialstatistics, please see the following:http://www.centralbank.ie/polstats/stats/summarychart/Documents/ie_financial_statistics_summary_chart_pack.pdfInterest Rate Statistics, May 2015http://www.centralbank.ie/polstats/stats/cmab/Pages/releases.aspxQuarterly Financial Accounts, Q4 2014http://www.centralbank.ie/polstats/stats/qfaccounts/Pages/releases.aspxMortgage Arrears Statistics, March 2015http://www.centralbank.ie/polstats/stats/mortgagearrears/Pages/releases.aspx


35Developments in the Euro Area EconomyOverviewMost recent macroeconomic indicators show a slightly stronger growth outlookfor 2015 than had been previously expected. According to recent forecasts,real GDP in the euro area is now expected to rise to 1.5 per cent in 2015 andto around 2 per cent in 2016. Inflation is expected to increase from 0.1 percent this year to 1.5 per cent in 2016. Economic activity in the euro area iscurrently benefitting from a number of factors: oil prices remain relatively low,the euro has depreciated over the past year positively impacting internationalprice competiveness, economic policies are supportive, and monetary policiesare accommodative. Financial markets and asset prices are respondingto the substantial liquidity created by the ECB’s expanded asset purchaseprogramme, preventing an increase in real interest rates by re-affirming inflationexpectations. Nonetheless, high unemployment rates are unwinding onlyvery slowly, while the sharp deterioration of economic and fiscal conditions inGreece also presents a potential downside risk.Section 1: Growth and InflationDuring the first quarter of 2015, real GDP grewby 0.4 per cent quarter-on-quarter in boththe euro area and in the European Union as awhole (Chart 1). This is the eighth consecutivequarterly increase; with both the industrialand services sectors providing positivecontributions to growth. Across countries, Italyand France recorded stronger growth than hadbeen expected, at 0.3 per cent and 0.6 percent respectively. Germany grew by less thanhad been expected; at 0.3 per cent quarteron-quarter.According to the reported datafrom Eurostat, two countries – Greece andFinland – were in recession in the first quarterof 2015.The breakdown of Q1 euro area GDPconfirmed that the modest growth seen inthe early months of this year was driven bystronger domestic demand, primarily dueto increases in household spending andinvestment, and reflecting in part the positiveeffects of lower oil prices and inflation. Bycontrast, the growth of exports slowed to 0.6per cent and, with imports growing 1.2 percent, there was a net trade drag on growth(Table 1).3210-1-2-3-4-5Chart 1: Euro Area GDP Growth% Quarter-on-Quarter ChangeQ1 Q2 Q3 Q4Q1Q2 Q3 Q4Q1Q2 Q3 Q4Q1Q2 Q3 Q4Q1Q2 Q3 Q4Q1Q2 Q3 Q4Q1Q2 Q3 Q42008 2009 2010 2011 2012 2013 2014 ‘15Germany Spain France ItalySource: Thomson Reuters Datastream.Q1


36Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 15Table 1: Quarterly Change Expenditure Components in Euro Area GDP2014 2015Q2 Q3 Q4 Q1Consumption 0.3 0.5 0.4 0.5Government 0.2 0.2 0.1 0.6Investment -0.5 0.1 0.4 0.8Inventories -0.1 -0.1 0.0 0.0Exports 1.3 1.4 0.8 0.6Imports 1.3 1.7 0.8 1.2GDP 0.1 0.2 0.4 0.4Source:Eurostat.More recent, albeit preliminary, trade datasuggest that exports may have picked up inthe second quarter. The seasonally-adjustedtrade surplus rose to a record high of €24.9billion in April, from €19.9 billion in March. Thecontinued decline in the value of the euro hasimpacted international trade: import values fellin April and export values rose for the secondstraight month. The result was an annualgrowth rate of 8.7 per cent in the nominal valueof exports, its strongest since August 2012.Despite these positive trade developments,leading indicators suggest that growth isunlikely to have picked up further in thesecond quarter (Chart 2). Survey data fromthe economic sentiment index (ESI) and thecomposite output purchasing managers index(PMI), point to stabilisation and continued,albeit moderate, growth in Q2. However, bothindicators are above their respective long-termaverages. Within the overall ESI, euro areaconsumer confidence remained relatively stablein the three months to June indicating that euroarea household spending is unlikely to gatherpace after the slight pick-up observed for Q1.Labour markets are still weak but continue toimprove since a low-point in early 2013. Therecovery is showing signs of becoming moreevenly spread across sectors and there is alsosome convergence between Member Statesas high-unemployment countries have seenthe best improvement in their labour marketindicators. For the euro area, headcountemployment increased by 0.1 per centquarter-on-quarter for the first quarter of 2015,maintaining a similar rise in Q4 of last year. Theunemployment rate decreased to 11.3 percent in Q1 2015 and the latest figure for Mayis 11.1 per cent. Survey information for thelabour market is pointing towards continuednear-term improvement for the first half of thisyear, especially in countries that have recentlyimplemented labour market reforms (e.g.Spain).Inflation has been recovering steadily in theeuro area in recent months, mainly drivenby the reduced negative pressure exertedby energy prices (Chart 3). According toEurostat’s flash estimates, euro area annualHICP inflation was 0.2 per cent in June 2015,as it was in May but well above the troughof -0.6 per cent in January. Likewise, HICPexcluding energy is now 0.9 per cent fromstable values of around 0.7 per cent sinceJanuary. However, the return to positiveinflation in May was not driven solely byenergy prices: inflation increased across allsubcomponents, including in the servicessector where prices rose 1.3 per cent from 1per cent in March.The impact of the depreciation of the euroon HICP has been slow to materialise. Thereare initial signs of the impact of the eurodepreciation on import prices, but with stilllimited pass-through to price developmentsin the early stages of the production chain.In fact, although the annual rate of industrialproducer price inflation excluding constructionand energy is gradually recovering, it has onlyjust turned positive. PMI survey indicators inthe manufacturing sectors are also showingtentative signs of recovery and indicate that the


Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 153720Chart 2: Economic Sentiment Indicator & SelectedComponents1205Chart 3: Euro Area Inflation% Year-on-Year Change10110401003-10902-20801-3070-40600-50MarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJun50-1MarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJun2008 2009 2010 2011 2012 2013 2014 20152008 2009 2010 2011 2012 2013 2014 2015Industry Consumers Services ESI (rhs)HICP Headline RateHICP Excluding EnergySource: European Commission.Source: Thomson Reuters Datastream.gradual pass-through of the euro depreciationto producer prices is expected to betransmitted also to the HICP in the upcomingmonths.Finally, the slack in labour markets whichwas noted above indicates muted near-terminflationary pressures through this channel,despite early signs of improvement in labourproductivity. Indeed, the year-on-year growthrate of unit labour cost has declined slightly inthe first quarter of 2015.The fiscal situation is improving and thecollective stance across the euro area isexpected to be broadly neutral. The nonstandardmonetary policy measures takenby the ECB are expected to have somepositive impact on the fiscal outlook throughthe decline in borrowing costs and a higherinflation outlook. The mild strengthening ofeconomic activity and a lower burden ofinterest payments on public debt will supportgovernment deficit ratios. Across the euro area,the government debt ratio is estimated to havepeaked in 2014 and should start declining fromthis year on the back of moderate economicgrowth and low interest rates.OutlookLooking ahead, the moderate economicrecovery is expected to continue. Growth inthe first quarter was largely driven by domesticdemand, but this is expected to broadenthrough the year. Compared with the March2015 ECB staff forecasts, the recent Juneprojections have remained virtually unchanged.It is expected that growth will average closeto 1.5 per cent this year, and it is expected toreach closer to 2 per cent in 2016 (Table 2).The risks to the economic forecasts for theeuro area have become more balanced asa result of recent monetary policy decisionsleading to improved financing conditions.While there are some signs that the weakereuro is now starting to boost exports throughbetter price competitiveness, imports are alsoexpected to pick up throughout the year inresponse to growing domestic demand andincreased activity in exports with high importcontent. As such, the net trade position isexpected to contribute only modestly toGDP growth during 2015. Furthermore, whilesurveys of export orders suggest that exportgrowth will continue to improve at least while


38Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 15Table 2: Latest forecasts of Euro Area growth in real GDPDate 2015 2016 2017EU Commission May 2015 1.5 1.9 –Eurosystem Staff (BMPE) June 2015 1.5 1.9 2.0IMF July 2015 1.5 1.7 –OECD May 2015 1.4 2.1 –3.02.52.01.51.00.50.0Chart 4: Forward Inflation Swap Rates% Year-on-Year ChangeJanFebMarAprMayJunJulAugSepOctNovDecJanFebMarAprMayJunIn terms of inflation, the June Eurosystem staffmacroeconomic projections expect euro areaannual HICP inflation to be 0.3 per cent in2015, 1.5 per cent in 2016, and 1.8 per centin 2017. Compared with the March ECB staffmacroeconomic projections, this representsan upward revision of 0.3 percentage pointsfor 2015, with no change to the projections for2016 and 2017. By comparison, accordingto the second quarter Survey of ProfessionalForecasters (SPF), inflation expectations for2015 have been revised down to 0.1 per centwhile the one-year ahead (2016) and the twoyearahead (2017) inflation expectations havebeen both revised up slightly to 1.2 per centand 1.6 per cent, respectively.201420151y4y1y9y5y5ySource: Bloomberg, own calculations.Notes: The chart illustrates 5-day moving averages of forwardinflation swap rates for the euro area, where the underlyinginflation index is the euro HICP excluding tobacco.the euro remains weak, this tailwind will fadein Q3 because the euro is unlikely to continueweakening at its previous pace. In addition,the renewed pick-up in oil prices and inflationcould also slow consumption and investment,as could uncertainty over the Greek situation.The recovery could also be dampened byongoing necessary balance sheet adjustments.In terms of employment, the EU Commissionprojects that the unemployment rate will onlydecline to 10.5 per cent in the euro area by theend of 2016 implying persistently-high structuralunemployment and large unemploymentgaps across the euro area. It cautions that theprojected rise in economic activity may not bestrong enough for a more substantial reductionin future unemployment rates.In terms of the longer term, the SPF indicatesthat expectations for inflation out to 2019have remained stable at 1.8 per cent sinceQ4 2014, which continues to be belowthe long-run average. On the other hand,measures of market-based long-term inflationcompensation have recovered since January.The five-in-five year inflation swap rate rose toaround 1.8 per cent in June from the troughof 1.5 per cent at the beginning of the year inline with the other market-based measuresof long-term inflation expectations, but theyremain below pre-crisis levels (see Chart 4).This might partly reflect a slow adjustment ininflation expectations after the announcementand implementation of the expanded assetpurchase programme, but also the persistenceof negative inflation risk premia. A negativeinflation risk premium signals that marketsexpect that a scenario with falling consumptionand falling inflation is more likely than ascenario with increasing inflation.


Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 1539Box A: US Monetary Policy: Looking Beyond Headline UnemploymentBy Arsenios SkaperdasIn contrast to the ECB, which has a mandate of price stability, the Federal Reserve has a dualmandate to keep both prices stable and maximum employment. It is not surprising, therefore,that the rate of unemployment is a keenly watched figure by households and financial marketsin the US. The decline in the headline rate of unemployment in the US from a peak of 10 percent in October 2009 to a rate of 5.5 per cent in May 2015 has important implications for USmonetary policy, since it is a key component of the gap between actual and potential output,which cannot be directly measured.Though an unemployment rate of 5.5 per cent appears low by European standards, this Boxdiscusses some less positive labour market data behind the headline US figures. In particular,this Box will show that the level of slack remains higher in the labour market than the headlineunemployment rate would suggest; 1 thus explaining some recent Federal Reserve statements.There are a range of measures of the labour market that have not reverted to pre-crisis levels:• Chart 1 shows that the labour forceparticipation rate has fallen below trendsince the start of the financial crisis. 2Some research has found that this dropin participation is due to demographicfactors, such as the ageing of the ‘BabyBoomer Generation’ 3 . Other factorsthat affect the participation rate includewealth, income, and the generosityof government benefits 4 . However,the Federal Reserve’s February 2015biannual Monetary Policy Report statedthat the participation rate “continuesto suggest more cyclical weaknessthan is indicated by the unemploymentrate”. Likewise, the employment-topopulationratio is low, though recoveringslowly. These indicators are relevantfor the implementation of US monetarypolicy with respect to the employmentpart of its objective. If labour marketslack is a result of cyclical factors, itindicates that monetary policy should beaccommodative in order to help returnthe economy to potential output. Onthe other hand, if structural influencesare driving decreases in participation,the outlook for potential growth is lessfavourable.%686664626058565452Box A Chart 1: US Labour Force ParticipationRate and Employment to Population RatioMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayLabour Force Participation RateEmployment to Population RatioGreen line denotes trend through 2008Q3Source: Federal Reserve Bank of St. Louis (FRED).NovMay2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014‘151 See Blanchflower, David G., and Andrew T. Levin. Labor Market Slack and Monetary Policy. No. w21094. National Bureau ofEconomic Research, 2015.2 The labour force is defined as the percentage of the civilian non-institutional population 16 and over working or looking forwork.3 Bullard, James. The rise and fall of labor force participation in the US. No. 227. Federal Reserve Bank of St. Louis, 2014.4 Daly, Mary, and Tali Regev. "Labor force participation and the prospects for US growth." FRBSF Economic Letter (2007) andDaly, Mary, Bart Hobijn, and Joyce Kwok. "Labor supply responses to changes in wealth and credit." FRBSF EconomicLetter (2009).


40Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 15Box A: US Monetary Policy: Looking Beyond Headline UnemploymentBy Arsenios Skaperdas• Chart 2 contains broader measures of unemployment, showing that the number ofunderemployed and discouraged workers (U6 unemployment) remains high. 5 This indicatoralso helps inform the Federal Reserve’s view of the labour market. As economic conditionsstrengthen, we would expect to see the U6 rate decrease, as workers currently in part-timeemployment are able to find full-time jobs. This measure persists in spite of the fact thatthe headline unemployment rate has converged near the US Congressional Budget Office’sestimate of the natural rate of unemployment, which attempts to measure unemploymentnot arising from fluctuations in aggregate demand.• Other indicators that remain below pre-recession levels 6 are the hire rate 7 (3.5 per cent inMay compared with 3.8 per cent) and the share of long-term unemployed 8 (28.6 per centin May compared with 19.1 per cent). The quit rate, which measures the percentage ofemployees who voluntarily leave their jobs, was also at 1.9 per cent in April in comparisonto 2.1 per cent before the crisis 9 . These are all measures that Fed Chair Janet Yellen hasstated as important for determining labour market slack, and that she has pointed to inorder to justify loose policy thus far 10 .• Finally, average hourly earnings have grown very slowly since the crisis (Chart 3). This ismirrored by similar trends in business sector compensation per hour (1.85 per cent yearon-yearin 2015 Q1). In a labour market characterised by supply constraints, one wouldexpect workers to bargain for higher wages. One indicator that has picked up slightly is theemployment compensation index, which grew by 0.7 per cent in 2015 Q1. As the headlinerate continues to fall, we should at some point see other measures of wage growth increaseas well.Box A Chart 2: Measures of USUnemployment4.0Box A Chart 3: US Earnings Growth20%3.53.0152.52.0101.51.050.50.00MayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMay2007 2008 2009 2010 2011 2012 2013 2014 ‘15MayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMayNovMay2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 ‘15Average Hourly Earnings Growth (Annualised)U6 Unemployment- Includes Underemployed andMarginally AttachedSource: Federal Reserve Bank of St. Louis (FRED).Unemployment RateNatural Rate of Unemployment (Short Term,Quarterly, Congressional Budget Office)Source: Federal Reserve Bank of St. Louis (FRED),Congressional Budget Office.5 Referred to as U-6.6 Levels are 2004-2007 (pre-recession) averages.7 The hire rate is defined as workers hired as a percentage of total employees.8 Long-term unemployed are those unemployed for 27 weeks or longer.9 Also 2004-2007 average.10 http://www.bloomberg.com/infographics/2014-04-02/yellens-labor-market-dashboard.html


Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 1541Box A: US Monetary Policy: Looking Beyond Headline UnemploymentBy Arsenios SkaperdasThis Box has gone behind the headline unemployment data to show how, despite theimprovement in the headline rate, weakness remains in other US labour market indicators. Inparticular, the recovery has been characterised by both persistently low wage growth and highbroad unemployment measures. Since the Federal Reserve’s mandate encompasses both theunemployment and inflation rates, market participants, as well as the FOMC, will be analysinga range of indicators to determine the strength of the labour market. Ultimately, however, moreinformation than that contained in labour market statistics or inflation rates may be importantfor understanding US policy. The FOMC ended its June (latest update) statement by declaringthat it may still keep rates lower than warranted in comparison to normal times, even if inflationand employment levels are close to those mandated.Section 2: Euro Area MonetaryPolicy DevelopmentsThere were two major policy developmentsin the euro area since the last Bulletin. First,the European Court of Justice announced itsjudgement on the compatibility of the ECSBprogramme of outright monetary transactionswith EU law, and second, purchases under theexpanded asset purchase programme, whichbegan in March, continued apace.On June 16, the European Court of Justice(ECJ) found that the ECB’s programme ofoutright monetary transactions (OMT) ispermitted under European Treaties. Theissue had been referred by the GermanConstitutional Court, which asked forguidance on whether the programme is withinthe powers of the ESCB and whether it iscompatible with the prohibition of monetaryfinancing. The ECJ found that OMT wascompatible in both instances. The Court ruledthat the OMT programme is a monetary policyprogramme rather than, for instance, a broadereconomic programme, and that its objectivewas to maintain the ‘singleness’ of euro areamonetary policy, which is a requirement underEU Treaties. As such, it is within the powers ofthe ESCB. In relation to the issue of monetaryfinancing, the Court found that this prohibitiondoes not prevent the ESCB from adoptingthe OMT programme and implementing itunder conditions which do not result in theESCB’s intervention having an effect equivalentto directly purchasing government bonds inprimary markets.Purchases began in the expanded assetpurchase programme (APP) in March and themonthly €60 billion targets have since beenreached. At the 3 June press conference,President Draghi reiterated the intention tocontinue purchases until at least September2016 and, in any case, until the GoverningCouncil sees a sustained adjustment in thepath of inflation that is consistent with the aimof achieving inflation rates below, but close to,2 per cent over the medium term.President Draghi also noted a number ofpositive effects of the programme, includingan increase in inflation expectations, animprovement in financing for householdsand corporates, and an easing in financingconditions. Chart 4 shows that inflationexpectations, particularly at longer horizons,have recovered from lows in mid-January, butremain below historical averages. Furthermore,borrowing conditions for households and firmshave improved somewhat, particularly fornon-financial corporates. The April 2015 banklending survey shows that banks continued thetrend visible since 2015 of easing their termsand conditions on all lending to non-financialcorporates and households with the exceptionof loans to households for house purchase.This improvement was mainly driven by afurther narrowing of margins. Furthermore, thesurvey on the access to finance of enterprises


42Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 15Box B: Monetary Policy Rates and Shadow Short RatesBy Valentina Colombo 1This Box discusses how the monetary stance can be assessed when non-standard measures,such as the expanded Asset Purchase Programme (APP) in the euro area, are beingimplemented. Typically central banks seek to influence inflation and the real economy bychanging official interest rates. If inflation is low, central banks tend to reduce interest rates inan attempt to stimulate consumption, economic growth and inflation (policy is expansionary).Similarly, when inflation is high, a central bank is likely to raise interest rates slowing the widereconomy and reducing inflation (policy is contractionary). Thus, whether interest rates are highor low indicates the ‘monetary stance’ of the central bank: whether it believes inflation is toohigh or too low. However, when interest rates hit the zero lower bound, and non-interest ratemeasures are used, how can the monetary stance be assessed?During the Great Recession, central banks of the main advanced economies attempted tocounteract the economic downturn by adopting an extraordinarily expansionary monetarypolicy stance. Although operating in different economic contexts, the Federal Reserve (Fed),the European Central Bank (ECB), the Bank of England (BoE) and the Bank of Japan (BoJ)lowered policy rates close to zero to stimulate the economy and avoid the risk of a persistentdeflationary process. However, with monetary policy rates close to the zero lower bound (ZLB),when further stimulus was needed, central banks turned to non-interest rate, or non-standard,policy measures.The measures adopted by central banks to counteract deflationary pressures and to fostereconomic growth included increased liquidity provision, extending the term of lending,modifying the collateral framework, forward guidance and asset-purchase programs (i.e.,quantitative easing, QE). The aims of these programs have been to reduce long-term interestrates and thereby stimulate the economy. 2 While these measures have no impact on theofficial interest rate, and therefore do not affect the ‘price’ of money, they affect the ‘quantity’of money, and thereby have substantial effects on the size and the composition of centralbanks’ balance sheets. Chart 1 depicts the balance sheets of the four major central banks.The chart shows that since the bankruptcy of the Lehman Brothers in September 2008, thebalance sheets of central banks have increased in size. Initially, this was due to the liquidityrequirements of the financial system in the immediate post-Lehman period. Later, the Fedlaunched a number of large scale asset purchase programmes (APPs) from as early as2008, with the BoE and the BoJ following suit in 2009 and 2010, respectively. At the endof 2011 the BoE, given the contraction of economic activity, expanded its QE programmefurther increasing its balance sheet. The BoJ significantly expanded its asset purchases witha new programme in 2013 which had a large effect on its balance sheet. The ECB extendedlarge amounts of liquidity into the financial system with two three-year long-term refinancingoperations in December 2011 and February 2012. Once repayment of the LTROs began inearly 2013, the ECB’s balance sheet started to decline. From the end of September 2014 itincreased again with the launch of other programs (i.e., the Targeted Long-Term RefinancingOperations, the third Covered Bond Purchase Program, and the Asset-Backed SecurityPurchase Program). Since March 2015, the ECB has been purchasing €60 billion a month inassets, further increasing its balance sheet.However, assessing the effect of these unconventional monetary policies on the overall stanceof monetary policy is an open issue and no consensus has yet been reached.1 Monetary Policy Division2 Several studies show the negative relation between term premium and economic activity. Rudebusch et al. (2007) show thatan (decrease) increase in the term premium of Treasury yields affects (positively) negatively the GDP. Gilchrist et al. (2009)find that unexpected increases in bond spreads cause large and persistent contractions in economic activity.


Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 1543Box B: Monetary Policy Rates and Shadow Short RatesBy Valentina ColomboAs such, a number of methods have beenadopted in the literature to estimate a‘shadow short rate’ (SSR) for monetarypolicy, which would be similar to theofficial interest rate if no other measureswere being employed, but which can takedifferent figures (including negative ones)when non-standard measures are beingimplemented. Based on Black’s (1995)seminal work, Krippner (2012, 2013) andWu and Xia (2014) estimate the shadowrate relying on financial variables describingthe full term structure. 3 Another method,employed by Lombardi and Zhu (2014) forthe US, constructs an SSR measure basedon dynamic-factor model. They extract‘factors’, which explain the co-movementsof several variables linked to conventionaland unconventional monetary policy tools(interest rate, monetary policy aggregates,assets and liabilities of central bank balancesheet) employed by the Fed, as proxiesfor monetary policy stance. Overall, suchshadow rates describe the interest ratethat may be observed in absence of ZLBenvironment.50045040035030025020015010050Box B Chart 1: Central Bank BalanceSheets: Total AssetsIndex: 2007 Q4=1002008 2009 2010 2011 2012 2013 2014 ‘15JapanUKUSEASource: Bloomberg and Federal Reserve Bank ofSt. Louis (FRED).3 Black’s approach (1995) relies on the shadow rate term structure model (SRTSM). The idea is that the interest rate that weobserve cannot be materially negative, otherwise holding cash (at zero interest rate) provides a free-risk investment.According to Black, the zero interest rate can be seen as an option. Black suggests computing the value of the option tohold cash at the ZLB, and then to subtract it from the observed nominal yield at ZLB. This renders the shadow yield curve (ayield curve that would exist in absence of the option to hold cash). Following Black, the short term interest rate can beexpressed as the maximum of the shadow rate and the zero lower bound. In Black (1995) the shadow rate is linear inGaussian factors (latent variables). However, an analytical solution is known only in a one-factor model. Krippner (2012,2013) models the interest rate as an option, as in Black (1995). However, to simplify the model he computes the value of thecall option to hold cash by relying on two factors and on the bond option-price framework. Alternatively, the shadow rateproposed by Wu and Xia (2014) relies on forward rates and three factors, with the estimation based on a Kalman filter.


44Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 15Box B: Monetary Policy Rates and Shadow Short RatesBy Valentina ColomboBelow, we focus on the estimates of Krippner (2012, 2013), since the author uses the samemethodology to construct SSRs for a number of countries, enabling a comparison of themonetary policy measures in different jurisdictions. 4What does the shadow short rate tell us about the current and overall stance of monetarypolicy? Chart 2 depicts the SSRs for the UK, US, euro area and Japan. While Japanesemonetary policy was generally more expansionary (the SSR is lower) prior to 2008, thestance of monetary policy in all four economies followed broadly the same pattern, byKrippner’s measure. Following the onset of the crisis, all central banks dramatically loosenedmonetary policy, as evidenced by the rapid decline in the SSRs. However, around 2010,there is a divergence in policy stance: while the SSRs for the other three economiescontinue downwards, in the euro area it levels off briefly before declining again in 2012. Thiscoincides with the interest rate cut by the ECB, following the rate increase of July 2011. Atthe beginning of 2013 the BoJ announced the expansion of its asset purchase programme.By the end of 2013, policy in the US and UK had begun to tighten. This reflects the Fed’sannouncement that it would reduce its asset purchase programmes, and the improvementof economic activity in the UK. Conversely, in the euro area policy continued to be loosened.Through 2014, policies diverged significantly as the Governing Council announced its packageof measures in June, and details of the ABS and covered bond purchase programmes inSeptember. 5 The announcement of the PSPP in January 2015 further lowered the SSR,suggesting a more accommodative environment.86420-2-4-6-8Box B Chart 2: Shadow Short Rates20002002 2004 2006 2008 2010 2012 2014 2016This Box has shown the difficulty indetermining the monetary stance whennon-interest rate measures are used, inparticular in light of the expanded APP inthe euro area. A number of methods toestimate the monetary stance were outlined,which took into account not just the officialinterest rate set by the central bank, butalso the non-standard measures beingemployed at any given time. Focussing onone methodology for estimating the shadowrate and comparing the monetary stanceinternationally indicates that the currentstance of monetary policy in the euro areais expansionary with respect to the othercentral banks.US SSR (Knippner)EA SSR (Knippner)UK SSR (Knippner)JPN SSR (Knippner)Source: Reserve Bank of New Zealand.4 The data consist of month-end government interest rates and overnight indexed swap (OIS). For the euro area Germangovernment bond data are employed. Wu and Xia (2014) propose SSR measures also for the euro area and the UKspanning until the beginning of 2014. We focus on Krippner’s measures, since it is available also for Japan and they areupdated monthly.5 See the ECB Monthly Bulletin, July 2014.


Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 1545Box B: Monetary Policy Rates and Shadow Short RatesBy Valentina ColomboReferencesBlack, F., 1995. “Interest rates as options”, Journal of Finance, 50: 1371-1376.Gilchrist, S., V. Yankov, and E. Zakrajšek, 2009. “Credit Market Shocks and EconomicFluctuations: Evidence from Corporate Bond and Stock Markets”, Journal of MonetaryEconomics, 56 (4): 471-93.Krippner, L., 2012. “Modifying Gaussian term structure models when interest rates are nearthe zero lower bound”, Reserve Bank of New Zealand Discussion Paper.Krippner, L., 2013. “A tractable framework for zero-lower-bound Gaussian term structuremodels”, Reserve Bank of New Zealand Discussion Paper.Lombardi, M., and F. Zhu, 2014. “A shadow policy rate to calibrate US monetary policy at thezero lower bound”, BIS WP No 452Rudebusch, G.D., B.P. Sack, and E.T. Swanson. 2007. “Macroeconomic Implications ofChanges in the Term Premium”, Review (Federal Reserve Bank of St. Louis), 89 (4): 241-69.Wu, J. C. and F. Xia, 2014. “Measuring the macroeconomic impact of monetary policy at thezero lower bound”, NBER WP No 20117(SAFE) indicated that credit market conditionsimproved for firms, including small andmedium-sized enterprises.The programme has lowered the yields onmost euro-area government bonds (Chart 6).Through to the end of May, ten-year yieldsfell in the range of 1 to 8 basis points lowerin Germany, France and Spain and werearound 30 to 75 basis points lower in Irelandand Portugal than in November last yearwhen expectations of ECB asset purchasesbegan to form. The fall in yields had beenmore noticeable for longer-term bonds thanthose at shorter maturities. Since bonds withshorter maturities tend to have lower yields, itis likely that the announcement that the ESCBwould only purchase bonds with a yield abovethat of the deposit facility (-0.2 per cent) hascontributed to this asymmetric movement.However, developments through June, in directresponse to the uncertainty regarding theGreece negotiations with creditors, reversedmost of these.Euro area yields in May and June alsoreflected higher volatility. This volatility ispartly a consequence of the broader low yieldenvironment: at very low levels of interestrates, asset prices tend to show highervolatility. Other causes include a number ofpositive surprises regarding the euro areaeconomy, technical market factors (such assupply pressures and low market liquidity)and a learning process whereby the marketis adapting to the Eurosystem’s large-scalepurchases of public sector bonds. Morerecently, uncertainty regarding the Greekfinancing situation increased the volatility ofGreek government bond yields substantially,with some volatility spillover to other peripheralcountries also evident.The expanded APP appears to have affecteda number of other financial market indicators.In most countries, the other asset classespurchased under the APP – covered bondsand asset-backed securities (ABSs) – mirroredthe developments for higher-rated sovereignbonds. In some countries, however, covered


46Developments in the Euro Area EconomyQuarterly Bulletin 03 / July 150.93Chart 5: Euro Exchange RatesEUR/GBPEUR/USD1.55 1600Chart 6: Selected Euro Area 10-Year SovereignBond Yield Spreads over Germany (bps)0.8814001.4512000.831.3510001.258000.780.731.151.056004002000.680.950MarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJunMarJunSepDecMarJunSepDecMarJunSepDecMarJunSepDecMarJun2011 2012 2013 2014 20152011 2012 2013 2014 2015EUR/GBP (Left Axis)Source: Thomson Reuters Datastream.EUR/USD (Right Axis)France Italy SpainIreland PortugalSource: Thomson Reuters Datastream.bonds and ABSs were affected by theuncertainty surrounding Greece’s access tofinance, resulting in some increases in coveredbond spreads and discount margins for ABSs.Euro area equities have increased with theprogramme. There are indications that banks’funding costs are being pushed down. Overtime, this should lead to a further improvementin credit conditions for euro area businessesand households. Finally, since November whenexpectations that an APP would be adoptedstarted to form, the euro has depreciatedsharply, also reflecting divergent economicprospects and monetary policy stances acrossthe major economies.


Section 2Quarterly Bulletin 03 / July 1547Signed ArticlesThe articles in this section are in theseries of signed articles on monetaryand general economic topics introducedin the autumn 1969 issue of the Bank’sBulletin. Any views expressed in thesearticles are not necessarily those heldby the Bank and are the personalresponsibility of the author.


48Data Gaps and Shadow Banking:Profiling Special Purpose Vehicles’Activities in IrelandBrian Godfrey, Neill Killeen and Kitty Moloney 1AbstractThe role of shadow banking and securitisation has gained increasing nationaland international attention since the start of the global financial crisis in2007. Ireland has a sizeable non-bank financial sector with a number of keycomponents including money market funds (MMFs), investment funds (IFs)and other financial intermediaries (OFIs). This Article focuses on the activitiesof financial vehicle corporations (FVCs) and special purpose vehicles (SPVs)within the OFI sector. The main features of these vehicles and their linkages tothe Irish and international economies are examined. The Article also discussesrecent regulatory developments and potential financial stability issues arisingfrom their activities. In order to address data gaps and to improve oversightof the SPV sector, the Central Bank of Ireland will extend quarterly reportingrequirements to SPVs.1 The authors are Economists in the Statistics Division and the Markets Supervision Directorate of the Central Bank of Ireland. Theviews expressed in this Article are solely the views of the authors and are not necessarily those held by the Central Bank of Irelandor the European System of Central Banks (ESCB). The authors would like to thank Kenneth Devine, Anastasios Matopoulos andNaoise Metadjer for excellent research assistance. We are grateful to John Flynn, Brian Golden, James Leen, Joe McNeill, GarethMurphy and David Owens for helpful comments on earlier drafts of the Article.


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 15491. IntroductionThe role of shadow banking and securitisationhas gained increasing national and internationalattention since the start of the global financialcrisis in 2007. In November 2010, the G20called for the Financial Stability Board (FSB)to develop recommendations to strengthenthe oversight and regulation of the shadowbanking system. The FSB defines shadowbanking as ‘credit intermediation involvingentities and activities fully or partially outsideof the regular banking system.’ 2 Variousdefinitions of shadow banking comprise someor all of the entities in the non-bank financialsector. 3Ireland has a sizeable non-bank financial sectorcomprising money market funds (MMFs),investment funds (IFs) and other financialintermediaries (OFIs). This paper focuses onthe activities of financial vehicle corporations(FVCs) and special purpose vehicles (SPVs) 4within the OFI sector. These vehicles are set upas tax neutral in accordance with Section 110of the Taxes Consolidation Act 1997 (Section110). 5 Since the fourth quarter of 2009, theCentral Bank of Ireland has collected data onIrish FVCs. These data feed into the EuropeanCentral Bank’s (ECB) FVC data and gives anindication of the level of securitisation activityacross the euro area. However, at presentthere is no comparable Irish or euro areadataset for SPVs.This data gap presents challenges for financialauthorities engaged in mapping and monitoringthe shadow banking sector in Ireland andEurope. 6 The main contribution of this paperis to fill in some of the data gaps for the Irishshadow banking system, thereby improvingthe transparency and oversight of this sector.To that end, this paper examines both theactivities of Irish FVCs engaged in securitisationactivity and the activities of other SPVsregistered in Ireland.Section 2 discusses the definitions ofFVCs and SPVs and outlines our researchmethodology. Section 3 examines the FVC andSPV industry in Ireland and briefly describesthe development of this sector in Ireland. Themain findings on the activities of FVCs andSPVs are discussed in Section 4. Section5 focuses on the new and existing financialservices regulations, which can shed light onFVCs’ and SPVs’ activities in Ireland and brieflydiscusses potential financial stability issues.Section 6 concludes.2. Definitions of FVCs/SPVs andMethodology2.1 Definitions of FVCs and SPVsFVCs and SPVs are legal entities that areoriginated by a sponsoring firm, usually abank, finance company or insurance company.Irish FVCs and SPVs engage in a wide rangeof activities which may include investmenttransactions, securitisation transactions,distressed debt transactions, balance sheetmanagement, and fundraising. FVCs aresecuritisation vehicles and are obliged to reportto the Central Bank of Ireland under an ECBRegulation. 72 See FSB (2014).3 The FSB, in its annual mapping exercise defines shadow banking as the total assets of the non-bank financial sector. FSB (2014)also produce a narrower measure of shadow banking, which is constructed by filtering out non-bank financial activities that have nodirect relation to credit intermediation (e.g. equity investment funds, intra-group activities of non-financial groups and retainedsecuritisation). In the academic literature, a number of alternative definitions of shadow banking have been proposed. For example,Claessens and Ratnovski (2014) define shadow banking as “all financial activities, except traditional banking, which rely on private orpublic backstop to operate.”4 For the purpose of this Article, SPVs refer to those vehicles which do not meet the ECB’s FVC definition, see Section 2.5 See Section 3 for an overview of the Section 110 framework in Ireland.6 See Godfrey and Golden (2012).7 Regulation ECB/2008/30 concerning statistics on the assets and liabilities of FVCs, which are engaged in securitisation typetransactions. An entity would qualify as an FVC if their principal activity meets the following criterion: ‘it intends to carry out, orcarries out, one or more securitisation and is insulated from the risk of bankruptcy or any other default of the originator’. On theissuance side, an entity must ‘issue or intends to issue, securities, securitisation fund units, other debt instruments and/or financialderivatives’ in either a public or private issuance. Furthermore, if the vehicle is part of a multi-vehicle structure where one of the othervehicles is an FVC then it would also be considered an FVC even if it was not directly involved in securitisation itself.


50Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in IrelandAn entity is an FVC if its main activity issecuritisation 8 as defined by the ECB FVCRegulation. The FVC Regulation seeks tocollect data on securitisation vehicles’ linkageswith the banking system. The financingarrangement supporting a securitisationtransaction should result in the issuance ofsome form of marketable debt instrument.Securitisation involves the transfer of creditrisk from a bank’s balance sheet to a FVC’sbalance sheet. This transfer of credit risk isfunded by the issuance of debt securities,which in some cases, can be brought back onto the balance sheet of the bank (i.e. retainedsecuritisation) and used as collateral with theECB in monetary operations. Alternatively,the debt securities can be sold on to otherinvestors (e.g. other banks, insurancecompanies, pension funds, hedge funds).SPVs have many characteristics of FVCsbut fall outside the ECB definition. The mainactivity of Irish SPVs is loan origination even if aminority of its activities pertain to securitisation.SPVs can also issue debt securities or theymay be set up for the purpose of financinga group or part of a group through theuse of loans. One of the key challenges ofanalysing SPVs incorporated in Ireland isthe categorisation of these activities owingto the complexity and opaqueness of theirtransactions.2.2 MethodologyTo examine this sector we construct a uniquefirm-level dataset of FVCs and SPVs registeredwith the Companies Registration Office (CRO)in Ireland. This dataset is based on 2012financial accounts. A number of variables arechosen to review the activities of these entities.These include firm-level information such astotal assets under management, the dateand address of incorporation, the number ofdirect employees and the fees paid to Irishcorporate service providers (e.g. legal fees,administration fees, audit fees). Information isalso collected on relevant counterparties suchas the name, location and sector of the FVCs’and SPVs’ creditors and debtors. In additionto collating the dataset, a series of meetingswere held with the directors of 26 SPVs. Themeetings took place from January to March2015 and assessed to what extent the vehicleswere within scope of existing and forthcomingfinancial services regulations.The methodology outlined above has anumber of limitations. Firstly, there is significantheterogeneity regarding the informationreported in the financial accounts. Forexample, some financial accounts includeinformation on the name and location of thedebtors, creditors and derivative counterpartieswhile other accounts do not disclose this levelof granularity. Secondly, the heterogeneousnature of the activities within this sector meansit is difficult to categorise the vehicles withinour dataset. Finally, the analysis is based ondata collected from a one-off exercise of 2012financial returns.3. The FVC and SPV Industry inIrelandBased on our analysis of financial accounts ofFVCs and SPVs, we estimate that there areapproximately 1,300 vehicles located in Irelandat the end of 2012. These vehicles are set upas broadly tax neutral under Section 110. 9Of this total, approximately 700 entities areFVCs, while the remaining 600 entities can beclassified as SPVs. Since the fourth quarter of2009, data on Irish FVCs has been collectedby the Central Bank of Ireland. 10 The mostrecent FVC data shows that there are 779FVCs resident in Ireland in the first quarter of2015 (Chart 1).Within the euro area there are ten countrieswhich have resident FVCs. Ireland hasthe largest proportion of domiciled FVCsby numbers and assets of any euro areacountry (Chart 2). Other jurisdictions such asLuxembourg and the Netherlands also have8 Securitisation is defined as a transaction(s) where the credit risk of an asset is transferred to the balance sheet of an entity, eitherthrough the economic transfer (purchase) of the asset or through the use of derivatives.9 Section 55 of the Finance Act 1996, http://www.irishstatutebook.ie/1996/en/act/pub/0009/print.html#sec5510 See Godfrey and Jackson (2011).


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 1551Chart 1: Overview of Section 110 vehicles inIrelandChart 2: Q1 2015: Number and Assets of FVCsin Euro AreaSection 110 vehicles:a tax neutral framework900800NumbersAssets bn450400700350600300500250779 FVCsMain activity: SecuritisationReporting since Q4 2009AUM €415bn (Q1 2015)Approx. 600 SPVsOther activitiesNon-reportingApprox. AUM €150bn(2012)40030020010020015010050Sources: Central Bank of Ireland, CompaniesRegistration Office (CRO) and authors’ calculations.Note: FVCs include NAMA vehicles.0Ireland Luxembourg Italy Netherlands SpainTotal Number of FVCs (LHS)France Germany Portugal Belgium MaltaAssets(EUR Billions) (RHS)0Sources: Central Bank of Ireland and European Central Bank (ECB).sizeable FVC populations. However, at presentthere is no comparable euro area dataset forSPVs who fall outside the FVC definition.Certain taxation provisions in Ireland allowFVCs and SPVs to be structured as broadlyprofit- and tax- neutral. These provisions wereoriginally introduced in 1991 11 to facilitate thesecuritisation of mortgages. These provisionswere extended to transactions outside theIFSC with the implementation of Section 110(effective in 1999). The Section 110 regimewas expanded by the Finance Act 2003 12 , theFinance Act 2008 13 and again in the FinanceAct 2011 14 to broaden the range of financialassets a Section 110 company can hold,manage or lease.A company must meet a number ofconditions to qualify under the Section110 framework. Firstly, the company mustbe resident in Ireland. Secondly, it mustacquire “qualifying assets” which includeshares, bonds, investment in money marketfunds, commodities, leases, hire purchaseagreements, greenhouse gas emissions,contracts for insurance and reinsurance, andthe ownership, management and leasing ofplant and machinery. Thirdly, the market valueof the qualifying assets must be at least €10million on the date the assets are first acquiredby the newly incorporated Section 110company. Finally, the company must notify theIrish tax authorities if it wishes to avail of theSection 110 framework.In addition to the Section 110 provisions,other reasons for FVCs and SPVs locating inIreland include an extensive double taxationtreaty network, a common law environment, acorporate administration support network, anefficient listing of securities on the Irish StockExchange (ISE), and Ireland’s membership ofthe OECD and European Union.11 Section 31 of the Finance Act 1991, http://www.irishstatutebook.ie/1991/en/act/pub/0013/print.html#sec3112 Section 48 of the Finance Act 2003, http://www.irishstatutebook.ie/2003/en/act/pub/0003/sec0048.html#sec4813 Section 36 of the Finance Act 2008, http://www.irishstatutebook.ie/2008/en/act/pub/0003/sec0036.html#sec3614 Section 40 of the Finance Act 2011, http://www.irishstatutebook.ie/2011/en/act/pub/0006/sec0040.html#sec40


52Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in Ireland4. Main FindingsThis section presents the main findings of ourresearch which is divided as follows: technicalfeatures, domestic linkages, internationallinkages and a series of case studies. The casestudies are generic but reflect some of thebusiness models employed by FVCs and SPVsincorporated in Ireland.250200150Chart 3: Number of new FVCs and SPVs in Irelandby year of incorporation, at end-2012Numbers4.1 Technical features of FVCs and SPVs100Our analysis of firm-level financial accountsfound that many of these vehicles are set upusing an orphan entity ownership structure. Asnoted by BIS (2009), one of the consequencesof this ownership structure is that it ensuresthat the entity is not owned by the originator,but rather by a charitable trust. These trustsare usually set up by a corporate serviceprovider or a law firm. This structure ensuresthat the entity should not be affected by anylegal claims against the originator (BIS, 2009).In addition, our analysis found that the majorityof FVCs and SPVs incorporated in Ireland haveno direct employees.Other legal protections used by the industryinclude the use of “limited recourse” and “nonpetition”covenants within the legal contracts."Limited recourse" means that creditors of thevehicle only have a claim on what the entityis paid. “Non-petition” refers to a situationwhereby creditors give up the right to petitionfor liquidation of the vehicle. Many of thecontracts underpinning the incorporation andactivities of these vehicles are governed byUK or US law even though the entities areregistered in Ireland. In this way, the industrycontinues to use the legal frameworks ofjurisdictions where the main legal tenetshave generally been tested, even thoughthe vehicles are registered outside of thesejurisdictions.The lifecycle of a FVC or SPV is dependenton the motivation and nature of its activities.Based on our discussions with industry, theaverage lifecycle of a vehicle can range fromapproximately five to ten years. Using financial5002000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Number of newly incorporated SPVsSources: Companies Registration Office (CRO) and authors’calculations.account information for FVCs and SPVsthat are active in 2012, we found that mostvehicles were established in 2006 (Chart 3). Itis noteworthy that the number of new vehiclesincorporated in Ireland falls significantly in 2009which coincides with the global financial crisisand the collapse in the securitisation market inEurope.Irish domiciled FVCs are usually fundedthrough a number of different types of debtissuance depending on the nature of thesecuritisation that the FVC is involved in. Thiscan range from commercial or consumer assetbacked securities, commercial or residentialmortgage backed securities, commercialpaper, profit participation notes and differenttypes of floating notes. Debt securities issuedby FVCs have to be marketable and areusually issued in multiple tranches dependingon the level of subordination of the securityissued. The more senior notes would have firstclaim on any cash that a FVC receives, whilethe more junior notes would have more riskexposure but would receive a higher rate ofinterest in compensation.


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 1553Chart 4: Top 20 Cross-Border Linkages – FVC/SPV Debtor LinksChart 5: Top 20 Cross-Border Linkages – FVC/SPV Creditor LinksSource: Companies Registration Office (CRO) and authors’calculationsSource: Companies Registration Office (CRO) and authors’calculationsIrish domiciled SPVs can be funded via theissuance of different note types including, forexample, profit participation notes, loan notes,index linked notes, floating rate notes and limitedrecourse notes. The risks and characteristicsassociated with these notes vary widely. Forexample, the returns from a profit participationnote relate to the profits of the SPV. The numberof investors can also vary significantly, forexample, depending on whether it is a privatelyissued loan note or a publically listed note.4.2 Domestic linkagesThere are 22 FVCs with approximately €39billion linked to Irish banks in the first quarterof 2015. The remaining FVCs and SPVs havelimited direct links to the Irish economy asthe majority of their assets and liabilities arelocated outside of Ireland. The main benefit tothe Irish economy comes through fees paidto Irish corporate service providers, law firms,auditors and the ISE. Based on our analysisof FVCs’ and SPVs’ financial accounts, weNote: AU = Australia; BE = Belgium; BM = Bermuda;CA = Canada; CH = Switzerland; CN = China; DE = Germany;DK = Denmark; ES = Spain; FI = Finland; FR = France;GB = United Kingdom; GE = Georgia; IE = Ireland; IT = Italy;JE = Jersey; JP = Japan; KY = Cayman Islands; KR = Korea;LU = Luxembourg; NL = Netherlands; NO = Norway;PT = Portugal; RU = Russia; SE = Sweden; US = UnitedStates.estimate that the average set up fees paidto Irish service providers is approximately€50,000 and the average annual administrativefees paid to Irish service providers ranges inbroad terms between €40,000 to €80,000. 15While these vehicles have little interactionwith the domestic economy, they can havea significant impact on Irish macroeconomicstatistics. This is due to the fact that thesevehicles are recorded as residents, meaningthere is a sizable impact on external sectorstatistics.4.3 International linkagesFVCs and SPVs are connected to the widerglobal financial system as the majority of theircreditors and debtors are located outside15 Fees depend on the complexity of the vehicles (number of debt securities issued etc.) and stage in the life cycle of the vehicle (e.g.fees are higher in year 1 with start-up fees). The financial accounts are not consistent in the treatment of fees and thus our estimatedrange is a guide only.


54Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in Irelandof Ireland. Charts 4 and 5 present the top20 cross-border linkages of Irish domiciledFVCs and SPVs. The charts are un-weightednetworks and therefore the size of the noderepresents the number of FVCs and SPVslinked to that country as opposed to the eurovalue of the exposure. Chart 4 shows that thetop 20 locations of debtors to Irish domiciledFVCs and SPVs. The United States, theUK, Germany, France, Italy, Russia and theNetherlands are the top locations of debtorsfor these vehicles.On the creditor side (Chart 5), the top locationsare the UK, the US, Germany, Luxembourgand the Cayman Islands. The large node forIreland in the creditor graph is explained byFVCs and SPVs that issue debt securitieson the ISE, intra-sector flows and domesticlinkages. Information on the location of thefinal investor is not readily available for debtsecurities as data are collected on a firstcounterparty basis. In addition, financinglinkages between FVCs and SPVs can alsoimpact the creditor links. As these vehiclescan be part of multi-vehicle structures, an Irishregistered entity may be listed as a creditor toanother Irish registered FVC or SPV. However,the ultimate creditor may be located outside ofIreland.4.4 Case StudiesThis section describes some generic casestudies of FVCs’ and SPVs’ activities.Case Study A: Irish domiciled SPV used as bankruptcy remote funding vehicleThis case study outlines a structure which uses an Irish domiciled SPV to ensure bankruptcyremoteness. Chart A summarises the transaction and the role of the Irish SPV.Chart A: Summary of TransactionsShares held on trust for charitable purposes(orphan vehicle structure)Proceeds from transferof receivablesLoansSenior lendersOriginator(MNC)Transfer of tradereceivablesIrishdomiciledSPVPrincipal and InterestSubordinatedlendersThe multinational corporation (MNC) transfers its receivables into an Irish domiciled SPVwhich uses these assets to attract cheaper funding. The Irish domiciled SPV receives loansfrom a syndicate of senior and subordinated lenders and uses these funds to buy the tradereceivables from the originator (the MNC). The MNC would have to pay a much higher rateif it were to raise finance directly but benefits from cheaper funding by simply isolating thereceivables in an Irish domiciled SPV. In order to ensure bankruptcy remoteness, the Irishdomiciled SPV is set up using an orphan vehicle structure whereby the shares of the SPV areheld on trust for charitable purposes.


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 1555Case Study B: Irish domiciled SPV used in a tax efficiency structureThis case study outlines a structure which uses an Irish domiciled SPV to ensure tax efficiency.Chart B summarises the transaction and the role of the Irish SPV.Chart B: Summary of TransactionsEntity located in Country A(Ultimate Parent)Gains utilising Country A/ Country Bdouble taxation treatyInvestment incompany locatedin Country CFundsGains utilising Irish/Country C doubletaxation treatyIrishdomiciledSPVProceeds of the notesNote redemptions andnote interest paymentsEntity located inCountry B(Immediate parentof Irish SPV)Cross-border payments made by the Irish SPV under a profit participating note to a countrywithin the EU or with whom Ireland has signed a double taxation treaty are free of Irishwithholding tax. However, in this case study, payments by an Irish SPV to Country A do notgain this exemption owing to the fact that Ireland does not have a double taxation treaty withCountry A. Country B, on the other hand, has a double taxation treaty with Country A whichallows the payments to be made free of withholding tax. Ireland is often the chosen hostjurisdiction for investment vehicles owing to Ireland’s wide network of comprehensive doubletaxation treaties. As illustrated in Chart B, the Irish domiciled SPV is utilised to take advantageof the Irish tax treaty with Country C owing to the fact that it is a more favourable treaty thanthe tax treaty between Country B and C.


56Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in IrelandCase Study C: Irish domiciled SPV structure and relevant regulationsChart C presents an example of a simple SPV structure which makes loans to a regulatedEuropean bank.Chart C: Summary of TransactionsShares held on trust for charitable purposes(orphan vehicle structure)Principal and InterestPrincipal and InterestBank Country AIrishdomiciledSPVStock Exchange –Note holders notdisclosedLoansProceeds of the notesInterest rate swapCross currency swapInterest rate swapCross currency swapBank Country BBank Country CThe SPV funds itself by issuing paper which is listed on a stock exchange and must thereforecomply with disclosure requirements and listing rules (e.g. Prospectus and TransparencyDirectives). As the SPV hedges various exposures with derivatives it must comply with theEuropean Market Infrastructures Regulation (EMIR) and report information on its derivativestrades to a trade repository. SPVs with strong cross-sector and border interlinkages (includingSPVs with strong interconnectedness with the regulated banking system as illustrated in ChartC), can raise concerns regarding contagion and financial stability.


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 1557Case Study D: Irish domiciled FVC structure investing in mortgage backed securitiesChart D presents an example of a FVC structure which invests in mortgage backed securitiesand issues different types of debt securities.Chart D: Summary of TransactionsInvestmentManagerPrincipal and interestpaymentsNon-euro interest andprincipalMortgagePortfolioFVC(Issuer)Asset SwapCounterpartyPurchase of collateralEuro interest and principalProceeds ofthe notesNotes redemption andnotes interest paymentsClass ANotesClass BNotesClass CNotesClass DNotesClass ENotesSubordinatedNotesThis FVC funds itself by issuing multiple “tranches” of debt securities and invests in a portfolioof mortgages from a bank. These transactions can be cross-border in nature. Each class ofdebt security has a different seniority with a credit rating assigned depending on the level ofseniority. The notes are redeemed in order of seniority and any defaults affect the subordinatednotes first which results in the lower rated securities receiving higher interest payments. Anasset swap counterparty can also be involved to hedge any currency risks if the notes havebeen issued in a different currency to that of the mortgages held.


58Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in IrelandConsidering the complexity of thesetransactions in terms of the number ofvehicles, securities and jurisdictions involved,it is possible that these entities may be usedby originators to obscure the true economicnature of their activities.5. Regulatory Developments andFinancial Stability Issues5.1 Relevant securities and marketsregulationsNo single regulation covers all of the activitiesof FVCs and SPVs. As noted by the CentralBank of Ireland (2014), various sectoralfinancial services regulations are likely toapply, directly or indirectly, to these vehicles(e.g. banking, insurance and fund regulations,investor disclosure and market monitoringregulations). These regulations will betterinform regulators seeking to assess thefinancial stability impact of FVCs’ and SPVs’activities.For example, FVCs and SPVs who engage inderivative trading will be within scope of theEuropean Union regulation on derivatives,central counterparties and trade repositories,the European Market Infrastructure Regulation(EMIR). EMIR imposes reporting requirementson all entities entering into derivative contracts.Our analysis suggests a significant minority ofIrish domiciled FVCs and SPVs are involved inderivative contracts.FVCs and SPVs may also fall under theProspectus and Transparency Directives shouldthey decide to publically issue debt. 16 Theprospectus must contain all information which,according to the particular nature of the issuer(and of the securities issued), is necessaryto enable investors to make an informedassessment of the investment. Informationincludes details of the assets and liabilities,financial position, profit and losses, andprospects of the issuer and of any guarantor;and the rights attaching to such securities.Publically listed debt issuances have fewerreporting requirements than equity issuancesunder the Regulation. There is, for example, nopublic register requirement of debt securitiesholders as exists for equity. Regulators may beable to get information on a first counterpartybasis but this may not identify the beneficialowner of the debt. If the first counterparty is astock exchange, regulators have no informationon the final investor. Our initial analysis showsthat most FVCs and some SPVs are issuingdebt publically but there are a significantnumber issuing debt privately.The Securities Financing TransactionRegulation (SFTR) is a new proposal by theEuropean Commission to develop a reportingregime for securities financing transactions(i.e. lending and borrowing of securitiesand commodities, repurchase or reverserepurchase transactions, or buy-sell backor sell-buy back transactions). Our analysissuggests the use of securities transactionfinancing by Irish domiciled FVCs and SPVs isrelatively limited.In addition to the securities and marketsregulations outlined above, there areforthcoming requirements under the CreditRatings Agencies Regulation (CRA3) forreporting of financial information on ratedinstruments. This will provide some informationon privately issued debt which is rated.Unrated privately issued debt by SPVs willcontinue to fall outside of scope. Risk retentionrequirements have also been put in place forbanks and insurers issuing securitisations. 17There have been calls from the Bank ofEngland and ECB (2014, 2015), EuropeanCommission (2015) and Segoviano et al.(2015) amongst others, to standardise andsimplify securitisation in order to reduce thefinancial stability risks posed by the lack oftransparency in the sector.Overall, while these existing and newregulations will improve oversight andtransparency of this sector, some FVCs andSPVs may remain partially or fully outside theregulatory perimeter. This presents challengesfor authorities engaged in mapping andmonitoring FVC and SPV activities and theshadow banking system in general. In addition,due to the cross-sectoral and global flow offunds within the FVC and SPV sector (see16 On a regulated market or make an offer of securities to the public within the European Economic Area.17 By virtue of Article 135(2) of Directive 2009/138/EC (Solvency II) for insurance undertakings and by virtue of Article 405 of Regulation(EU) No 575/2013 (CRR) for credit institutions.


Data Gaps and Shadow Banking: ProfilingSpecial Purpose Vehicles’ Activities in IrelandQuarterly Bulletin 03 / July 1559Sections 4.3 and 4.4), good macro-oversightof this sector will require data sharing andgeneral co-operation amongst regulators.5.2 Financial Stability IssuesSecuritisation and other non-bank creditintermediation allow investors to diversify andmanage risk. This allows borrowers to reducethe cost of capital by ring-fencing assets andactivities or by accessing new pools of credit.However, despite these benefits, distress in thenon-bank financial sector can also lead to thebuild-up of systemic risk and thereby threatenthe functioning of the entire financial system(Segoviano et al., 2015). Some potential risksidentified by international standard setterssuch as the FSB (2011) and others includethe concentration of business models andassets, high leverage, maturity or liquiditymismatch, illiquid assets, and imperfect creditrisk transfer. Our analysis, although preliminaryin nature, identified some of these features inIrish domiciled FVCs and SPVs (e.g. similarbusiness models, illiquid assets, etc.)FVCs and SPVs have significantinterconnectedness with the regulatedbanking system owing to direct contractualarrangements such as funding linkages. 18The extent of the interconnectedness is hardto measure accurately as the linkage may beimplicit rather than explicit. 18 This complexitymakes risk assessment more challenging. Forexample, it obscures the assessment of theloss absorption capacity of the vehicle andmakes balance sheet data (e.g. leverage) lessmeaningful.Non-bank entities such as FVCs andSPVs are subject to both lighter regulatoryrequirements and less intensive supervisionthan banks. As these entities remain on oroutside the regulatory perimeter, they can alsopotentially exacerbate the vulnerabilities withinthe financial system. Given the limitationsin regulatory oversight, Constancio (2015)highlights the need to develop a monitoringframework for the non-bank financial systemincluding the expansion of macroprudentialtools for non-bank financial entities.To fully assess the financial stability implicationsof this sector, detailed granular data is required.As SPV risks are mainly external, these dataare required to map the international linkagesof SPVs and their interconnectedness with theregulated banking system. In order to fill someof these data gaps, the Central Bank of Irelandwill extend its reporting requirements to includeSPVs, requiring them to report the samequarterly data as FVCs.6. ConclusionThe global financial crisis highlighted the need tobetter understand the activities of entities withinthe shadow banking system. Owing to limitedgranular data for a significant portion of theshadow banking system in Ireland, it is difficultto assess fully the financial stability implicationsof activities within this sector. Motivated bythese data gaps, we construct a unique firmleveldataset of FVCs and SPVs which areincorporated in Ireland and which avail of theSection 110 framework. Based on these data,we estimate that there are approximately 1,300FVCs and SPVs registered in Ireland in 2012.These vehicles are engaged in a broad arrayof activities including investment transactions,securitisation transactions, distressed debttransactions, balance sheet management, andfundraising. Irish domiciled FVCs and SPVs alsohave significant interconnectedness with theregulated banking system.While existing and new financial servicesregulations will improve oversight andtransparency of this sector, some SPVs mayremain fully or partially outside the regulatoryperimeter. This presents challenges for authoritiesengaged in mapping and monitoring SPVactivities and the shadow banking system ingeneral. Some of the characteristics of IrishFVCs and SPVs could potentially pose risks tointernational financial stability (as outlined by theFSB and others) owing to their activities, theirinternational financial linkages and the limitedoversight of the sector. Later this year, the CentralBank of Ireland will extend its FVC reportingrequirements to SPVs in order to improve thetransparency and oversight of this sector.18 See Gorton and Souleles (2007) and Archarya et al. (2013) for discussions of the importance of funding linkages and sponsorsupport in determining the functionality of the SPV market.


60Data Gaps and Shadow Banking: ProfilingQuarterly Bulletin 03 / July 15Special Purpose Vehicles’ Activities in IrelandReferencesAcharya, V., Schnab, P., and G. Suarez (2013),"Securitization without risk transfer.", Journal ofFinancial Economics, 107 (3),p. 515-536.Bank of England and ECB (2014), “The casefor a better functioning securitisation marketin the European Union”, A Joint DiscussionPaper, 2014.Bank of England and ECB (2015), “An EUframework for simple, transparent andstandardised securitisation”, Joint responsefrom the Bank of England and the EuropeanCentral Bank to the Consultation Document ofthe European Commission.Godfrey B. and C. Jackson (2011), “Meetingthe Statistical Challenges of FinancialInnovation: Introducing New Data onSecuritisation”, Central Bank Quarterly BulletinQ3 2011.Gorton, G. B., and N. S. Souleles, (2007),“Special purpose vehicles and securitization”.In The risks of financial institutions (pp. 549-602). University of Chicago Press.Segoviano, M., Jones, B., Linder, P., andJ. Blankenheim (2015), “Securitization: TheRoad Ahead”, IMF Staff Discussion Note,International Monetary Fund, January.Bank for International Settlements (BIS) BaselCommittee on Banking Supervision, (2009),“The Joint Forum: Report on Special PurposeEntities”, September.Central Bank of Ireland (2014), “Box 6:Monitoring FVC and SPV Activity in Ireland”,Macro-Financial Review, p. 39, December2014.Claessens, S., and L. Ratnovski (2014), “Whatis Shadow Banking?”, IMF Working Papers14/25, International Monetary Fund.Constancio, V. (2015), “Reinforcing financialstability in the euro area”, Speech at the OMFIFGolden Series Lecture, London 8 May 2015.European Commission (2015), “An EUframework for simple, transparent andstandardised securitisation”, ConsultationDocument, February 2015.FSB (2011) “Shadow Banking: StrengtheningOversight and Regulation; Recommendationsof the Financial Stability Board” October.FSB (2014), “Global Shadow BankingMonitoring Report 2014”, November.Godfrey B. and B. Golden (2012), “MeasuringShadow Banking in Ireland using GranularData”, Central Bank Quarterly Bulletin Q42012.


61The Expanded Asset Purchase Programme– What, Why and How of Euro Area QEBy Peter Dunne, Mary Everett and Rebecca Stuart 1AbstractThis article explains the what, why and how of the ECB’s expanded assetpurchase programme, commonly referred to as ‘Quantitative Easing’. Thescope and scale of this purchase programme is unparalleled in the euro areaand it is expected to have a large effect on the euro area economy. This articlediscusses the details of the programme, the reasons it was introduced, and thevarious channels through which it is expected to affect the real economy.1 The authors are economists in the Monetary Policy Division. We thank Danielle Kedan, Reamonn Lydon, Martin O’Brien and GillianPhelan for comments. The views expressed are the authors' and do not necessarily represent those held by the Central Bank ofIreland or the European System of Central Banks.


62The Expanded Asset Purchase Programme – What, Quarterly Bulletin 03 / July 15Why and How of Euro Area QE1. IntroductionOn 22 January 2015, the Governing Councilof the ECB announced that it would purchasegovernment bonds on a large scale 2 , a practicecommonly referred to as ‘Quantitative Easing’.With this announcement, the Eurosystemcommitted to purchasing more than €1 trillionof securities by September 2016. When theprogramme was announced, headline inflationhad been below 1 per cent for over a year, andhad turned negative the previous month. Thepurpose of the programme is to return inflationto a path consistent with the ECB’s statedobjective of below, but close to, 2 per cent,over the medium term.Purchasing public sector bonds is not anew concept. Indeed, the ECB has done sopreviously, although to a much smaller extent,in the Securities Markets Programme whichwas initiated in 2010. Furthermore, a number ofother central banks, notably the Bank of Englandand the Federal Reserve have initiated similarprogrammes since the financial crisis. However,the scale and scope of the current programmeis unparalleled in the euro area. The programmeis likely to have wide reaching effects on theeuro area economy. This article discusses theprogramme, why it was implemented, its aims,and the channels through which it is expected toaffect the real economy.The article is structured as follows. The nextsection discusses the context and details ofthe expanded asset purchase programme.Section 3 discusses the channels throughwhich the programme is expected to affect thereal economy. Section 4 concludes.2. What and why: reasons forand details of the programmeTraditionally, central banks ease monetarypolicy by reducing interest rates. However,sometimes central banks cut interest rates solow that they cannot reduce them any further;this is referred to as the zero lower bound(ZLB). 3 When this happens, central banks mustfind other ways to ease monetary policy toincrease inflation. In July 2013, with the euroarea having reached what was considered tobe very close to the zero lower bound 4 , theGoverning Council of the ECB attempted to dothis by introducing ‘forward guidance’ on thefuture path of the ECB’s policy rate conditionalon the economic outlook – essentiallyindicating that interest rates would remain atpresent or lower levels for an extended periodof time. 5However, having fallen to less than 1 per centin October 2013, the inflation rate continued todecline through much of the first half of 2014,with little expectation of a near-term pick-up.As a result, on 5 June 2014, the GoverningCouncil announced a package of measuresto further ease monetary policy. That packageincluded intensifying preparatory work relatedto the outright purchases in the asset-backedsecurities (ABS) market. On 4 September2014, the Governing Council lowered the mainrefinancing rate to 0.05 percent and announcedthat the Eurosystem would purchase simple andtransparent ABSs and covered bonds issued byeuro area financial institutions, referred to as theasset-backed securities purchase programme(ABSPP) and the third covered bond purchaseprogramme (CBPP3).These announcements were made in thecontext of falling inflation and downwardrevisions to ECB staff projections of inflationand growth. Through the end of 2014 andinto early 2015, many indicators of actual andexpected inflation in the euro area continued todrift downwards. The Governing Council notedthat since ‘potential second-round effects onwage and price-setting threatened to adverselyaffect medium-term price developments, thissituation required a forceful monetary policy2 It was also announced that the bonds of agencies and European institutions would be purchased.3 Although it is referred to as the ‘zero lower bound’, in practice the zero lower bound is not so clearly defined and is considered to bemarginally above zero.4 At that time, the interst rate was 0.5 per cent. Since then three further cuts to the rate have been made, most recently to 0.05 percent in September 2014.5 The Governing Council had used several other non-standard measures prior to forward guidance, including the expansion of thecollateral framework, the extension of fixed rate full allotment and the provision of very long term liquidity (in the form of VLTROsimplemented in December 2011 and February 2012).


The Expanded Asset Purchase Programme –What, Why and How of Euro Area QEQuarterly Bulletin 03 / July 1563response’. 6 Furthermore, the sharp declinein crude oil prices had reinforced marketexpectations of lower inflation, economic slackremained sizeable and credit growth wassubdued. As a result, on 22 January 2015the Governing Council announced that it wasadding a public sector purchase programme(PSPP) to the existing ABSPP and CBPP3programmes. Collectively, they are referred toas the expanded asset purchase programme(expanded APP).The Governing Council has stated that underthe expanded APP it will purchase €60 billionof securities monthly at least until September2016. These purchases began in March 2015.The PSPP will make up the majority of thesepurchases. Since it is so much larger in sizeand scope than the other components of theexpanded APP, commentators only beganusing the term ‘Quantitative Easing’ after thePSPP was announced (similarly, large assetpurchase programmes in other countriesalso attracted the same name, see Box 1).However, the expanded APP includes allthree of these programmes; for instance, themonthly €60 billion purchase target relates topurchases under the CBPP3, the ABSPP andthe PSPP.The aim of the expanded programmeannounced in January 2015 was to fulfil theECB’s price stability mandate, and to mitigatethe risk of a too prolonged period of lowinflation by firmly anchoring medium to longterminflation expectations. With interest ratesat their lower bound, the Governing Councilintends that the purchase of securities, and theeasing in the monetary stance that this entails,will improve financing conditions for firms andhouseholds in the euro area. Furthermore, itis intended that the programme will reinforcethe Governing Council’s forward guidanceand highlight the differences in the monetarypolicy cycle between major advancedeconomies, since it has been stated thatthe monthly purchases will continue until theGoverning Council believes that the inflationpath is consistent with rates in line with theECB’s medium term target, but at least untilSeptember 2016.Box 1: Quantitative Easing programmes in the US and the UKBy Danielle KedanMany central banks have conducted quantitative easing programmes in response to thefinancial crisis. This Box discusses those initiated by the Federal Reserve and the Bank ofEngland, and outlines some evidence of the impact of these programmes.Federal ReserveThe Federal Reserve has conducted three QE programmes since late 2008, in the wakeof the collapse of Lehman Brothers. These are popularly referred to as QE1, QE2 andQE3. In November 2008, the Federal Open Market Committee (FOMC) of the FederalReserve announced a programme (QE1) to purchase up to $600bn in agency mortgagebackedsecurities (MBSs) and agency debt 7 with the stated aim of reducing the costs ofborrowing and increasing the availability of credit for house purchases. With the continuedeconomic contraction, however, the FOMC decided in March 2009 to substantially expandthe programme in order to support economic recovery and preserve price stability. It wasannounced that up to $1.25 trillion of agency MBS would be bought, along with up to $200bnof agency debt and up to $300bn of longer-term Treasury debt. These purchases werecompleted in early 2010 and amounted in total to just under 12 per cent of US GDP. 86 See press statement, 22 January 2015: http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html7 The agencies associated with this debt were housing-related government-sponsored enterprises. Debt issued by these agencieswas viewed by market participants as benefitting from an implicit government guarantee.


