On the Hook for Impaired Bank Lending: Do Sovereign-Bank Interlinkages Affect the Net Cost of a Fiscal Stimulus?
by Robert Kellya and Kieran McQuinnb
Recently, some notable contributions suggest that discretionary
fiscal policy can be an effective and self-financing policy
option in the presence of extreme macroeconomic conditions.
Given the special relationship between the Irish sovereign and
its main financial institutions, this paper assesses the implications
for the Irish fiscal accounts of certain macroeconomic
policy responses. Using a comprehensive empirical framework,
the paper examines the relationship between house prices,
unemployment, and mortgage arrears. Loan loss forecasts over
the period 2012–14 are then generated for the mortgage book of
the main Irish financial institutions under two different scenarios.
It is shown that macroeconomic policies, which alleviate
levels of mortgage distress, improve the solvency position of
the guaranteed Irish institutions, thereby reducing the sovereign’s
future capital obligations. Thus, the unique situation the
sovereign finds itself in vis-´a-vis its main financial institutions
may have significant implications for the net cost of a fiscal
JEL Codes: G21, R30, C58.
Full article (PDF, 34 pages, 1549 kb)
a Central Bank of Ireland
b Economic and Social Research Institute (ESRI)