Reaching a solid consensus on growth forecasts

Experts have become prudent in their outlook, writes Marc Coleman, Economics Editor

The Department of Finance produced one in August, while the Economic and Social Research Institute (ESRI), International Monetary Fund (IMF) and employers' federation Ibec came out with theirs in the past two weeks. Autumn is a time for economic forecasts and they come thick and fast from any economic or financial institution with a crystal ball.

The latest comes from the Central Bank of Ireland. Its deep bank of talented economists, independence and strong links to the forecasting system of the European Central Bank (ECB) all combine to make its latest forecast a good benchmark for the others. And some benchmark is needed.

Forecasts for this year's growth vary from the Central Bank's 4.25 per cent to the ESRI's 5.7 per cent. But most of the recent forecasts are closer to the Central Bank's view of the world.

The nearest forecast to it is the department's August forecast of 5.1 per cent and Minister for Finance Brian Cowen admitted in September that this number would be re-examined to assess the impact of the oil price increases in late summer.

So the economy is likely to grow by about 4.5 per cent this year, less than originally expected. Good growth if not great growth, as a certain football pundit might say.

What are economic forecasts used for and what are the implications of different forecasts?

Trade unions use them to predict how inflation will affect their members' living standards. They also use them to assess the private sector and Government capacity to fund pay increases. The Government uses them to forecast tax revenues, unemployment and welfare spending.

The private sector uses them to assess business conditions. Central banks use them to assess the risks of inflation rising and whether interest rates should be increased. Our system of social partnership makes them particularly important in this country.

Unions look for signs that pay increases are desirable and affordable and are in a stronger negotiating position when growth forecasts are robust. The Government is in two minds about forecasts. Strong forecasts are good for electoral reasons.

But poor forecasts help to dampen the expectations of backbenchers for spending increases and increases in public sector pay. The private sector is also in two minds. It likes strong forecasts when assessing opportunities for business growth and weak ones when dealing with unions. So any differences in outlook for the economy matter.

Before looking at those differences, some areas of agreement are relevant. The good news in all of the forecasts relate to inflation. It is likely to remain low in spite of a recent oil-induced spike.

This is because the dreaded "second-round" effects - where oil price rises prompt spiralling increases in prices and wages - are so far absent. This outlook is true of Ireland and broadly true of the euro zone, so interest rates are unlikely to rise any time soon.

Another point of agreement is less benign and that relates to productivity. An economy can grow for two reasons. The first is because the number of people in the State is growing. The second is because, on average, the people in the economy are becoming more productive.

The Central Bank is in broad agreement with other forecasters that the contribution of productivity growth to overall growth is very weak. It expects employment to grow by 4 per cent, explaining almost all of the 4.25 growth in the economy. This is happening because employment growth is taking place in sectors that have relatively low productivity, such as the services, construction and financial services sectors.

The most productive sector, manufacturing, is losing jobs at a modest but steady pace. What are the implications of recent forecasts? In social partnership negotiations, unions may emphasise the ESRI's most recent forecast. They will also point to recent evidence of burgeoning public finances as a good reason for generous increases in public sector pay.

Ibec will refer to its lower forecast, but the fact that productivity growth is so weak will make the case for strong wage growth harder to sustain. The widespread consensus that inflation will remain low will add weight to this argument.

The other impact will be on budgetary policy. Like economic growth, tax revenue growth is strong in numerical terms, but reflects imbalance in the economy. The Central Bank predicts that Government revenues will exceed expectations by €1.2 billion at the end of year, based on Exchequer returns to September. By an interesting coincidence, that is exactly the figure for the general Government deficit this year in the last budget.

On Monday, the IMF called on the Government to cut back Government spending on the basis that the economy needed cooling down.

The Central Bank has set the bar a little lower. Don't spend the extra revenue, but use it to balance your budget. With growth coming down from the dizzy heights of the past decade, a mood of prudence is taking over.