Monthly Archives: August 2015

Who Pays the Bills?

Sovereign Debt Guarantees and Default: Lessons from the UK and Ireland, 1920-1938

By Nathan Foley-Fisher (Federal Reserve Board) and Eoin McLaughlin (St. Andrews)

Abstract We study the daily yields on Irish land bonds listed on the Dublin Stock Exchange during the years 1920-1938. We exploit structural differences in bonds guaranteed by the UK and Irish governments to find Irish events that had long term effects on the credibility of government guarantees. We document two major events: The Anglo-Irish Treaty of 1921 and Ireland’s default on intergovernmental payments in 1932. We discuss the political and economic forces behind the Irish and UK governments’ decisions. Our finding has implications for modern-day proposals to issue jointly-guaranteed sovereign debt.


Distributed by NEP-HIS on: 2015-05-16

Review by Sarah Charity (Queen’s University of Belfast)

This working paper abets us in shedding some light on the financial implications for current economic events. One that dominated the headlines most prominently was Scotland’s decision to vote on independence in their recent referendum. Hard-line fiscal policy makers held their breath while questions simmered such as; would an independent Scotland continue debt repayments to Britain? What if they defaulted on these payments? The authors investigate how public debt in Ireland was dealt with during their severance from the political state of the United Kingdom in the early 20th century, focusing on the implementation of UK- and Irish-backed land bonds over this period of significant Irish land reform, when ownership was transferred from landlords to tenants. From this episode in Irish history, we can draw comparisons and learn lessons for today.


Foley-Fisher and McLaughlin look to previous studies in which yield spreads between UK and Irish government bonds are analysed, such as that of Nevin (1963) and Ó Gráda (1994). They contribute to the existing literature by concentrating on land bonds. They base their methodology on the idea of particular structural breaks occurring in their time-series data. They build on the discoveries of Willard et al. (1996) who defined breaks as a change in the intercept of the time series – ‘a shift in the mean’ (p.11-12), while Zussman et al. (2008) also searched for ‘breakpoints’ (p.4) in their methodology. They analyse the shifts in ‘perceived value of sovereign guarantees’ (p.11) by looking for changes in the mean of the yield spreads.

The impact of bond spreads ‘diffused’ (p.15) around three significant events. The first break coincides with the Anglo Irish Treaty passing in 1921 while the second occurred a decade later when the default by Ireland on land bond payments beckoned. Around this time, Eamon De Valera, founder of Irish political party Fianna Fáil, announced the ‘Free State would not honour the bi-annual payments due under various financial agreements between Ireland and the UK’ (p.14). The final break came at the end of the sample period, however this is discounted as irrelevant due to trade war negotiations being ‘unlikely…(to be) sufficient’ (p.15).

Parliamentary acts sanctioned the used of generous government guaranteed land bonds to finance state mortgages, rather similar to the volatile mortgage backed securities of the recent credit crisis, allowing farmers to borrow significant amounts of credit at lower rates. The idea was to curtail the Irish Nationalists, however it proved unsuccessful and the ‘hardline republicans’ (p.6) received independence through the signing of the Treaty in December 1921. A new dawn was on the horizon, bringing with it the promise of a new government – but it was lamentably overshadowed by the onset of the Irish Civil War. The newly established Free State was released from its obligation towards UK public debt in return for permanent partition; however it agreed to maintain annuity payments along with issuance of more land bonds.

The authors calculate the credibility of UK guarantees, otherwise known as sovereign risk, post-independence using yield spreads controlling for risks of inflation and exchange rate alternations. They acknowledge other scholars in assessing the importance of credibility in economic features such as the ‘cost of government finance’ (p.5) as investigated by Flandreau & Zumer (2009) and the estimated behaviour of the government as a ‘counterparty in other contracts’ (p.5) as seen in Cole & Kehoe (1998). Foley-Fisher and McLaughlin found the spread over UK government bonds to be 60 basis points indicating a low credit risk for the UK- and Irish-backed land bonds. Through their estimations they suggested that the increased yield spread of the land bonds during the ‘benchmark’ years from 1921 to 1932 was highly significant. After Ireland defaulted, the land bonds were no longer considered risky and the spread on UK-backed land bonds returned to zero. The authors are perhaps slightly restricted by their sample period. Mercille (2006, p.3) tells us little research exists on the significant long-term costs related to yield spreads, forcing us to seek answers elsewhere.


