Country Analysis --- Ireland Macroeconomic background The Irish sovereign debt crisis was caused by the state

guaranteeing of Irish banks involved in the Irish property bubble, which burst in 2007. The original output level is at Y1, above the natural level of output. The Irish banks lost around 100bn, much of it related to the defaulted loans to property developers and homeowners. Using the IS-LM framework, the banking crisis resulted in reduced net worth for banks, decrease in lending as well as investment and consumption spending, resulted in the sharp leftward shift of IS curve from IS1 to IS2, reducing output and causing a recession. GDP decreased by over 3% in 2008 and nearly 7% In 2009. (Global Finance, 2012) To promote growth and inject liquidity into Irish banks, the National Asset Management Agency was created to acquire large property related loans from six main Irish banks. This caused a substantial increase in Irish sovereign debt, Ireland's credit rating declined rapidly and yields on Irish 10 year government bond increased sharply. The national budget deteriorated from surplus in 2007 to -32% of GDP in 2010. (Reuters, 2011) Policy responses Ireland was forced to seek assistance from EU and IMF with a 67.5bn bailout, in return the government agreed to austerity measures in order to reduce its budget deficit to under 3% by 2015. As a result, the Irish government adopted sharp fiscal contraction of 6bn through reduction in government spending and tax increases starting in 2011. The theory of IS/LM on budget deficit reduction for the short term should lead to contraction of output in the short run by the leftward shift of IS curve. However, the Irish GDP actually increased in 2011 by 1.4% as represented by the small rightward shift of the IS curve from IS2 to IS3. This anomaly can be explained by the large increase in export of 5% more than offset the decrease in government expenditure, investment and consumption spending as Y=C()+I()+G()+NX(). (Ernst & Young, 2012) Implications The Irish budget deficit have been reduced to -12.6% in 2011 and -8.6% in 2012. It is projected to fall further to -3.1% by 2015. (Ernst & Young, 2012) Another factor at play is the role of expectation about the future. With the reduction in budget deficit, investors gain confidence that the future interest rate will decrease. This is supported by the drop in Irish 10 year government yield to below 6% in August 2012. (Bloomberg, 2012) This is a sharp decrease from the record high of 12% in July 2011. In the medium run, a lower budget deficit implies higher saving and

higher investment, output will increase to natural level. It is represented by the rightward shift of the IS curve from IS3 to ISn over the long term to the natural level of output. In conclusion, the policy of fiscal deficit reduction fits into the IS-LM framework with the anomaly explained by the increase in net export. It is generally effective in addressing the European sovereign debt crisis of Ireland. It allowed Ireland to return to the financial market at affordable rate and sustain itself over the long term without sovereign debt default which would be catastrophic.

References 1. Eurozone forecast Autumn 2012, Ireland, Ernst and Young, Irelandhttp://www.ey.com/Publication/vwLUAssets/Eurozone_forecast_Autumn_20 12_Ireland/$FILE/Eurozone_forecast_Autumn_2012_Ireland.pdf Retrieved on 29 Oct 2012 2. Ireland Country Report: GDP data and GDP forecasts; economic, financial and trade information, Global Finance, http://www.gfmag.com/gdp-data-countryreports/251-ireland-gdp-country-report.html#ixzz2ArZfwlp5 Retrieved on 29 Oct 2012 3. Irish Banks Shut Out of Market as Sovereign Returns: Euro Credit, Bloomberg, http://www.bloomberg.com/news/2012-08-23/irish-banks-shut-out-of-market-assovereign-returns-euro-credit.html Retrieved on 29 Oct 2012 4.Irish budget deficit 18.7 billion Euros in 2010, Reuters http://uk.reuters.com/article/2011/01/05/uk-ireland-economy-deficitidUKTRE7043LW20110105 Retrieved on 29 Oct 2012