Future of the economy depends on who you ask

Once again the Irish economy has surpassed all expectations and has continued to boom. But still there are siren warnings from a broad range of commentators that it is now seriously overheating.

Certainly the economy has continued to boom and inflation is picking up. But is this a serious turning point? Will 2000 be the year that commentators look back on and say that it was the time when things began to finally career out of control?

Almost inevitably, there are two distinct schools of thought on this. Institutions such as the IMF, the OECD, the Central Bank and to some extent the ESRI all point to inflationary pressures and say the economy is in danger of overheating. In the jargon, the dangers of a hard landing are increasing.

The other school maintains that because Ireland is so open to the rest of the world the only inflation here is imported from elsewhere. And with global price pressures being firmly downward, we are not in any danger. Because the Central Bank no longer has control of interest rates and exchange rates there is no fear of a run on the pound. Furthermore, interest rates cannot be increased so even booming house prices cannot collapse in the way that they did in London and elsewhere in Britain in the late 1980s. As one commentator put it: we can simply keep on filling the Champagne bucket.

But it is unclear so far which is right. The likelihood is that there is some validity on both sides. Economists such as Mr Jim Power, chief economist at Bank of Ireland, argue that an employment shock, or in other words a series of layoffs or redundancies, would be enough to tip the balance.

Others such as Davy's Mr Jim O'Leary say that the recent Budget was inflationary, that it will push inflation up towards 4 per cent and could undermine the housing market with possible serious repercussions for the economy.

What is certainly true is that the economy continues to grow by up to 9 per cent a year, in terms of Gross National Product. Official data is only available for the period to March 1999 but there is a general belief that while growth may have slowed up to September, it has taken off again since.

Exports and the multinational sector, in particular, have driven the economy in recent years. That is likely to continue in 2000. As the UK and other euro-zone economies pick up further in the new year, Ireland's export performance should be boosted still further. However, because of constraints such as labour supply the increase may not be quite as fast as this year. In addition, the official level of growth in the economy will be held back as imports rise even faster than exports. Nevertheless, even the inherently conservative Department of Finance is still expecting growth of more than 7 per cent.

But there are some worrying signs. According to the Central Bank, indigenous firms - even in the high-tech sector - are not doing anywhere near as well as the multinationals. Productivity is only growing by 2 per cent among these companies and with labour supply growing at the same rate the overall impact is negligible. This is very worrying according to the Bank, particularly given likely wage developments.

Of course overall inflation will be very important. According to Davy's Mr O'Leary, there are still inflationary dangers. He says there are limitations to the theory that because Ireland is such a small open economy it cannot run up inflationary pressures.

He points out that while the State imports a lot of goods there is still a domestic side to the economy and Irish consumers do spend a non-trivial proportion of their annual increase in disposable incomes on home-produced goods and services. Thus the inflation rate is not simply a function of price movements in the rest of the world and exchange rate changes; it also reflects domestic demand pressures.

The boost given to the economy on Budget Day and with subsequent measures will raise disposable income by around 4.5 per cent, about twice the average boost delivered by budgets of the past five years. This will raise consumer spending next year and beyond. This is bound to feed through to inflation, according to Mr O'Leary and, indeed, institutions such as the ESRI and the Central Bank.

Already services inflation is running at more than 5 per cent and as it accelerates inflation itself is likely to reach 4 per cent. This will certainly increase the pressure on wages and is likely to feed through to a higher wage settlement under the new national agreement than would otherwise have been the case.

So what else is in store for 2000? There can be little doubt but that the house price boom will continue. According to the ESRI, house prices will rise by around 15 per cent in the coming year, a forecast with which the Central Bank agrees. The Budget of course underlines these forecasts.

According to Mr O'Leary the deceleration in prices seen in 1999 is now at an end. The Budget will mean that instead of prices rising by up to 10 per cent in 2000 they will now rise by around 15 per cent and by 10 per cent in the following two years to 2002. That is another threat to the stability of the economy and will leave first-time buyers even further behind and make housing even more unaffordable.