64The Expanded Asset Purchase Programme –Quarterly Bulletin 03 / July 15What, Why and How of Euro Area QEBox 1: Quantitative Easing programmes in the US and the UKBy Danielle KedanIn November 2010, it was announced that the Federal Reserve would expand its balancesheet further by purchasing an additional $600bn in longer-term Treasuries by the end ofthe second quarter of 2011, at a pace of about $75bn per month (QE2). With the aim ofsupporting economic recovery and ensuring that inflation would be at levels consistent withprice stability over time, the FOMC decided in September 2011 to extend the maturity of itssecurities holdings.The Maturities Extension Program, also known as “Operation Twist”, involved the purchase of$400bn of Treasury securities with remaining maturities of 6 to 30 years, funded by the saleof an equal amount of Treasury securities with remaining maturities of 3 years or less. Thelast expansion of the Federal Reserve’s asset purchases (QE3) was announced in late 2012,when the FOMC decided to purchase additional agency MBS at a pace of $40bn per monthand to continue reinvesting principal payments from agency debt and agency MBS in agencyMBS. In addition, the Committee decided to further expand its holdings of Treasury securitiesat a pace of $45bn per month. Purchases were reduced gradually throughout 2014 and wereconcluded in October of that year. In total, the Federal Reserve’s asset purchases amountedto over 20 per cent of US GDP.Bank of EnglandIn early 2009, the Bank of England’s Asset Purchase Facility (APF) was established. Theobjectives of the APF were twofold. First, high-quality private sector securities (commercialpaper and corporate bonds) could be purchased with the aim of improving market liquidity andincreasing the flow of corporate credit. Second, the APF could be used for monetary policypurposes to ease the stance of policy through the purchase of medium- to long-maturity UKgovernment bonds via the creation of central bank reserves. Although some private sectorsecurities were purchased as part of the Bank of England’s asset purchase programme,purchases of UK government bonds dominated the APF.Purchases under the APF began in March 2009, when the Monetary Policy Committee (MPC)stated that it would buy £75bn of assets over three months. In May of that year, the MPCannounced an extension of asset purchases by an additional £50bn. The APF was extendedagain later in 2009, bringing purchases to £200bn by the end of the year. 9 Amid deteriorationin the medium-term inflation outlook, the Bank of England announced another expansion ofasset purchases by £75bn in October 2011. Further expansions were announced in 2012,bringing the total size of the APF to £375bn by end 2012, which amounted to over 20 percent of GDP.The table below presents a broad summary of the Federal Reserve and Bank of England QEprogrammes.Assets includedMaturities of sovereignbonds purchasedTotal amountpurchased(sovereign +other)Federal ReserveQE1 12/08-03/10Focus on 2-10 years$1,750bnQE2 11/10-06/11 US Treasuries, agency Focus on 2-10 years $600bndebt and agency MBSQE3 09/12-10/14Focus on 7-10 and 20-30 years$1,630bnBank of England03/09-11/12 UK gilts, corporate bondsand commercial paperFocus on 5-25 years£375bn


The Expanded Asset Purchase Programme –What, Why and How of Euro Area QEQuarterly Bulletin 03 / July 1565Box 1: Quantitative Easing programmes in the US and the UKBy Danielle KedanEstimated impact of these measuresStudies find that central bank asset purchase programmes in the US and UK during thefinancial crisis had a positive effect on both GDP and inflation. Estimates of the magnitudeof the effects of QE fall within a wide range, however, as illustrated in a literature review bythe IMF (2013). Direct comparison of results across studies is complicated by the fact thatsample periods vary between papers and different approaches can be used to assess themacroeconomic impact of QE. Focusing on a recent paper, Weale and Wieladek (2014) findthat asset purchases worth 1 per cent of nominal GDP have positive effects on real GDP andinflation of 0.36 per cent and 0.38 per cent in the US, and of 0.18 per cent and 0.3 per cent inthe UK, respectively.8 Nominal GDP in 2010.9 For further discussion of the Bank of England’s quantitative easing policy, see Joyce et al. (2011).3. How will the expanded APPwork?This section describes the main channelsthrough which the expanded APP can beexpected to affect the real economy. Caremust be taken in interpreting indicators atthis stage. Firstly, changes in economic datacan occur for a number of reasons, includinga general economic upturn, and we do notattempt to disentangle these effects. Secondly,monetary policy tends to affect the economywith long and variable lags. It is thought thatwhen central banks change interest rates theeconomic effect is only felt 1-2 years later,while purchases under the expanded APPhave only been taking place since March2015. As such what is presented in thisSection describes the likely ways in which theprogramme will impact the economy, ratherthan attempting to quantify the actual impactat this early stage. Nonetheless, a more indepthanalysis will allow firmer conclusions tobe drawn. Ample international literature pointsto effects of quantitative easing programmesin other countries across a range of variables.Drawing on this, the Central Bank will estimatethe impact of the expanded APP on the euroarea economy as more data become available.Box 2 gives an overview of some of themethods that could be employed.The mechanism through which centralbank asset purchases is expected to workis to expand broad money supply, therebyraising asset prices, lowering bond yieldsand reducing long-term interest rates. As aresult, there should be a greater incentiveto spend money today rather than save,and thus the economy can be stimulated,and inflation increased. In this context, threeprimary channels through which a centralbank’s purchases of government securitiescan affect the real economy have beenidentified in the economic literature: theportfolio rebalancing channel, the bank lendingchannel and the signalling channel. Figure 1presents a stylised framework that highlightsthese three transmission channels and theirmacroeconomic outcomes. In the followingsections, these three channels are discussed inmore detail.


66The Expanded Asset Purchase Programme –Quarterly Bulletin 03 / July 15What, Why and How of Euro Area QEFigure 1: Transmission channels of asset purchases to the macro economyECB asset purchasesPortfolio rebalancingBank lending channel viaincreased reservesSignalling channel viaexpectations, confidence,and exchange rateWealth effectCost ofborrowingdecreasesBank lending increasesSpending andincome increasesInflation increasesBox 2: Conducting in-depth analysis of the effect of the expanded APP on the euro areaBy Peter Dunne and Mary EverettAs of yet there are too few data observations to conduct an in-depth analysis of themacroeconomic effect of the expanded APP. Furthermore, it cannot be inferred that changesobserved so far in macroeconomic and financial data are caused by the programme itself orby other factors, such as the general economic upturn. However, once more data are availablea number of techniques can be used. This Box describes some of these methods.The direct and indirect price-effects of the expanded APP can be assessed by using an‘event-study’ methodology. 10 This method seeks to isolate the effect of programme purchases,or ‘events’, by using high frequency event data. The relationship between bond pricemovements and purchase amounts (in a variety of pre- and post-‘event’ windows) is estimatedand tested for statistical significance. Other variables that normally explain variation in bondprice movements are included to control for their effects. The effect of the announcement ofthe expanded APP, and the anticipation of the announcement, can be assessed in a similarway, with the price effects averaged across a number of individual bonds and across differentbond markets.Event study methods can also be used to isolate the impact of the expanded APP oncorporate bond prices and other close substitutes for sovereign bonds. These wider effectsof the expanded APP can be expected as a result of the portfolio rebalancing behaviour ofinvestors (discussed in Section 3.1). Examination of changes in investors’ portfolios comparedto their historical behaviour (using the methods of Butt et al., 2012) can help determinewhether the expanded APP is the main cause of recent developments. In addition, the positiveeffects of asset purchases on new bond issuance activity can be assessed using regressiontechniques that control for other potential explanations of such activity. 11


The Expanded Asset Purchase Programme –What, Why and How of Euro Area QEQuarterly Bulletin 03 / July 1567Box 2: Conducting in-depth analysis of the effect of the expanded APP on the euro areaBy Peter Dunne and Mary EverettThe signalling effects of intervention programmes can be measured by analysis of adjustmentsin inflation and interest rate expectations. This can be assessed by examining whetherrevisions in these expectations around the time of the expanded APP are statisticallysignificant, and whether they indicate a change in perceptions about how effective theEurosystem will be in achieving its inflation objectives. Two broad approaches have beentaken in the literature. The first assesses whether the term structure of interest rates haschanged due to the pass-through to longer term yields of the expectations that short termrates will stay lower for longer than usual (e.g., Bauer and Rudebusch, 2013). A secondassesses whether there has been any change in the anchoring of long term inflationexpectations by modelling the Phillips curve which controls for the effects of a narrowing ofthe output gap (e.g., Kaihatsu and Nakajima, 2015). Whether changes in inflation expectationsmatter for actual inflation through their influence on wage bargaining and price setting, asdescribed by Krugman (1998), Svensson (2003) and Woodford (2012), may be considered aspart of post-expanded APP research plans using an approach similar to Gilchrist et al., 2015.10 For example, an event study can be used to identify the response of a price variable to an unanticipated event, such as theECB's announcement on January 22nd on euro area government bonds.11 See Marco Lo Duca, Giulio Nicoletti and Ariadna Vidal Martinez (2014).3.1. Portfolio rebalancing channelThe portfolio rebalancing channel is frequentlyconsidered to be the most effective channelthrough which central bank asset purchasesimpact the real economy. Since the centralbank purchases government securities withcash 12 , institutions that sell securities havetwo choices in terms of what to do with thecash: firstly, they may retain the proceeds oftheir sales on deposit (the consequences ofthis for bank lending are discussed below), or,secondly, they may use the cash to purchaseother assets (reallocate their portfolios towardsother assets), for example corporate bondsand/or equity securities. Greater demand forthese assets increases their prices and lowerstheir yields. Higher asset prices increase thewealth of holders, which should result in aboost to their spending. Falling bond yieldsreduce the borrowing costs for corporates (andother issuers of bonds) resulting in investment,thereby improving the prospects for the realeconomy.Empirical evidence in support of thistransmission mechanism has been found instudies for the US, UK and Japan. In their studyof the Federal Reserve’s public and private assetpurchase programmes, Carpenter et al. (2015)found that sellers to the Federal Reserve weremainly households and other non-bank financialinstitutions, comprising hedge funds, brokerdealers and insurance companies. Subsequentportfolio rebalancing by these investors waslargely towards corporate bonds. Joyce etal. (2014) examine the effects of the Bank ofEngland’s quantitative easing policy on theinvestment behaviour of institutional investors.Their micro-level analysis of UK insurancecompanies and pension funds shows that salesof UK Gilts to the Bank of England give rise toreinvestment in riskier assets by these investorsin the form of corporate bonds. An examinationof portfolio rebalancing in Japan is presented inHogen and Saito (2014). During the Quantitativeand Qualitative Monetary Easing programmeintroduced in April 2013, Japanese banksand foreign investors were the largest sellersof government bonds to the Bank of Japan.Portfolio rebalancing towards bank loans,equity securities and corporate bonds tookplace following sales by these investors of theirgovernment bonds.Given the expected transmission mechanismof the portfolio rebalancing channel, theimpacts of the expanded APP may be seen in12 The “cash” received in exchange for government securities by banks is technically termed central bank reserves. The depositaccounts of non-bank investors are credited in exchange for selling government securities to the central bank.


68The Expanded Asset Purchase Programme –Quarterly Bulletin 03 / July 15What, Why and How of Euro Area QE4000Figure 2: Irish and euro area equity indicesIndexExpanded APPanouncementExpanded APPimplementationIndex700065003.53.0Figure 3: Irish and selected euro area government10 year bond yieldsPer centExpanded APPanouncementExpanded APPimplementation350060002.555002.0300050001.51.045000.52500Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun2014 2015Euro area (EURO STOXX 50) (LHS) Ireland (ISEQ Overall)40000.0Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun2014 2015Ireland Germany Italy France SpainData source: Thomson Reuters Datastream.Data source: Thomson Reuters Datastream.developments in equity prices and governmentbond yields. In particular, should it act toraise demand for both of these assets, wewould expect the price of both to rise, withthe effect that government yields fall. 13 Thevalue of equities in Ireland and elsewherein the euro area increased following theECB’s announcement of the expanded APPon January 22, and this trend continuedfollowing the start of purchases on March 9(Figure 2). Following the announcement ofthe programme, yields on Irish governmentbonds continued their downward trajectory(Figure 3). More recent increases in Irish andeuro area government bond yields in May andJune may reflect improved macroeconomicfundamentals, increased euro area governmentbond issuance, developments in the UK andUS and the overshooting of yield declines.3.2. Bank lending channelThe central bank 'creates' money when it buysgovernment securities from a bank. 14 Banksrequire a certain amount of cash to meetdaily requirements 15 , however banks will notusually choose to hold cash in excess of theserequirements, and will instead seek to make areturn on it. Since cash attracts a low rate ofinterest (currently a negative rate in the euroarea), banks could benefit from an expansionof lending to the real economy, subject to theirown capital constraints. 16Even if the central bank buys assets fromfinancial institutions that are not banks (forinstance, pension funds hold large quantitiesof government bonds) this can still indirectlyaffect bank lending. When a non-bank investorsells government bonds to the central bank,the cash it receives becomes a deposit atits commercial bank. If they do not use thiscash to invest in an alternative asset, thedeposits held by the commercial bank expand.The bank may choose to employ these newdeposits by expanding its credit supply to thereal economy.13 Indeed, the reduction in sovereign borrowing costs across the euro area as well as the repatriation of central bank profits togovernments is likely to have an impact on euro area public finances.14 That is, there is an increase in the monetary base, or reserves held by banks at the central bank plus currency in circulation equal tothe amount of central bank asset purchases.15 Particularly, reserve requirements and liquidity needs.16 A detailed discussion of how an asset purchases programme affects money supply can be found in Butt et al. (2012).


The Expanded Asset Purchase Programme –What, Why and How of Euro Area QEQuarterly Bulletin 03 / July 15691.21.00.80.60.40.20.0-0.2-0.4JanFigure 4: Change in Irish and euro banks’ holdingsof euro area government securities as a percentageof total assetsPer cent of total assetsMarMayJulIrelandSepNovJanMarMayJulSepEuro area (average)NovJanMarMayJulExpanded APPimplementation2012 2013 2014 2015Data sources: Central Bank of Ireland Money and BankingStatistics and ECB Statistical Data Warehouse.SepNovJanMarMaygovernment securities to the ESCB theirdeposits in commercial banks would also rise.3.3. Signalling channelThe announcement and implementation of anasset purchase programme by a central bankdemonstrates its intention to meet its inflationobjective and signals that it expects to maintaininterest rates at a low level for a sustainedperiod. 17 Increased confidence and certainty inthe economic outlook, alongside the low levelof long-run real interest rates should not onlyencourage spending but could also increasecredit demand. Furthermore, by weakening theeuro against other currencies, the programmecan raise inflation expectations since demandincreases for exports, and imports becomemore expensive. Finally, higher inflationexpectations could cause firms to raise pricesin anticipation, leading to a more direct impacton inflation.Another indirect effect, which acts counterto the above, is the impact on bank lendingthrough a reduction in long-term interest rates.This can lower banks’ net interest margins,and, if they are capital constrained, reducetheir ability to lend to the real economy.In terms of the impact of the bank lendingchannel in Ireland, according to the ECB’sApril Bank Lending Survey (BLS), Irish banksexpect the expanded APP to support theircredit supply to households and non-financialcorporates due to increased availability ofliquidity, as opposed to an easing of creditstandards. However, it is not possible at thisstage to determine the extent to which this hasoccurred. The BLS responses also indicatedthat Irish banks intended to increase assetsales in the second quarter of 2015. Holdingsof euro area government securities by Irishand euro area banks have been decliningsince the beginning of 2015, a trend whichhas continued since the implementation ofthe ECB’s PSPP in March (Figure 4). If nonbankfinancial institutions, including insurancecompanies and pension funds, were selling4. ConclusionThe announcement of the expanded APPby the Governing Council of the ECB inJanuary 2015 marked the beginning of anunprecedented programme of asset purchasesin the euro area, the effect of which is likely tobe wide ranging. This article has discussed thereasons behind the decision to introduce theprogramme, the details of how the programmewill be carried out, and the channels throughwhich it is expected to affect the real economy.Three channels in particular are highlighted:the portfolio rebalancing channel, the banklending channel and the signalling channel.Finally, the article outlines some of variableswhich might reasonably be affected by theprogramme. However, it is beyond the scopeof this article to draw firm conclusions on theeffect of the programme. Ample internationalliterature points to effects of quantitative easingprogrammes in other countries across a rangeof variables. Drawing on this, the CentralBank will estimate the impact of the expandedAPP on the euro area economy as more databecome available.17 Indeed, this is explicitly part of the intention with the announcement of the PSPP, see Section 2 for discussion.


70The Expanded Asset Purchase Programme –Quarterly Bulletin 03 / July 15What, Why and How of Euro Area QEBox 3: The role of national central banks in the expanded APPBy William Hynes and Rebecca StuartThis Box outlines some of the details of how purchases will be made under the expanded APPand the effect that purchases will have on central banks’ balance sheets. The programme willbe conducted on a decentralised basis, thereby having a significant impact on the balancesheet of national central banks (NCBs). In conducting these purchases, NCBs are guided bythe modalities of the programme as set out by the Governing Council, some of which are alsodiscussed here.During the programme, €60 billion in securities will be purchased per month. The vast majorityof this will under the PSPP, through which bonds issued by euro area central governments,agencies and European institutions will be purchased in secondary markets. With regard toagencies and institutions who sell assets to the ECB, the intention is that these institutions willbuy other assets and extend credit to the real economy. In terms of central government debt,each NCB will focus exclusively on its home market, with purchases determined by the ECB’scapital key.Public sector securities must have a remaining maturity of between 2 and 30 years at thetime of purchase. The Eurosystem will be considered on the same level as private investors interms of creditor treatment. To ensure that the Eurosystem does not obtain a blocking minorityin the event of a debt restructuring involving collective action clauses, the securities will alsobe subject to an issue limit of 25 per cent, and an issuer limit of 33 per cent. The issuer limitis also intended to ‘safeguard market functioning and price formation as well as to mitigatethe risk of the ECB becoming a dominant creditor of euro area governments’. 18 Purchasesof securities of European institutions (which will be 12 per cent of PSPP purchases) will besubject to loss sharing, but NCBs’ purchases of sovereign bonds will not.The primary impact of asset purchases is to increase the balance sheet size of NCBs aswell as the Eurosystem as a whole. In meeting their monthly purchase quota, each NCB islikely to purchase bonds from both domestic and international counterparties. Purchasesfrom domestic counterparties will result in an increase in their current account holdings 19 atthe NCB corresponding to the value of the assets purchased. Purchases from internationalcounterparties are slightly more complicated, and may well result in higher Eurosystemliabilities for the purchasing NCB rather than increased current account holdings of domesticinstitutions. Nonetheless, regardless of the location of the counterparty, the same outcome ofasset purchases follows for the Eurosystem; increased central bank asset holdings funded bythe provision of additional liquidity to the banking system.18 See Q&A on PSPP: https://www.ecb.europa.eu/mopo/liq/html/pspp-qa.en.html19 This is because, any excess liquidity in the system will, by default, end up on the central bank’s balance sheet. Aninstitution’s current account with the central bank is made up of its minimum reserve requirement plus any excess to thisamount. Minimum reserve requirements are renumerated at the MRO rate (0.05%) , while any excess above this amount aswell as holdings in the deposit facility are renumerated at the deposit facility rate (-0.2%).


