Partying and Irish implications of the monetary union

The job of a central banker, according to William McChesney Martin Jr. - the longest serving Federal Reserve chairman - is "to take away the punch bowl just as the party gets going." This is in order to prevent the economy from overheating and to keep inflation and inflation expectations in check.

But what happens when a country no longer has control over its monetary policy, as happened Ireland after it joined the Euro? In this case, fiscal policy has to step in and become the policy lever through which a country can pursue price stability and sustainable economic growth. In short, the Minister for Finance must become part Governor of the Central Bank, part Minister for Finance.

Ireland's fundamental misunderstanding of its role in a monetary union lies at the heart of many of our current financial problems. During the height of the Celtic Tiger, interest rates in the Eurozone were are inappropriately low levels for Ireland, whose economy and inflation level was booming. The Irish government should have been aware of its new role and tried to keep inflation in check through fiscal policy. Instead of doing this, it let these high inflation levels become built into people's expectations, which helped wages increase to unsustainable levels in the public and private sector, as well as feed the massive increases in public sector spending during the Ahern era. Government policy fed the boom, precisely at the time when it should have been aiming to keep it in check.

Instead of taking the advice of McChesney Martin Jr. and taking away the punch bowl as the party got going, the Irish government instead took the advice of Chuck Prince (CEO of Citigroup during the boom years) who said: "When the music stops... things will be complicated. But as long as the music is playing, you've got to get up and dance!"