Foley-Fisher and McLaughlin suggest that the cost of Ireland’s default was greater for their British counterparts. They give reasons for the UK’s intervention such as the insignificant cost to the UK Treasury, who continued making interest repayments to ensure bond holders remained intact; UK war loan negotiations and the fact land bonds were mostly held in the UK ensured Whitehall was an interested party. The authors provide us with a contrasting government reaction to default in another commonwealth country, using the contemporaneous case of Newfoundland, whose debt profile bore echoes of Ireland’s. As previously mentioned, the cost for the UK government of bondholders’ losses through passing on Ireland’s default far outweighed the benefits. In the Newfoundland example, the UK government’s reaction was to withdraw from the imminent burden of financial instability and force confederation of the Dominion with Canada, thus shedding the burden for bondholders’ losses – a consequence independence-seeking Scotland may have wanted to consider.

In the absence of case studies, Ireland’s historical sovereign break up ensures Foley-Fisher and McLaughlin’s ‘simple empirical strategy’ (C.R, 2014) is applicable to and useful in multiple current financial situations whether it be the aforementioned Scottish referendum, or the pending disintegration of Catalonia from Spain. Moodys (2014) discovered that 75% of the 17 country break ups which have occurred since 1983 resulted in sovereign default by the preceding or the new state – albeit these implications ‘cannot be easily applied’ (p.3) to more recent breakups, paving the way for this exploration of Ireland as the model to follow.

This paper describes apportioning fiscal liabilities as ‘complex’ and provides advice for states in the process of seeking dissolution – uncertainty is persistent. Debt must be paid and it may be guaranteed by the Treasury of the former union in the wake of default, but the ambiguity in the outcome remains. According to the blogger C.R., writing in The Economist (2014), it seems as if partition is more straightforward politically rather than financially or economically. From what Foley-Fisher and McLaughlin have taught us in their empirical study, the cost of default and fiscal uncertainty lingers long after secession. In conclusion, the exploits of our Irish ancestors from the previous century are what we, alongside other state governments, must contemplate when the sword of political state break-up strikes again.


Cole, H. L. & Kehoe, P. J. (1998), ‘Models of Sovereign Debt: Partial versus General Reputations’, International Economic Review 39(1), 55–70.

C.R (Feb. 21st 2014) The economics of Scottish Independence- a messy divorce, Blighty Britain Available at: (Accessed: March 22nd 2015)

Ferguson, N. (2006), ‘Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War’, Economic History Review 59, 70– 112

Flandreau, M. & Zumer, F. (2009), The Making of Global Finance 1880-1913, Paris: OECD Publishing.

Hancock, W. (1964), Survey of British Commonwealth Affairs. Volume I Problems of Nationality 1918-1936, Oxford: Oxford University Press.

Mauro, P., Sussman, N. & Yafeh, Y. (2006), Emerging Markets and Financial Globalization, Oxford: Oxford University Press.

Mercille, J. (2006) ‘The Media and the Question of Sovereign Debt Default in the European Economic Crisis: The Case of Ireland’, University of Sheffield, Available at: (Accessed August 18, 2015).

Moodys (May 21st. 2014) When countries broke up, sovereign default risk spiked, Available at:–PR_299968?WT.mc_id=NLTITLE_YYYYMMDD_PR_299968 (Accessed: March 23rd. 2015).

Nevin, E. (1963), ‘The Capital Stock of Irish Industry’, Economic and Social Research Institute(ESRI) paper No. 17, Dublin. Available at: (Accessed August 18, 2015).

Ó Gráda, C. (1994), Ireland: A new Economic History 1780-1939, Clarendon Press, Oxford.