The Expanded Asset Purchase Programme –What, Why and How of Euro Area QEQuarterly Bulletin 03 / July 1571ReferencesBauer, M. D. and Rudebusch, G. D. (2013).“Monetary policy expectations at the zerolower bound,” Federal Reserve Bank of SanFrancisco Working Paper Series, 18.Butt, N., Domit, S., McLeay, M., Thomas, R.and Kirkham, L. (2012). “What can the moneydata tell us about the impact of QE?” Bank ofEngland Quarterly Bulletin, Bank of England,Vol. 52, No.4, pp. 321-331.Carpenter, S., Demiralp S., Ihrig, J. and Klee,E. (2015), “Analyzing Federal Reserve assetpurchases: From whom does the Fed buy?”Journal of Banking & Finance, Vol. 52, pp.230–244.Gilchrist, S., Schoenle, R., Sim, J. W., andZakrajsek, E. (2015). “Inflation DynamicsDuring the Financial Crisis,” Washington Boardof Governors of the Federal Reserve System,Finance and Economics Discussion Series,2015-012.Hogen, Y. and Saito, M. (2014). “PortfolioRebalancing Following the Bank of Japan'sGovernment Bond Purchases: EmpiricalAnalysis Using Data on Bank Loans andInvestment Flows,” Bank of Japan ResearchPapers 14-06-19, Bank of Japan.Krishnamurthy, A. and Vissing-Jorgensen, A.(2011). “The Effects of Quantitative Easing onInterest Rates: Channels and Implications forPolicy,” NBER Working Papers 17555, NationalBureau of Economic Research.Krugman, P. R. (1998). “It’s Baaack: Japan’sSlump and the Return of the Liquidity Trap,”Brookings Papers on Economic Activity No. 2,pp.137-206.Lo Duca, M., Nicoletti, G. and Vidal Martinez,A. (2014). “Global Corporate Bond Issuance:What Role for US Quantitative Easing?” ECBWorking Paper Series No. 1649.Svensson, L. E. O. (2003). “Escaping from aLiquidity Trap: The Foolproof Way and Others,"Journal of Economic Perspectives, 17(4),pp.145-166.Weale, M. and Wieladek, T. (2014). “Whatare the macroeconomic effects of assetpurchases?” External MPC Unit DiscussionPaper No. 42, Bank of England.Woodford, M. (2012). “Methods of PolicyAccommodation at the Interest-Rate LowerBound,” Working Paper for Jackson HoleSymposium.IMF (2013). “Unconventional monetary policies– recent experience and prospects,” Staffnote,18 April.Joyce, M., Tong, M. and Woods, R. (2011).“The United Kingdom's quantitative easingpolicy: design, operation and impact,” Bank ofEngland Quarterly Bulletin, Bank of England,Vol. 51, No. 3, pp. 200-212.Joyce, M., Liu, Z. and Tonks, I. (2014).“Institutional investor portfolio allocation,quantitative easing and the global financialcrisis,” Bank of England working papers 510,Bank of England.Kaihatsu, S. and Nakajima J. (2015). “HasTrend Inflation Shifted?: An Empirical AnalysisWith a Regime-Switching Model,” Bank ofJapan Working Paper Series, No. 15-E-3.


72Quarterly Bulletin 03 / July 15The Expanded Asset Purchase Programme –What, Why and How of Euro Area QE


73Labour Cost Adjustment during the Crisis:Firm-level EvidenceSuzanne Linehan, Reamonn Lydon and John Scally 1AbstractThis paper introduces a new firm-level dataset, based on the results from asurvey on the wage-setting practices of Irish firms in the second half of 2014.These survey results represent a useful resource for policy makers, allowingfor firm-level analysis of the approach to the adjustment of labour demand andwages in the face of a large negative shock. A number of findings are worthhighlighting in relation to these results: in terms of the labour cost cuttingapproach, firms relied upon both reductions in the quantity (employment andhours) and the price of labour (wages); employee numbers was the mostwidely used margin of adjustment, followed by wage cuts and hours. Whilethe majority of Irish firms opted to freeze base wages, in the region of 60 percent, there is strong evidence of downward wage flexibility, with almost onequarter of firms surveyed cutting wages. A comparison with previous findings inrelation to Ireland and other euro area countries points to a dramatic increasein the incidence of wage freezes and wage cuts amongst Irish firms during the2008-2013 period.1 Irish Economic Analysis Division, Central Bank of Ireland. The views expressed in this article are those of the authors only and donot necessarily reflect the views of the Central Bank of Ireland or the ESCB. We would like to acknowledge the work of the staff ofIpsos MRBI, who co-ordinated the survey fieldwork as well as Brian Condon and Stephen Byrne for assistance with data andcharts. We are grateful to John Flynn for helpful comments on previous drafts of the Article.


74Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level Evidence1. IntroductionThis article presents the results from a surveycarried out in the second half of 2014 on thewage-setting practices of Irish firms. The aimof the survey, which was undertaken as partof the Central Bank of Ireland’s participationin the Eurosystem's Wage Dynamics researchNetwork (WDN), was to understand exactlyhow firms adjusted their labour demand andwage levels in the face of a large economicshock. Whilst the WDN survey looks at a broadrange of cost factors at the firm level, suchas non-labour input and finance costs, it is aparticularly rich source of information on labourcosts.Aggregate data on labour costs, such as theNational Income and Expenditure accountsor the CSO Employment Hours Earnings andCost Survey (EHECS) data, does not showa pronounced pattern of downward wageflexibility during the crisis. The prevailing viewis that a substantial proportion of the reductionin firms’ overall wage bill was achieved bycutting the number of people in work. 2 Thereare, however, inherent limitations to aggregatewage data – for instance, wage dynamics at amacro level do not solely reflect developmentsat a firm level as changes in the compositionof employment also play a role. As a result,a number of Irish studies have gone beyondthe use of aggregate wage data. The mainmessages from these papers are as follows:• Doris et al. (2014), using an administrativedataset on employees’ tax returns, findconsiderable heterogeneity in annualearnings developments - whilst the share ofworkers who saw a cut rose to 54 per centat the height of the recession in 2009, asignificant proportion of employees (44 percent) also experienced earnings increases.• CSO (2010) uses firm-level data fromEHECS to show that almost two-thirds ofemployers had cut their wage bill by morethan 2 per cent during 2008/2009, withthe primary method of reduction beingemployment, followed by hours and hourlypay.• Walsh (2012), in a longitudinal study of firmlevel data, concludes that changes in thewage bill over the 2009 to 2011 periodlargely came about through reductions inemployment, with a smaller contributionfrom changes in average hourly earningsand weekly paid hours.• Bergin et al. (2012) find similar results toWalsh (2012) - that firms chose to reducestaff numbers, hours worked and bonuspayments in preference to reducing wages.• Using a database on the earnings ofrecent college graduates, Conefrey andSmith (2013) show that new labour marketentrants experienced a significant decline inearnings during the recession.The WDN survey results provide an idealopportunity to examine Irish firms’ approachto labour cost adjustment during the crisisusing a firm-level dataset and thereby add tothe findings of the studies cited above. Theresults of the survey allow us to distinguishbetween the main channels of labour costadjustment to a shock, namely: the quantity oflabour employed (which covers both numbersin employment and average hours per worker)and the price of labour (wages).Results from previous WDN waves yieldedconsiderable evidence of the existence ofdownward wage rigidities both in Ireland andthe euro area 3 . Therefore, one of the key issuesto be considered using this firm-level dataset isthe degree of wage flexibility during the crisis.A more general motivation is to gain a betterunderstanding of the wage setting process,which is of particular relevance to central banksgiven the link between wage formation and themonetary policy transmission mechanism.The paper is structured as follows. Section 2describes the survey, its design and samplecharacteristics in more detail. Section 3presents the main survey results relating tothe composition of labour cost adjustmentamongst the firms surveyed. Section 3.1examines the quantity margin of labour cost2 CSO - National Income and Expenditure Accounts and Quarterly National Household Survey.3 See Bertola et al. (2010), Keeney and Lawless (2010) and Rõõm and Messina (2009).


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1575adjustment via employment and hours worked,while section 3.2 considers the issue of priceor wage flexibility, with a particular emphasison the degree to which downward wageadjustment occurred. Section 4 briefly outlinessome of the other findings from the WDNsurvey and section 5 concludes.2. WDN Survey Design andSample Characteristics2.1 Background to the SurveyIn the second half of 2014, the Central Bankof Ireland (CBI) surveyed over 1,500 firms ona range of issues, including: wage-settingpractices, factors affecting labour demand andprice-setting behaviour as part of a coordinatedresearch effort known as the Wage DynamicsNetwork (WDN). The WDN is a EuropeanSystem of Central Banks research network setup in July 2006, with the original aim of lookingat the link between wage setting behaviourand price setting. The current WDN wave isspecifically motivated by the need to gain someinsight into how output shocks affected labourdemand and wage-setting behaviour during thecrisis. There have been two previous waves ofWDN surveys - in 2007/2008 (“WDN 1”) and2009 (“WDN 2”). The Central Bank of Ireland(CBI) participated in the first wave (Lawless etal., 2009), but not the second wave. The currentthird wave of the survey was carried out in 2014and 27 countries took part. The WDN websitecontains further information on the activitiesof the research network, as well as morebackground on the survey.2.2 Survey DesignThe Survey was designed in collaboration withother members of the Eurosystem’s WDN.The questionnaire is divided into ‘core’ and‘non-core’ sections or questions. The ‘core’questions account for the bulk of the contentand are common across countries, whereasthe ‘non-core’ questions relate to countryspecificissues. The survey was divided intofive sections:1. Information about the firm such as itsstructure, ownership, sector etc.2. Changes to the firm’s economicenvironment e.g. demand factors, costsand in particular labour costs.3. Labour demand during and after therecession.4. Wage setting practices - information onthe frequency of wage changes, the extentof collective bargaining agreements, theprevalence of wage cuts and freezes andthe reasons for reluctance to cut wages.5. Price-setting – frequency of, and factorsaffecting, firms’ approach to price setting.The survey questions were generally qualitativein nature, with participants given categoricaloptions from strong decrease to strongincrease, for example. The survey asks aboutfirm behaviour during two time periods: 2008-2009 and 2010-2013. In the case of Ireland,this split broadly refers to what might betermed the ‘trough’ years of the recession(2008-2009) and the 'bottoming out' andtentative signs of recovery (2010-2013).2.3 Fieldwork and Sample CharacteristicsFollowing a tender in early 2014, the CentralBank of Ireland commissioned Ipsos-MRBIto carry out a postal survey. The survey wascompleted by managing directors, financialcontrollers or other suitably qualified individualsand excludes public sector organisations. 4 The1,569 responses represent a response rate of5 per cent. Responses are weighted to matchpopulation weights in terms of firm size, sectorand region (Table 1).As with any survey, there are a number ofissues to be aware of when analysing theresults. Firstly, the survey was conducted in2014 and refers to periods up to seven yearsprior, raising the possibility that respondentscould misremember, or fail to check, eventsin the more distant past. Moreover, the4 In addition to the postal self-completion questionnaire, firms had the option to complete it online, although in practice few firms usedthis option.


76Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceTable 1: Characteristics of firms in the surveyFirms 1,569Size % Years in operation %Micro (2-10 emp) 77.4%


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1577Box 1: Are the WDN Survey Results Consistent with Other Survey Data?There is more of a divergence between the surveys when we look at the 2010 to 2013 period.This is hardly surprising as the economic situation facing some Irish firms in 2010 was potentiallydifferent to that in 2013. In 2010, the BSS in November of that year indicated that 34 per centof firms were cutting wages, declining to just 5 per cent by November of 2013; the mid-point ofthis range is 20 per cent. This compares to base wage cuts of 21 per cent over the entire 2010-2013 period as reported in the WDN. Taken together, these comparisons suggest that the wagedynamics recalled by WDN respondents may not suffer from serious recall problems.Figure 3 indicates that the BSS points to a greater reduction employment in 2009 as the severity ofthe downturn became apparent, with 65 per cent of firms indicating that they had cut employmentcompared to 25 per cent in early 2008; the WDN recorded declines in employment of 31 per centover this period. However, if we look at averages over the period, the two surveys correspond muchmore closely - the BSS averages 45 per cent compared to the WDNs 30 per cent employmentcuts. The larger employment response in the BSS could be accounted for by the presence of morelarge multinationals in the sample. By 2013, the BSS indicates that businesses had emerged fromjob-shedding mode and had begun to rehire, with more firms increasing employment (33 per cent)than decreasing (16 per cent). Overall, it appears that the average BSS responses closely mirrordevelopments in the WDN.Figure B1.1: Base wage changesFigure B1.2: Base wage changes 2010/1380% of respondents80% of respondents70706060505040403030202010100WDN 2008/9BSS 20090WDN 2010/3BSS 2010BSS 2013DecreaseNo Change/IncreaseDecrease No Change IncreaseFigure B1.3: Employment changes 2008/9Figure B1.4: Employment changes 2010/1370% of respondents70% of respondents6060505040403030202010100WDN 2008/9BSS 2008 MarchBSS 20090WDN 2010/3BSS 2010BSS 2013Decrease No Change IncreaseDecrease No Change Increase


78Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceFigure Figure 1: Changes 1: Changes in labour in labour costs costs 2008-09 2008-09 and and the the relationship between demand shocks and labour cost adjustmentConstruction Construction% firms % firms citing citing a moderate a or or strong decrease in in labour costs in in 2008-090.5 0.5Industry IndustryProfessional servicesProfessional services0.40.4Arts & other servicesArts & other servicesAdmin/Education0.3Admin/Education0.3Financial services/Real estateancial services/Real estateInformation & communication0.2rmation & communication0.2Wholesale/RetailWholesale/RetailAccomodationAccomodation0.1Transport0.1TransportHealthHealth0.00% 20% 40% 60% 80% 100% 0.0 0.00.200.400.600.801.000% 20% 40% 60% 80% 100% 0.00.200.400.600.801.00% of firms citing a moderate or strong decrease in demand in 2008-09Decrease labour costs Unchanged Increased% of firms citing a moderate or strong decrease in demand in 2008-09Decrease labour costs Unchanged Increased3. Labour Cost AdjustmentWe know from the aggregate data that at theonset of the recession in 2008 firms movedquickly to reduce labour costs. In the two yearsthat followed, unemployment jumped from 4 to15 per cent, employment dropped by 15 percent and total hours worked by 20 per cent. Inthe WDN, around one-third of firms reported astrong or moderate reduction in labour costsduring both 2008-09 and 2010-13. There is,however, considerable heterogeneity acrosssectors - for instance, 44 per cent of firmsin the construction sector cut labour costsduring the most intensive phase of the crisis;the corresponding share in the health servicessector was around 15 per cent (Figure 1). Thesecond panel in Figure 1 shows that there is astrong positive correlation between reductionsin labour costs and demand shocks. Weexplore this relationship further below in aregression framework.Firms were asked about the compositionof changes to labour costs: specifically, interms of base wages, permanent/temporaryemployees, working hours or flexible wagecomponents or a combination, thereof. Surveyresults (Table 2) suggest that firms were relyingupon all available mechanisms to adjust labourcosts downwards, albeit to varying degrees.The most widely employed approach tolabour cost reduction during both sub-periodswas to cut permanent employee numbers– approximately 30.6 per cent and 29.6 percent of firms surveyed reported a reductionin employees during the 2008-09 and 2010-13 period, respectively. Such a finding isconsistent with both available macro wagedata and existing literature (CSO (2009), Walsh(2012)), which suggests that the employmentchannel was the dominant approach to labourcost reduction over the 2008 to 2012 period.Looking to wage developments, the majorityof firms surveyed froze wages, in the regionof 60 per cent. Nevertheless, about 24 percent of firms actually cut wages over bothsub-periods. A similar share of firms, aroundone quarter, relied upon the more flexiblecomponents of wages such as bonuses andother discretionary compensation. Employeeworking hours represented a relatively lessimportant margin of labour cost reductionamongst the firms surveyed. A further andmore detailed analysis of the quantity andprice adjustment of labour costs is provided inSections 3.1 and 3.2, respectively.It is not possible at this stage to do a full crosscountrycomparison as the results from thethird WDN wave have yet to be released forall countries. Instead, in Table 3, we comparethe Irish results with the responses of the


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1579Table 2: Adjustment of Labour Cost Components (% of survey respondents) 5Main Strategy 2008-2009 2010-2013Employment - PermanentReduced 30.6 29.6Unchanged 61.1 51.5Increased 8.2 18.9Hours WorkedReduced 21.1 22.4Unchanged 70.7 62.3Increased 8.3 15.3Base WagesReduced 23.9 23.3Unchanged 62.2 58.0Increased 14.0 18.7Flexible WagesReduced 25.6 22.7Unchanged 69.5 68.4Increased 4.9 9.0WDN 2 survey, which was conducted amid thefinancial crisis, during the summer of 2009, ina subset of countries. 6 The most noteworthydifference between the two sets of results isthe pronounced increase in the incidence ofdownward wage adjustment amongst Irishfirms during both sub-periods - reductions inboth flexible wage components (e.g. bonuses)and base wages were much more heavily reliedupon by Irish firms. The incidence of basewage cuts is second only to Estonia, where 44per cent of firms cut wages 7 . As regards theadjustment of the quantity of labour, Irish firmsrelied more heavily on reductions in permanentemployees and hours worked throughout the2008-09 and 2010-13 period than was thecase in WDN 2, when temporary employeeadjustment dominated. Arguably, one reasonfor the higher incidence of base wage cuts andfreezes was the greater intensity and natureof the negative shock experienced by Irishfirms since 2008. Furthermore, the effectiveabandonment of collective wage bargainingand pre-existing weak employment protectionincreased the scope to lower wages andpermanent employment, thereby reducing thereliance on more flexible components suchas hours worked and temporary employees.This is consistent with the findings of Babeckyet al. (2008) that high country level bargainingcoverage and the strictness of employmentprotection legislation increase downwardnominal wage rigidity. In addition, the lowinflation environment prevailing throughout2008 to 2013 may have been more conduciveto wage freezes and cuts.3.1 Labour Cost Adjustment: QuantityThis section explores in more detail howfirms sought to adjust the quantity of labouremployed after 2008. We pay particularattention to the choice between adjustmentsat the intensive margin (hours) versus theextensive margin (numbers employed).Previous research has shown that theparticular mode of adjustment can depend on5 Table 2 includes firm responses in relation to four of the seven labour cost components.6 Ten countries (Belgium, Czech Republic, Estonia, Spain, France, Italy, Luxembourg, Netherlands, Austria and Poland) participated inWDN 2, covering over 5500 firms. It updated the findings of WDN 1, which was based on a survey carried out pre-crisis. WDN 2asked about firms’ reactions to the negative demand shock in the context of the financial and economic crisis in 2008.7 http://www.ecb.europa.eu/home/pdf/wdn_finalreport_dec2009.pdf


80Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceTable 3: WDN 2 (EA) vis-à-vis WDN 3 (IE) Labour Cost Reduction Following ShockMain Strategy (% of firms) WDN 2 82009WDN 32008-09WDN 32010-2013Adjust the amount of labourReduce number of temporary employees 27.5 16.7 17.4Reduce number of permanent employees 16.6 30.6 29.6Reduce hours worked per employee 15.4 21.1 22.4Adjust the price of labourReduce flexible wage components 8.6 25.6 22.7Reduce base wages 1.5 23.9 23.3a range of factors including; the institutionalsetup of the labour market in a given countryor sector and the extent to which firms believethe shock to be permanent or temporary. 9Figure 2 charts the changes in employmentand hours worked by sector. The constructionsector, as expected, reported the largestdeclines over both periods, with almost 60 percent of firms reporting reduced employment;the information and communication technologysector, on the other hand, registered thelargest employment increases over bothperiods. With regard to hours worked, firmsin the construction and the accommodationand food services sectors were more likelyto have reduced hours, which is consistentwith the view that these firms’ employees aremore likely to be contracted with flexible hours.Indeed, the accommodation sector registeredthe largest decrease in working hours in the2010-13 period. Those in the administrationand education sector reported the largestincrease in hours in the 2010-13 period.To investigate the possible drivers of thechanges in employment, we run a probitregression where the dependent variableequals one if the firm cut employment in2008-09 or 2010-13 (see Table 4). We controlfor firm size, sector, whether it is primarilyforeign or domestically owned, the scale ofthe reported demand shock in each period,the share of labour costs in total costs and theproportion of high-skilled workers in the firm.This indicates that large firms were morelikely to have decreased employment inboth periods. Controlling for the size of theshock, firms in the construction, services andfinancial services sectors were also morelikely to have reported reducing employment.There is a strong positive correlation betweenthe incidence of demand shocks andemployments cuts. Firms with a higher labourcost share were more likely to have decreasedemployment in both periods.As highlighted above, the survey results inrelation to employment adjustment corroboratethe findings of comparable firm-level studies 10in suggesting that it was the most commonapproach to wage bill reduction in Irelandduring the crisis. A reliance on the reduction ofemployee numbers could reflect the scale anddistribution of the demand shock in Ireland,which had a high sectoral concentrationand therefore a significant proportion of joblosses in the labour-intensive constructionand industry sectors. In order to gain insightinto the composition of the employmentadjustment, firms who claimed to havereduced their labour inputs in either periodwere asked to what extent certain measureswere used to reduce the quantity of labouremployed; firms could choose multipleoptions. We group the measures under thefollowing headings: (i) Layoffs (collective,8 ECB Monthly Bulletin, July 2010, pp. 61.9 See Bertola (2010) for a brief overview of the literature and some findings in respect of WDN 2.10 See Walsh (2012) and Bergin (2012).


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1581Figure Figure 2: Changes 2: Changes in in Employment and Hours Worked by by Sector: Sector: 2008-09 2008-09 and and 2010-13 2010-13Construction ConstructionConstruction ConstructionIndustry IndustryAccomodation AccomodationProfessionalProfessionalservicesservicesArts,Arts,EntertainmentEntertainment& other& otherservicesservicesArts, Entertainment & other servicesArts, Entertainment & other servicesIndustryIndustry2008-092008-09Information & communicationInformation & communicationWholesale/retailWholesale/retailAccomodationAccomodationAdmin/EducationAdmin/EducationFinancial services/Real estate2008-092008-09Wholesale/retailWholesale/retailHealthHealthInformation & communicationInformation & communicationProfessional servicesProfessional servicesAdmin/EducationFinancial services/Real estateHealthAdmin/EducationTransportHealthTransportTransportFinancial services/Real estateTransportFinancial services/Real estate0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%EmploymentHours Worked0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%Decrease Unchanged Increase Decrease Unchanged IncreaseEmploymentHours WorkedDecrease Unchanged Increase Decrease Unchanged Increase2010-132010-13ConstructionAdmin/EducationConstructionIndustryAdmin/EducationProfessional servicesIndustryArts, Entertainment & other servicesProfessional servicesAccomodationArts, Entertainment & other servicesWholesale/retailFinancialAccomodationservices/Real estateWholesale/retail HealthFinancial services/Real Information & communicationestateHealthTransportInformation & communicationTransport2010-132010-13AccomodationConstructionAccomodationArts, Entertainment & other servicesConstructionHealthArts, Entertainment & other servicesIndustryHealthWholesale/retailIndustryAdmin/EducationProfessionalWholesale/retailservicesInformation & communication Admin/EducationProfessional Transport servicesFinancial Information services/Real & communication estate0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%Transport 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%EmploymentHours WorkedDecrease Unchanged Increase Financial services/Real estate Decrease Unchanged Increase0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%EmploymentHours WorkedDecrease Unchanged Increase Decrease Unchanged Increase


82Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceTable 4: Probit: dependent variable = 1 if firm cut employment in 2008-09 or 2010-13VARIABLESEmploymentdecrease2008-09 2010-13MarginsEmploymentdecreaseMarginsFirm sizeMicro (2-10 emp) [omitted] 0.294 [omitted] 0.2668(0.014) (0.0147)Small (11-49 emp) 0.173* 0.340 0.145 0.308(0.0902) (0.205) (0.0890) (0.0215)Medium/Large (50+ emp) 0.577*** 0.461 0.337** 0.368(0.136) (0.0374) (0.134) (0.038)Foreign ownedNo [omitted] 0.327 [omitted] 0.285(0.0116) (0.015)Yes -0.550*** 0.295 0.206 0.3475(0.192) (0.042) (0.162) (0.048)Sector (a)Industry [omitted] 0.417 [omitted] 0.292(0.038) (0.036)Construction 0.241 0.491 0.497** 0.451(0.212) (0.054) (0.207) (0.057)Services (excl. Financial Services) -0.338** 0.317 -0.0208 0.285(0.135) (0.013) (0.132) (0.013)Financial Services -0.656*** 0.233 -0.185 0.239(0.180) (0.031) (0.172) (0.032)Demand shock (c)Strong decrease [omitted] 0.598 [omitted] 0.556(0.022) (0.028)Moderate decrease -0.774*** 0.311 -0.489*** 0.367(0.0920) (0.0227) (0.0986) (0.025)Unchanged -1.551*** 0.108 -0.966*** 0.210(0.122) (0.018) (0.119) (0.02)Moderate increase -1.804*** 0.701 -1.407*** 0.107(0.160) (0.018) (0.114) (0.015)Strong increase -1.711*** 0.828 -1.869*** 0.0454(0.248) (0.034) (0.234) (0.037)Labour cost share (b) 0.388** 0.0653 0.127 0.024(0.191) (0.032) (0.182) (0.029)%Hi-skill manual workers (b) 0.126 -0.0212 0.0518 0.0083(0.159) (0.026) (0.152) (0.024)%Hi-skill non-manual workers (b) 0.327*** 0.055 0.0499 0.008(0.118) (0.0197) (0.112) (0.018)Constant 0.138 -0.0219(0.172) (0.168)Observations 1,331 1,388(a) NACE Rev 2 categories are group into four categories here for cell size reasons. The public and agricultural sectorsare also excluded.(b) The margins for continuous variables are calculated for a 0.5 percentage change, e.g. an increase in the labourcost share from 25 to 75 per cent, or an increase in the proportion of hi-skilled workers in the firm from 25 to 75 percent.(c) A demand shock is defined as a change in the level of demand for products/services.


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1583LayoffsFreeze on new hiresReduced hoursReduction in temporary workersEarly retirementFigure 3: Percentage of firms using a givenmeasure to reduce labour input, conditional onanswering ‘yes’ to a reduction in labour inputs0% 10% 20% 30% 40% 50% 60% 70%2010-13 2008-09hours reductions over layoffs, we find thatthe majority of these firms are in the servicessector (professional services, wholesale andretail trade and other services). Such a findingis consistent with the more flexible nature ofemployment contracts within these sectors.Conversely, firms that opted for layoffstended to be more heavily concentrated inconstruction, industry and financial services.Given that these sectors bore the brunt of thedemand shock – both on the basis of changesto output at the sectoral level and the fact thatsignificantly more firms in these sectors in thesurvey cited negative demand shocks as a keyfactor affecting firm activity in 2008-09 – thistentatively suggests that the more ‘permanent’the shock the less likely we are to observehours reductions.individual or temporary); (ii) reduced hours;(iii) early retirement; (iv) a reduction or freezein new hires; or (v) non-renewal of temporarycontracts. The responses are categorical,that is, firms could respond “Not at all (used)”,“Marginally”, “Moderately” or “Strongly”.The most widely used measure for reducinglabour inputs are layoffs or a freeze on newhires (Figure 3). The least important marginsof adjustment are early retirement schemes ornon-renewal of temporary/contract workers,although this may misrepresent the scale towhich such measures were used as the chartsneither conditions on the average age ofworkers within the firm nor the prevalence ofcontract workers in the firm.Regarding the choice of adjustment at theintensive (hours) and extensive (workers)margin, we find a high degree of overlapbetween the two. For example, two thirdsof firms that reduced hours in 2008-09 alsoused layoffs to reduce labour inputs. Similarly,around half of firms that used layoffs alsoreduced working hours during 2010-13.Analysing the responses of firms that chose3.2 Labour Cost Adjustment: PriceThis section examines firms’ reliance on wageadjustments in response to a shock. Firmswere asked the following question:Please indicate how [base wages or piecework rates / flexible wage components]changed during 2008-2009 and 2010-2013.Responses are on a one to five scale rangingfrom “Strong decrease” to “Strong increase”.Figure 4 shows the percentage of firms bysector that decreased (bottom two categories),increased (top two categories) or left wagesunchanged. In line with patterns highlightedin CSO (2010), a high proportion of firms inthe construction (40 per cent) and industry(30 per cent) sectors cut wages in the earlyperiod in particular. The rankings are broadlyunchanged when we look at flexible wages (thesecond panel in Figure 4), with one exception:the financial services / real estate sector.From being close to the bottom in the basewage change ranking (2008-09), the financialservices / real estate sector moves up theranking when we look at changes to flexiblewage components. A possible explanationfor this is that the flexible wage componentaccounts for a larger portion of the overallwage bill for firms in this sector. For example,


84Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceFigure 4: Changes Figure in 4: base Changes and flexible in base and wages flexible by sector: wages 2008-09 by sector: and 2008-09 2010-13 and 2010-13ConstructionConstructionConstructionConstructionProfessional servicesIndustryProfessional servicesIndustryProfessional services Professional servicesInformation & communicationInformation & communicationntertainment & other Arts, services Entertainment & other servicesInformation & communication Information & communication2008-09Wholesale/retailWholesale/retail2008-09Financial services/Real Financial estate services/Real estateArts, Entertainment Arts, & Entertainment other services& other services2008-09Wholesale/retailWholesale/retailAdmin/EducationAdmin/EducationAdmin/EducationAdmin/EducationAccomodationIndustryAccomodationIndustryFinancial services/Real estateAccomodationFinancial services/Real estateAccomodationHealthHealthHealthHealthTransportTransportTransportTransport0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%Decrease base wages Unchanged Increase base wagesDecrease flexible wages Unchanged Increase flexible wagesDecrease base wages Unchanged Increase base wagesDecrease flexible wages Unchanged Increase flexible wagesAdmin/EducationAdmin/EducationConstructionConstructionIndustryIndustryArts, Entertainment & other servicesConstructionConstructionAdmin/EducationAdmin/EducationProfessional servicesProfessional servicesInformation & communicationntertainment & other servicesInformation & communicationInformation & communicationIndustryInformation & communication2010-13Professional servicesHealthProfessional servicesHealthAccomodation2010-132010-13Arts, Entertainment Industry& other servicesArts, Entertainment & other Financial services services/Real estateFinancial services/Real estate HealthAccomodationWholesale/retailHealthWholesale/retailWholesale/retailTransportWholesale/retail AccomodationTransport Financial services/Real estateAccomodationTransportFinancial services/Real estate0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%Transport0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 10% 20% Decrease 30% 40% base 50% wages 60% Unchanged 70% 80% 90% Increase 100% base wages0% 10% Decrease 20% 30% flexible 40% wages 50% 60% Unchanged 70% 80% Increase 90% flexible 100% wagesDecrease base wages Unchanged Increase base wagesDecrease flexible wages Unchanged Increase flexible wages


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1585Table 5: Probit: dependent variable = 1 if firm cut base wages in 2008-09 or 2010-13VARIABLESWagedecrease2008-09 2010-13MarginsWagedecreaseMarginsFirm sizeMicro (2-10 emp) [omitted] 0.221 [omitted] 0.207(0.014) (0.013)Small (11-49 emp) 0.221** 0.280 -0.0476 0.195(0.0915) (0.021) (0.0934) (0.019)Medium/Large (50+ emp) 0.310** 0.306 0.121 0.240(0.137) (0.037) (0.144) (0.037)Foreign ownedNo [omitted] 0.256 [omitted] 0.213(0.011) (0.011)Yes -0.550*** 0.130 -0.524** 0.101(0.192) (0.034) (0.216) (0.034)SectorIndustry [omitted] 0.266 [omitted] 0.215(0.037) (0.035)Construction 0.169 0.315 0.295 0.301(0.217) (0.053) (0.214) (0.055)Services (excl. Financial Services) -0.0290 0.258 -0.00706 0.213(0.141) (0.013) (0.140) (0.012)Financial Services -0.545*** 0.137 -0.404** 0.123(0.193) (0.026) (0.192) (0.026)Demand shock (a)Strong decrease [omitted] 0.436 [omitted] 0.358(0.023) (0.027)Moderate decrease -0.528*** 0.251 -0.255** 0.270(0.0932) (0.022) (0.101) (0.023)Unchanged -1.199*** 0.094 -0.891*** 0.109(0.124) (0.017) (0.134) (0.02)Moderate increase -1.578*** 0.046 -1.011*** 0.088(0.180) (0.016) (0.119) (0.015)Strong increase -1.284*** 0.081 -0.679*** 0.152(0.253) (0.036) (0.179) (0.037)Labour cost share (b) 0.390** 0.0555 0.220 0.029(0.193) 0.0274 (0.190) (0.025)%Hi-skill manual workers (b) -0.0931 -0.013 -0.0249 -0.003(0.165) (0.023) (0.160) (0.021)%Hi-skill non-manual workers (a) 0.391*** 0.056 0.291** 0.038(0.119) (0.0169) (0.116) (0.015)Constant -0.478*** -0.510***(0.175) (0.176)Observations 1,334 1,392(a) A demand shock is defined as a change in the level of demand for products/services.(b) The margins for continuous variables are calculated for a 0.5 percentage change, e.g. an increase in the labourcost share from 25 to 75 per cent, or an increase in the proportion of hi-skilled workers in the firm from 25 to 75 percent.


86Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceMoraleComparisonsProductivityFigure 5: Firms’ reasons for not cutting base wagesthey froze wages in the 2008-2009 period,falling only marginally to 58 per cent in the2010-2013 period. The incidence of payfreezes was highest amongst smaller firms andthose in the labour-intensive distributive tradessector. 11EffortDislike unpred.Higher empl. turnoverAttractivenessReputationLabour regs/coll. Agreement0% 10% 20% 30% 40% 50% 60% 70%Reaons for not cutting wages (% answering relevant or very relevant)the survey results indicate that a greaterproportion of the wage bill for firms in thissector is accounted for by performance relatedpay – 7 per cent in 2013, versus 3 per cent inall other sectors.To investigate the correlations in the data moreformally, as with employment changes, werun a probit regression where the dependentvariable equals one if the firm cut base wagesin 2008-09 or 2010-13 (Table 5). Again, wecontrol for firm size, sector, whether it isprimarily foreign or domestically owned, thescale of the reported demand shock in eachperiod, the share of labour costs in total costsand the proportion of high-skilled workers inthe firm.In the earlier period, smaller firms (


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1587Table 6: Labour cost of new hires versus existing workers (controlling for experience and tasks)% of firms saying new hires costs were much lower, lower, similar, higher or much higherpre-2008 2008-09 2010-13Much lower 2.7% 4.1% 6.2%Lower 10.2% 18.3% 23.3%Similar 76.9% 73.1% 62.7%Higher 8.3% 3.7% 5.9%Much higher 1.9% 0.9% 1.8%100.0% 100.0% 100.0%for not cutting wages was the negative impacton employees’ morale; firms surveyed alsoemphasised concerns about productivity andthe impact on worker-effort (Figure 5).To place the scale of the wage freezes andwage cuts in context, comparable results inrespect of WDN 1 for Ireland are considered.Wave 1 of the WDN reported that in the fiveyears prior to 2007, approximately 2.1 per centof firms surveyed had reduced base wages,while a further 7.1 per cent were found to havefrozen wages. Wage cuts and wage freezeswere therefore much more frequently used byfirms over the 2008-09 and 2010-13 periodvis-à-vis the WDN 1 results. This dramaticincrease in the incidence of wage freezes andwage cuts is likely to have reflected the scale ofthe shock and the fact that firms were forcedto respond with more permanent measuresas the crisis deepened. Furthermore, changesin the institutional wage setting arrangementsin Ireland over recent years are likely to havefacilitated the downward adjustment of basewages. It is also worth noting that the incidenceof downward wage adjustment amongst firmsin this survey contrast somewhat with previouscross-country studies - Bertola et al (2010) andRõõm and Messina (2009) all find less than2 per cent of firms/employees reduced basewages.Consistent with the findings of Doris et al(2014) and Walsh (2012), a sizable share offirms did not implement pay freezes or cuts butincreased wages, with almost 14 per cent ofbusinesses surveyed actually increasing wagesduring the 2008-2009 period, rising further to18.7 per cent in the 2010-2013 period. Thismay help to account for some of the apparentrigidity in aggregate wage data as it is likelyto have dampened the magnitude of wageadjustment at a macro level. Foreign-ownedfirms accounted for almost half of the firmsindicating that they had increased wage ratesthroughout both sub-periods and, indeed,this is consistent with anecdotal evidence ofmultinational firms facing shortages of highskilledlabour in recent years, particularly in ITservices.An alternative to an outright cut in base wagesmay be to hire new employees at a lower wagelevel than similar workers and, as a result, theaverage wage change may understate thedownward adjustment at the margin. There issome evidence to suggest that firms in recentyears have hired new workers at lower pay,see Conefrey and Smith (2014). In the WDN,firms were asked about labour cost differencesbetween new hires and existing workers withthe same skill and experience set as existingworkers. The responses received would seemto confirm this pattern, with an increasingproportion of firms paying newly hired workersat either a ‘lower’ or ‘much lower’ level relativeto existing workers - this share was 12.9per cent pre-2008, whereas by the 2010-13period, it had more than doubled to 29.5 percent (Table 6). The pattern is broadly similaracross all sectors, with the exception offinancial services firms, where the increase inthe negative differential against new workerswas more pronounced, jumping from 10.9 percent pre-2008 to 35.5 per cent in 2010-13.Hiring new workers at lower wage rates thanexisting workers appears, on the basis of oursurvey results, to have become an increasinglycommon approach to reducing labour costs atthe margin.


88Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceTable 7: Frequency of wage changes for main occupational group in the firm2006 pre-2008 2008-09 2010-13At least once per year 58.4 45.7 22.5 14.7Every two years 7.8 19.5 17.2 12.7Less than once every 2 years 4.6 13.1 20.0 25.3Never/Don't know 29.2 21.7 40.3 47.4Notes: Data for 2006 is taken from the Wave 1 survey, as reported in Keeney et al. (2009)The frequency with which firms changewages affects the speed with which they canrespond to shocks. In an attempt to addressthis important aspect of wage rigidity, firmswere asked about the frequency of base wagechanges both before and during the recession.During the 2010-13 period, one quarter offirms surveyed indicated that they tend toreview wages less than once every two yearsand a further 27 per cent change wages morefrequently than that (Table 7). A pronouncedpattern of declining wage changing frequencyis evident - 58.4 per cent of firms respondedthat they set wages on at least an annual basisaccording to WDN 1 results, whereas this hadfallen sharply to 22.5 per cent in 2008-09 andfurther to just 14.7 per cent by the 2010-13period. Such a reduction in the frequency ofwage change may serve to impede the abilityof firms to react to unexpected economicdevelopments in the future. It is, however,important to note that the results from theWDN 1 survey and the pre-crisis period pertainto a time during which centralised wagebargaining agreements 12 were implementedand hence, wages are likely to have changedmore frequently.4. Other Findings from theSurveyWhile the focus of this article is on theapproach to labour cost adjustment by firmsduring the crisis, this section briefly considerssome other issues covered by the surveyrelating to wage and price dynamics, includinginstitutional features of the labour market,price-setting and the forward looking elementsof the survey.4.1 Institutional FactorsInstitutional factors (e.g. employmentprotection legislation, union density andwage bargaining institutions) are often citedas playing an important role in determiningthe composition of labour cost adjustmentTable 8: Collective bargaining agreements% firms saying a collective pay agreement was in place2006/07 2008 2013All firms 61.4 8.4 7.4Industry & manufacturing 14.4 14.6 10.0Construction 7.8 10.7 10.2Retail and Transportation7.7 6.0Accommodation & Food 34.67.1 6.2Financial, Professional & Administrative -43.26.7 5.1Other 8.5 9.7Notes: Figures for 2006/07 are from Tables 3 and 4 in Keeney et al. (2009). The sector data for 2006/07 refers toNational Wage Agreements only. There was a change in the sector classification between the two survey waves, whichmeans we have to group the distribution and services sectors from 2006/07.12 According to the WDN 1 results for Ireland, 61.6 per cent of firms surveyed applied the prevailing national wage agreement, namely,‘Towards 2016’, either in full or partially (Lawless et al., 2009).


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1589Table 9: Firms’ expectations for their labour input for 2015Increase No change DecreaseSales 43.6 38.4 22.5Employment 21.2 66.4 6.6Hours per worker 13.7 75.3 5.7Base wages 23.2 68.7 2.5Economic uncertaintyHigh payroll taxesHigh wagesFigure 6: Obstacles to hiring new workerscase of 2006/07, National Wage Agreements).The main difference is in the services anddistribution sectors, where coverage has fallenaway significantly. The absence of a collectivebargaining process and union representationreduces potential barriers to lowering wagesfrom the perspective of a firm.Access2financeFiring costsHiring costsSkills shortage0 10 20 30 40% firms answering relevant or very relevantmechanisms used by firms and they have beenhighlighted as a major source of downwardwage rigidity by previous WDN studies 13 .Institutional wage-setting arrangements areof further interest in an Irish context given thatthere have been some distinct changes inthis area since the crisis began, most notablythe changes to centralised wage bargainingprocesses and the reform of the framework forsectoral wage agreements.As Table 8 shows, there has been almosta complete collapse in the application ofany form of collective bargaining agreementsince the start of the recession. In terms ofthe sectoral coverage, both industry andconstruction firms have similar levels ofcollective bargaining agreements (or, in theFirms were also asked if any obstacles existedto hiring new workers in 2013. A range ofpossible answers are provided, includinguncertainty about economic conditions,lack of required skills, high wages, etc. Thetwo standout factors cited by firms areUncertainty about economic conditions andHigh payroll taxes (Figure 6). As regards theeconomic uncertainty ‘obstacle’, there is astark difference between the answers of firmsserving the domestic market vis-a-vis foreign- almost 40 per cent of domestically-orientedfirms surveyed cite this as an obstacle tolabour input expansion, whereas it is closer to20 per cent in respect of firms serving foreignmarkets. A relatively small proportion (20 percent) of firms cited ‘High wages’ as an obstacleto hiring new workers. Unsurprisingly, firms thathad previously responded that it was easier tohire new workers at lower wages since the startof the recession – a large number of whom arein the construction sector – were far less likelyto cite high wages as an obstacle to hiring.4.2 Labour Market expectationsGiven the flexibility apparent in the Irish labourmarket, it is also of interest as to firms’ futureexpectations of their labour input (Table 9). For13 For instance, Babecky et al. (2008) find that high country-level bargaining coverage and the strictness of EPL increase downwardnominal wage rigidity


90Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceTable 10: Price setting behaviourHow do you set prices…% firmsFollow competitors 26.1%Costs + profit margin 28.3%Negotiate with customers 18.7%Price is regulated 4.6%Price set by parent 2.4%Price set by main customers 2.2%Price set by other influence 2.6%No answer 14.9%100.0%More freq.changes inlabour costsFigure 7: Frequency with which firms change pricesof main product/serviceimprove, both employment and hours workedare forecast to pick up in 2015, suggestive ofa more positive outlook for the labour marketthis year.More freq.changes inother input costs4.3 Price SettingMore freq. pricechange by competitorsMore volatile demandStronger competition0 5 10 15 20 25 30 35 40% firmsexample, following the downward adjustment,do firms expect their labour input to return toprevious levels under more normal economicconditions? Will they adjust hours or numbers?Will they reverse any wage cuts? In light ofthis, the questionnaire included a questionon future labour market expectations. Firmswere asked about their expectations forwages, employment, hours and sales for theforthcoming year (referring to 2015). Table 9shows that the proportion of firms expectingwages to decrease drops from 23 per centin 2010-2013 to just 2.5 per cent in 2015,with 23 per cent of firms expecting wages toincrease. This is suggestive of a considerablerebound in base wages. As sales expectationsThe final set of questions focuses on pricesetting behaviour and the degree to whichprices are flexible. In terms of firms' approachto setting prices, around 28 per cent ofrespondents indicated that they use a costbasedapproach, while an additional 26 percent follow competitor’s price-setting (Table10).In an attempt to uncover whether there hadbeen a change in price flexibility post-crisis,a further question asked whether firms hadaltered the frequency of price changes overthe 2010-13 period relative to pre-2008.Around 33 per cent of firms surveyed indicatedthat the crisis had resulted in a change in thefrequency of price changes. Figure 7 illustratesthat the most important factor behind theincreased frequency of price changes overthe 2010-13 period relative to pre-crisis wasstronger competition in the main productmarket, with more than 35 per cent of firmsciting this as the most relevant reason. Achange in labour costs was the least citedreason for price changes. In the case of lessfrequent price changes, the main driver wasreported to have been less frequent pricechanges by competitors (2.0 per cent) followedclosely by less volatile demand (1.8 per cent


Labour Cost Adjustment during the Crisis:Firm-level EvidenceQuarterly Bulletin 03 / July 1591of firms), albeit of much smaller magnitude.Focussing specifically on developments incompetitive pressures during the crisis, 40per cent of firms surveyed indicated either amoderate or a strong increase in the 2008-09 period; the corresponding share for the2010-13 period was approximately 50 percent. It is noteworthy that the frequency ofprice adjustment is higher than is the casefor base wages. The dominant factor behindfirms reporting increased frequency of priceadjustment was a higher level of competition,suggesting that wage costs were not thedominant factor here.5. Summary of Survey Findingsand ConclusionsAn overview of the WDN survey results forIreland highlighted a number of noteworthyfindings in relation to the approach firmsused to adjust labour costs in response to anegative demand shock:• When examining the labour cost-cuttingstrategies implemented by firms surveyed,these consisted, to varying degrees, ofboth reducing the quantity of labour interms of permanent employment andhours worked, as well as cutting wagecosts via base wages and the more flexiblecomponents. Employee numbers werethe most widely relied upon margin ofadjustment, followed by wage cuts andhours.• Irish firms predominantly controlled wagecosts via wage restraint – approximately60 per cent of firms indicated that theyfroze base wages during both sub-periods,with the incidence of pay freezes highestamongst small firms and those in thelabour-intensive distributive trades sector.Such a high incidence of wage freezescould be interpreted as pointing to theexistence of downward wage rigidity,in line with the literature. Nevertheless,there is strong evidence of downwardwage adjustment, with almost a quarterof firms surveyed indicating that theyhad cut base wages during the 2008/09and the 2010/13 period. A cross-countrycomparison on the basis of WDN 2 resultssuggests that such an incidence of basewage cuts is second only to Estonia, where44 per cent of firms cut wages.• A comparison of WDN 3 survey resultswith the findings from WDN 1 in respect ofIreland suggests that a dramatic increasein the incidence of both wage cuts andwage freezes occurred during the crisis –the percentage of surveyed firms reportingwage freezes of around 60 per centcompares with 7.1 per cent in the five yearsprior to 2006/2007 (Lawless et al., 2009).The increased importance of wage freezes/cuts is held to reflect both the intensity andnature of the shock experienced by Irishfirms as well as the institutional features ofthe Irish labour market.• Reflecting a dichotomy in the types of firmsoperating in Ireland, a significant proportionof firms actually increased wagesthroughout 2008 to 2013. The presence ofthe high-tech sectors ensured that demandfor skilled labour remained high. Thesefirms were generally more insulated fromdomestic developments and continued tooffer employees attractive remunerationpackages in line with productivity. Thisfirm-level survey suggests that thesewage increases masked the extent ofthe downward wage adjustment in theaggregate wage data.Overall, this firm-level survey revealed that, inkeeping with Ireland's international reputationas having a flexible labour market, theresponse of firms to the crisis was remarkablyflexible – both in terms of past experience andcompared to other countries. The adjustmentwas not universal, however, some businessesexperienced an unprecedented drop in output,with subsequent reductions in labour costson all fronts, including basic wages; otheremployers were more insulated from thedecline and continued to increase wages.


92Labour Cost Adjustment during the Crisis:Quarterly Bulletin 03 / July 15Firm-level EvidenceReferencesBergin, A., Kelly, E. and McGuiness, S. (2012),“Explaining Changes in Earnings and LabourCosts During the Recession,” Dublin: ESRI.Bertola, G., Dabusinskas, A., Hoeberichts,M., Izquierdo, M., Kwapil, C., Montornes, J.and Radowski, D. (2010). “Price, Wage andEmployment Response to Shocks: Evidencefrom the WDN Survey”, European CentralBank, Working Paper No. 1164.Central Statistics Office (2010), “Analysisof wage bill change in enterprises andcomponents of change, Quarter 3 2008 toQuarter 3 2009”, Central Statistics Office,Ireland.Conefrey, T., and Smith, R. (2014). “On theslide? Salary scales for new graduates 2004-2012”. Central Bank of Ireland, EconomicsLetters series, Vol. 2014, No. 1.Keeney, M., Lawless, M. and Murphy, A.(2009). “Wage Setting and Wage Flexibilityin Ireland:Results from a Firm-level Survey”.Central Bank of Ireland, Quarterly BulletinArticle, October 2009.Keeney, M. and M. Lawless (2010). “WageSetting and Wage Flexibility in Ireland: Resultsfrom a Firm-level Survey”, Central Bankand Financial Services Authority of Ireland,Research Technical Paper 1/RT/10.Rõõm, T. and Messina, J. (2009). “DownwardWage Rigidity during the Current Financial andEconomic Crisis”, mimeo.Walsh, K. (2012). “Wage bill change in Irelandduring recession - How have employersreacted to the downturn?” Journal of theStatistical and Social Inquiry Society ofIreland, One Hundred and Sixty-Fifth Session2011/2012.Dickens, W.T., L. Goette (2006), "EstimatingWage Rigidity for the International WageFlexibility Project". Working Paper, BrookingsInstitution.Dickens W.T., L. Goette, E.L. Groshen, S.Holden, J. Messina, M.E. Schweitzer, J.Turunen, and M.E. Ward (2007), "How wageschange: micro evidence from the InternationalWage Flexibility Project", Journal of EconomicPerspectives, 21(2), 195-214.Doris, A., O'Neill, D. and Sweetman, O. (2013).“Wage Flexibility and the Great Recession:The Response of the Irish Labour Market,” IZADiscussion Papers 7787, Institute for the Studyof Labor (IZA).European Central Bank (2009), ‘New SurveyEvidence on Wage Setting in Europe’,European Central Bank, Monthly Bulletin,October.European Central Bank (2010), ‘LabourMarket Adjustments to the Recession in theEuro Area’, European Central Bank, MonthlyBulletin, July.


Section 3Quarterly Bulletin 03 / July 151Statistical Appendix


2Statistical Appendix Quarterly Bulletin 03 / July 15Statistical AppendixThe publication of the Statistical Appendix of the Quarterly Bulletin wasdiscontinued from Quarterly Bulletin 1 2014. Statistical data compiled by theCentral Bank are accessible on the Statistics page of the Central Bank’s website,http://www.centralbank.ie/polstats/stats/Pages/default.aspx. Some tables, previouslypublished in the Statistical Appendix, have been expanded to provide morecomprehensive data. A number of statistical tables, which were not published in earlierBulletins, have also been added.The list of statistical tables and links to access them on the website are given on thefollowing page.


Statistical AppendixQuarterly Bulletin 03 / July 153STATISTICAL TABLES: CENTRAL BANK WEBSITE LINKSMoney and Banking:http://www.centralbank.ie/polstats/stats/cmab/Pages/Money%20and%20Banking.aspx• Summary Irish Private Sector Credit and Deposits• Financial Statement of the Central Bank of Ireland• Credit Institutions – Aggregate Balance Sheet• Credit Institutions (Domestic Market Group) – Aggregate Balance SheetBusiness Credit and Deposits:http://www.centralbank.ie/polstats/stats/cmab/Pages/BusinessCredit.aspx• Credit Advanced to Irish Resident Private-Sector Enterprises• Deposits from Irish Resident Private-Sector EnterprisesPrivate Household Credit and Deposits:http://www.centralbank.ie/polstats/stats/cmab/Pages/HouseholdCredit.aspx• Credit Advanced to and Deposits from Irish Private HouseholdsMoney Market Funds:http://www.centralbank.ie/polstats/stats/cmab/Pages/MoneyMarketFunds.aspx• Money Market Funds Aggregate Balance Sheet• Money Market Funds Currency Breakdown of AssetsRetail Interest Rates:http://www.centralbank.ie/POLSTATS/STATS/CMAB/Pages/Retail%20Interest%20Rate%20Statistics.aspx• Retail Interest Rates - Deposits, Outstanding Amounts• Retail Interest Rates - Loans, Outstanding Amounts• Retail Interest Rates and Volumes - Loans and Deposits, New Business• Official and Selected Interest RatesInvestment Funds:http://www.centralbank.ie/polstats/stats/investfunds/Pages/data.aspx• Ireland: Investment Funds DataSecurities Issues:http://www.centralbank.ie/polstats/stats/sis/Pages/Issues.aspx• Securities Issues StatisticsFinancial Vehicle Corporations:http://www.centralbank.ie/polstats/stats/fvc/Pages/data.aspx• Irish Financial Vehicle CorporationsLocational Banking Statistics:http://www.centralbank.ie/polstats/stats/locational/Pages/data.aspx• Total Positions of Banking Offices Resident in Ireland vis-a-vis Residents and Non-ResidentsQuarterly Financial Accounts:http://www.centralbank.ie/polstats/stats/qfaccounts/Pages/Data.aspx• Financial Accounts for Ireland: Q1 2012 to presentPublic Finances and Competitiveness Indicators:http://www.centralbank.ie/polstats/stats/sis/Pages/SecuritiesHoldingsStatistics.aspx• Gross National Debt• Holdings of Irish Government Long-term Bondshttp://www.centralbank.ie/polstats/stats/Pages/hcis.aspx• Nominal and Real HCIs


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