ECONOMICS: FIRST, A visit to the "I told you so" department. Readers of this column know that, for some time now, I have been a good deal more pessimistic about the short-term prospects for the Irish economy than the professional forecasters.
In my column last October, I warned that forecasts of house-building activity for 2008 were pitched much too high. In January, I predicted that the overall economic slowdown was going to be much sharper than was consistent with the then "consensus" that GDP would grow by 2.5-3 per cent this year.
My reasoning at the time was threefold:
(i) that the weakness in residential construction was being underestimated;
(ii) that the probability of significant spillover effects from a collapsing housing market was being cheerfully downplayed, and
(iii) that the fall-out from the international financial crisis, in the shape of tightening credit conditions and an appreciating euro, was being ignored.
So it has come to pass. Over the past few months the economic indicators have painted a much grimmer picture than was evident at the start of the year. The downturn in the housing sector has been steeper and its baleful influence on other areas of economic activity more pronounced than expected, while the credit crunch has started to bite with a vengeance. As a result, the professionals have been frantically cutting their forecasts in a bid to keep them abreast of the emerging reality (so much for the charge that they were talking the economy down!).
The latest forecasts from the likes of Davy, Goodbody and the ESRI quarterly economic commentary team now envisage GNP growth of about 1 per cent this year. For an economy with a potential growth rate of an estimated 4 per cent, this is a bleak prospect and implies a big rise in unemployment. Still, the balance of risks to the latest forecasts remains skewed to the downside.
My own view is that GNP is now much more likely to contract than expand this year. If this is what transpires, it will be for the first time in a quarter century: the last year that registered a decline in GNP was 1983. There are other unwelcome records being set: the household sector is currently confronting the cocktail of rising unemployment and falling house prices for the first time since the early 1990s.
Indeed, many households have never operated against this background before. Is it any wonder therefore, that there has been a marked shift in the psychology of consumers, manifested inter alia in falling retail sales volumes?
Of course, as 2008 matures, the focus shifts to next year and beyond. The steepness of this year's slowdown, however spectacular it may prove to be, is becoming ever less important an issue than the questions of how long recession will last/how soon recovery will get under way. The question of how soon recovery will begin begs the question of what will bring it about.
Typically, recovery from recession is sparked by monetary easing, fiscal expansion or, in a small open economy like Ireland, an exchange rate depreciation and/or an international upswing. One of the worrying things now is that none of these catalysts seems likely to come into play any time soon.
As far as the international environment is concerned, forecasters are busy revising downwards their numbers, not only for 2008 but for 2009 as well. It is now generally expected that economic performance in the US and the euro zone next year will be not much different from this year's very tepid effort, so the continuation of sluggish growth among our main trading partners remains the most likely prospect for the coming 12-18 months.
Nor is there much relief in prospect on either the interest rate or exchange rate fronts. Animated by concern about accelerating inflation, the ECB is not about to cut its interest rate, even as lending institutions are being forced to raise theirs because of ongoing liquidity problems in interbank markets.
As far as exchange rates are concerned, the one that is of most acute concern from an Irish point of view - the sterling-euro rate - seems more likely to continue rising than to fall back. Indeed, last week's report on the economy from Davy suggested that the sterling-euro exchange rate might be headed for 0.90. This would imply a notional sterling-Irish pound rate of 1.14 and would spell very bad news for the exposed sectors of the economy.
What of fiscal policy? Well, there is zero likelihood of a fiscal stimulus. On the contrary, because this year's budget deficit is in danger of breaching the stability and growth pact limit of 3 per cent of GDP and next year's will almost certainly do so on a no-policy-change basis, fiscal policy design for 2009 will be all about correction and consolidation. This means, of course, that it will be contradictory, perhaps severely so.
The good news, as stated in the ESRI's medium-term review last week, is that all of the above will eventually pass and the economy will return to its medium-term growth path. Or, as Chance the gardener was fond of pointing out in Peter Sellers's penultimate film, Being There, winter is followed by spring. That's certainly true but sometimes wintry conditions last a bit longer than usual. My guess is that this is one of those times.