Willard, K. L., Guinnane, T. W. & Rosen, H. S. (1996), ‘Turning points in the Civil War: views from the Greenback market’, American Economic Review 86, 1001–1018.

Zussman, A., Zussman, N. & Nielson, M. O. (2008), ‘Asset Market Prespectives on the Israeli-Palestinian conflict’, Economica 75, 84–115.

By failing to prepare, you are preparing to fail

The European Crisis in the Context of the History of Previous Financial Crisis

by Michael Bordo & Harold James

Abstract – There are some striking similarities between the pre 1914 gold standard and EMU today. Both arrangements are based on fixed exchange rates, monetary and fiscal orthodoxy. Each regime gave easy access by financially underdeveloped peripheral countries to capital from the core countries. But the gold standard was a contingent rule—in the case of an emergency like a major war or a serious financial crisis –a country could temporarily devalue its currency. The EMU has no such safety valve. Capital flows in both regimes fuelled asset price booms via the banking system ending in major crises in the peripheral countries. But not having the escape clause has meant that present day Greece and other peripheral European countries have suffered much greater economic harm than did Argentina in the Baring Crisis of 1890.


Circulated by NEP-HIS on: 2015-01-26

Reviewed by: Stephen Billington (Queen’s University of Belfast)


In this paper Bordo and James seek to analyse the impact of the financial crisis of 2007-8 in the context of previous crisis. Specifically by comparing the experience of periphery countries of the Eurozone with those of the “classic” Gold Standard.


In their paper Bordo and James give a synopsis of the similarities which emerged between both monetary regimes. By adhering to a gold parity there was an expansion in the banking system, through large capital inflows, which was underpinned by a strong effective state to allow for greater borrowing. A nation was effective if it held an international diplomatic commitment, which in turn required them to sign into international systems, all the while this played into the hands of radical political parties who played on civilian nationalism[1]; these events combined lead to great inflows of capital into peripheral countries which inevitably led to fiscal instability and a resulting crisis. Similar dilemmas occurred within the EMU, but much more intensely.


This brings me to the main point that the authors emphasize, that of the contingency rule of the classic gold standard. The latter allowed member countries a “safety valve for fiscal policy”. Essentially this was an escape clause that permitted a country to temporarily devalue its currency in an emergency, such as the outbreak of war or a financial crisis, but would return to normalcy soon after, that is, they would return to previous levels. Bordo and James’ argument is that this lack of a contingency within the EMU allowed for a more severe financial crisis to afflict the periphery countries (Greece, Ireland and Portugal) than had affected gold standard peripheries (Argentina, Italy and Australia) as modern day EMU countries did (and do) not have to option to devalue their currency.


Bordo and James point out that crisis during the gold standard were very sharp, but did not last as long as the 2007-8 crisis. This because the exclusion clause during the gold standard enabled a “breathing space” and as a result most countries were back to growth within a few short years. The EMU story is quite different, say Bordo and James. Mundell (1961) argued that a successful monetary union requires the existence of a well-functioning mechanism for adjustment, what we see in the EMU are a case of worse dilemmas due primarily to this absence of an escape clause.

“Gold outflows, and, with money and credit growth tied to gold, lower money and credit growth. The lower money and credit growth would cause prices and wages to fall (or would lead to reductions in the growth rates of prices and wages), helping to restore competitiveness, thus eliminating the external deficits”

The above quote provided by Gibson, Palivos and Tavlas (2014) highlights how the gold standard allowed a country to adjust to a deficit. This point reinforces how Bordo & James argue that due to the constricting nature of the EMU there is no “safety valve” to allowed EU countries to release the steam from increasing debt levels. With respect to the Argentine Baring Crisis of 1890, while the crisis was very sharp in terms of real GDP, pre-crisis levels of GDP were again reached by 1893 – clearly a contrast with the Euro as some countries are still in recession with very little progress having been made as suggested by the following headline: “Greece’s current GDP is stuck in ancient Greece” – Business Insider (2013).

