The Irish economy was hit by a severe crisis in 2008, after over a decade of strong growth that propelled Ireland to the fourth highest level of GDP per capita in the OECD. Initially growth was well founded on solid productivity increases. However, during a period of low-cost funding on international markets and low risk aversion globally, the expansion became increasingly reliant on a speculative housing bubble financed by lax bank lending standards and excessive credit expansion that collapsed in 2008 in the midst of the global economic and financial crisis. During the latter part of the boom, the acceleration of wages eroded international cost-competitiveness and the banking system became over-extended and, once the bubble burst, would have been insolvent without state support. Capital injections to help resolve the crisis have resulted in a sharply higher public debt. In the aftermath, households have been hit by wage cuts, job losses, tax increases and falling house prices, though living standards and perceptions of well-being remain high by international standards.

From 1994 to 2007 the Irish economy was a stellar performer. GDP growth averaged 7% per annum pushing Irish living standards to the fourth highest in the OECD. Growth was initially well-founded and genuine progress in the Celtic Tiger years has left Ireland with one of the most structurally sound economies in the OECD.

Ireland’s banking crisis, one of the most severe in the OECD area, and the associated economic recession have taken a heavy toll on public finances. Large public deficits have accumulated since 2008 and net public debt, which had been eliminated, has soared once again. The rapid deterioration of the fiscal accounts, together with the government guarantee of banks’ liabilities, has led to Ireland losing the confidence of the sovereign bond market and requiring financial assistance from the international community. With one of the highest levels of gross public debt relative to GDP in the OECD, high bond spreads and weak nominal GDP growth, returning to a healthy fiscal position poses a significant challenge. A sustained effort will be needed to eliminate the budget deficit, regain the confidence of financial markets and to seek to increase trend growth through appropriate structural reforms. The economic adjustment programme supported by the IMF and the EU foresees a gradual consolidation of the public finances to stabilise and reduce the debt to GDP ratio and restore fiscal sustainability. The programme builds on significant progress that has already been made to contain the deterioration of fiscal accounts and the government plans to introduce further fiscal adjustment in 2012 and later years in line with the programme. The programme also foresees a strengthening of the fiscal framework, with large institutional changes intended to secure a path of fiscal sustainability in the medium-term. The consolidation effort is also underpinned by efforts to increase public sector efficiency, which provides a growth-friendly avenue for reducing the deficit in a durable way.

Ireland is recovering from an extremely large banking crisis born of overexuberant property lending. The government has taken a wide range of measures to tackle the crisis over the past 3 years. Larger bad property loans have been transferred to a government controlled “bad bank”, NAMA, and the associated heavy losses fully recognised by the banks. NAMA needs to focus on maximising tax payer returns from disposing of this asset portfolio. The banking system was recapitalised in mid 2011 following stringent bank “stress tests”, which proved to be a crucial turning point in the crisis by helping to draw a line under losses. Restructuring of the domestic banking system around two core pillar banks is underway but the domestic banking system is still too large. Selling down the banks’ large portfolio of foreign assets will help to downsize the banks. It will assist in reducing reliance on eurosystem liquidity while minimising the squeeze on domestic credit. As confidence in the financial system is regained, the authorities should further restrict the government guarantee of bank liabilities. Revamped bank regulation and supervision should utilise a wider set of indicators and rules beyond standard capital ratios and pay greater attention to macro-financial linkages.

After a recession of historic proportions, an export-led recovery is gaining traction in Ireland. The pace of recovery, however, varies sharply across sectors. While export-oriented manufacturing and services, led by large multinationals, have reached record-high levels of output, inward-oriented sectors, where Irishowned SMEs predominate, are by and large still struggling to emerge from the crisis. Reflecting the weakness of this traditional sector, which is labour intensive, unemployment rates remain very high, particularly among young men with low or intermediate qualifications, often formerly employed in the construction sector. To tackle high and persistent unemployment and thus stave off social exclusion, Ireland needs to further pursue an integrated three-pillar strategy: welfare reform to ensure that work pays; better activation policies to assist labour reallocation across sectors; and a sustained restraint in wages and other business costs to restore international competitiveness. In particular, often building on recent policy initiatives or commitments, this chapter recommends reforms to further enhance product-market competition, improve innovation efforts and ameliorate the quality of education, which are key to economic prosperity.