Spending boom is coming but will not last forever

John FitzGerald: Higher taxation will be needed once excess savings are depleted

Comment on the economy tends to be strongly procyclical, with pessimism reigning supreme in a recession and euphoria predominating in boom times.

It is not often that analysts foresee a dramatic change in circumstances when looking ahead a year or two. However, this time round there is a degree of economic optimism creeping in here, even though unemployment is higher than it was in any previous Irish crisis.

Yesterday the ESRI published its latest economic forecast covering 2021-22. For the first six months of this year, they have revised down their expectations in the light of a longer-than-expected lockdown. Nonetheless, the gradual roll out of vaccinations provides a promise that Ireland, along with most other developed economies, will return to a more normal economic life later this year.

The ESRI is not alone in forecasting very rapid growth in the autumn and in 2022. The prospects for the US have been revised upwards due to the successful delivery of the Biden stimulus programme. The drivers of economic recovery, both here and elsewhere, will come both from the domestic economy and from trade with a recovering global economy.

Across the EU and US, a key factor in the expected rapid rebound is the huge accumulation of savings in households’ bank accounts.

In the year to February, exceptional savings by US households amounted to around 9 per cent of its national income. Since then, the Biden stimulus has begun, which will lift excess savings further.

The EU Commission in November forecast cumulative excess household savings in the euro area between 2020 and 2021 of a similar magnitude: 9 per cent of GDP. For Ireland, the figure may end up being even higher.

These excess savings have arisen because, while governments have largely insulated households against a fall in income due to shuttered economies, households have not been able to spend their income on a range of goods and services.

By the time people are free to choose what they do with their savings, it will be late this year or into next year. The ESRI see these pent-up savings producing a significant consumer boom before the end of the year, and expect consumption next year to rise by 10 per cent, the biggest increase since 2000. VAT revenue for 2022 is forecast to be 25 per cent up on this year.

A significant part of this expenditure may go on hospitality, and particularly on holidays. Trips to the sun will see some of the savings spent abroad but, likewise, Europeans and US residents are also likely to take the foreign holidays they have been denied over the past year. So, the outflow of Irish holiday spending is likely to be counterbalanced by an inflow of tourist revenue.

Limited supply

Problems are looming in the housing market, which the pandemic has temporarily masked as people have temporarily relocated out of town. Supply is already tight, and the ESRI is forecasting that housing completions this year and next year will be down to 15,000 from last year’s 20,000.

Younger buyers have built up their savings, as have their parents – the bank of mum and dad – so there will be a lot more money for deposits chasing this limited supply. Pent-up savings will put upward pressure on prices.

There’s a baseline demand for around 30,000 additional homes a year. If households put all their excess savings into housing, it could buy over 50,000 homes.

However, houses don’t appear by magic, they have to be built first, and that’s a slow process, with an under-powered construction sector. In the short-term, tackling a new bout of house price inflation will be an exceptionally difficult challenge for the Government.

The ESRI also notes that the Central Bank’s prudential rules have kept a lid on house prices. However, the Central Bank’s mandate is to protect consumers and the financial system, not to control a new bout of house price inflation.

The good times and the headaches that will arise as people unwind their savings won’t go on indefinitely. Excess savings will run down, and the expected consumer boom will almost certainly be over by the end of 2023.

However, while it lasts, the Irish Government, and governments elsewhere, will see a windfall gain in tax revenue. Though official forecasts for here and other countries still foresee deficits next year, it is possible that there could be a pleasant surprise from higher tax receipts.

However, after the boom peters out, the time will come to adjust taxation because day-to-day public expenditure has been ratcheted up during the pandemic.