Government could add to inflationary squeeze with untargeted measures, fiscal council warns

The State cannot protect everybody from inflation and will only compound the current cost-of-living squeeze if it relies on untargeted measures to deal with the problem, the Irish Fiscal Advisory Council (Ifac) has said.

“The Government faces a delicate balancing act in protecting the economy and poorer households from higher energy and food prices, while avoiding adding to inflation through second-round effects,” the council said in its latest report.

The fear is that if the Government tries to match price increases with corresponding welfare and public sector wage hikes, it will only end up chasing inflation and adding to existing price pressures. The cost of fully indexing welfare and public sector pay for inflation would be in the region of €3.3 billion, the council calculated. Instead it advised the Government to only partially track wider price and wage increases so as to create fiscal space for new projects.

“This approach would see spending increase without providing excessive stimulus to an already fast outlook for growth; it would help avoid the risk of second-round increases in prices and wages, potentially destabilising the economy and the public finances,” it said.

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With inflation running at a two-decade high of 7 per cent here, and the euro zone’s recovery from the pandemic faltering in the face of Russian energy threats, forecasters are warning that the Continent could be pitched into a period of stagflation, which is characterised by low growth and high inflation. In its report, the council said the Irish economy was continuing to grow despite the inflationary challenge but that the risks were high, including those associated with the war in Ukraine.

“Energy and food price increases have taken inflation to the highest rate in a generation. Further price rises and tightening financial conditions could herald a global downturn,” it said, noting that as a small open economy, Ireland is particularly sensitive to investment decisions and trade spillovers from its main trading partners.

“However, Ireland currently has favourable exposures to high-skill sectors, including those with less cyclical tendencies such as information and communication technologies and pharmaceuticals, which have shown resilience during challenging periods for the global economy,” it said.

As a result, it is possible that the Irish economy is relatively well-placed to weather a downturn in economic activity abroad, it said. In its report, the council commended the Government for sticking to a 5 per cent spending rule but said major policy commitments relating to healthcare and climate change need to be properly costed and factored in to future spending plans.

“There are major medium-term challenges for which the Government has not set out credible plans. These pressures on public spending raise significant questions about how they will be accommodated within the Government’s spending rule alongside existing policies, it said.

Council chairman Sebastian Barnes said tax receipts have been boosted by a swift recovery and strong taxes, in part thanks to the massive support provided during the pandemic. “But, the Government now faces difficult choices,” he said.

“Supporting poorer households, keeping a lid on further price increases, and implementing other policies will be complicated in the short run. At the same time, more clarity is needed on how the Government will deliver on its longer-term goals while ensuring prudent management of the public finances,” he said.