The following graph highlights the issue that in Europe most countries are still lagging behind the pre-crisis levels of GDP.


Bordo and James clearly support this argument. Delles and Tavlas (2013) also argue that the adjustment mechanism of core and periphery countries limited the size and persistence of external deficits. They put forward that the durability of the gold standard relied on this mechanism. This is reinforced by Bloomfield (1959) who states it “facilitated adjustments to balance of payments disequilibrium”.

Vinals (1996) further supports the authors’ sentiments by arguing that the Treaty of Maastricht restricts an individual member’s room to manoeuvre as the Treaty requires sound fiscal policies, with debt limited to 60% of GDP and annual deficits no greater than 3% of GDP – meaning a member cannot smooth over these imbalances through spending or taxation.

Gibson, Palivos and Tavlas (2014) state “a major cost of monetary unions is the reduced flexibility to adjust to asymmetric shocks”. They argue that internal devaluations must occur to adjust to fiscal imbalances, but go on to argue that these are much harder to implement than in theory, again supported by Vinals (1996).


Bordo and James focus primarily on three EU periphery countries which are doing badly, namely Greece, Ireland and Portugal. However they neglect the remaining countries within the EU which can also be classed as a periphery. According the Wallerstein (1974) the periphery can be seen as the less developed countries, these could include further countries such as those from eastern Europe[2]. By looking at a more expansive view of peripheral countries we can see that these other peripherals had quick recoveries with sharp decreases in GDP growth, as in the case of the Gold standard countries, but swiftly recovered to high levels of growth again while the main peripheral countries the authors analyse do lag behind.

Untitled2See note 3

Bordo and James do provide a strong insight into the relationship between an adjustment mechanism to combating fiscal imbalances as a means of explaining the poor recovery of certain peripheral countries (i.e. Greece, Ireland, Portugal) and highlight the implications of this in the future of the EMU. If the EMU cannot find a contingency rule as the gold standard then recessions may leave them as vulnerable in the future as they are now.


1) This process can be thought of as a trilemma, Obstfeld, Taylor and Shambaugh (2004) give a better explanation. In the EU the problem was intensified as governments could back higher levels of debt, and there was no provision for European banking supervision, the commitment to EU integration let markets believe that there were no limits to debt levels. This led to inflows in periphery countries where banks could become too big to be rescued.

2) Latvia, Lithuania, Slovakia, Slovenia, and even Cyprus can be included based on low GDP per capita which is equivalent to Greece.

3) Data taken from Eurostat comparing real GDP growth levels of lesser developed countries within the Eurozone who all use the euro and would be locked into the same system of no adjustment.


Bloomfield, A. (1959) Monetary Policy under the International Gold Standard. New York: Federal Reserve Bank of New York.

Business Insider (2013). Every Country in Europe Should be Glad it’s Not Greece. [Accessed 19/03/2015].

Eurostat, Real GDP Growth Rates [Accessed 21/03/2015].

Dellas, Harris; Tavlas, George S. (2013). The Gold Standard, The Euro, and The Origins of the Greek Sovereign Debt Crisis. Cato Journal 33(3): 491-520.

Gibson, Heather D; Palivos, Theodore; Tavlas, George S. (2014). The Crisis in the Euro Area: An Analytic Overview.Journal of Macroeconomics 39: 233-239.

Mundell, Robert A. (1961). A Theory of Optimum Currency Areas. The American Economic Review 51(4): 657-665.

Obstfeld, Maurice. Taylor, Alan. Shambaugh, Jay C. (2004). The Trilemma in History: Trade-Offs among Exchange Rates, Monetary Policies and Capital Mobility. National Bureau of Economic Research (NBER working paper 10396).

Vinals, Jose. (1996). European Monetary Integration: A Narrow or Wide EMU?. European Economic Review 40(3-5): 1103-1109.

Wallerstein, Immanuel (1974). The Modern World-System I: Capitalist Agriculture and the Origins of the European World-Economy in the Sixteenth Century. New York: Academic Press.