'Rip-off Ireland' is more myth than reality

Economics: The term "Rip-off Ireland" has gained currency of late, and the letters column of this newspaper is testimony to the resonance of the term with the public at large. Most of the letter-writers detail examples of what they perceive as extravagantly high prices in Ireland, and often compare them unfavourably with experience elsewhere.

Some of these quoted examples are less convincing than others (prices in low-income countries such as Portugal and Greece are inevitably going to be below that of a high-income country like Ireland), but they tap into a widespread belief that prices in Ireland are in some way unjustifiably out of kilter with our European peer group.

Comparing absolute price levels across economies is tricky, and the figures that are published tend to be a number of years out of date, although the most recent have pointed to Irish prices being well above the euro area norm. Information on changes in the price level, in contrast, is readily available every month with the publication of inflation rates.

In that context, Ireland's inflation reading for December, released last week, deserved more attention than it received. The headline rate was 2.6 per cent, but this is not useful for comparative purposes.

For comparison, the appropriate measure is the Harmonised Index of Consumer Prices (HICP), which is calculated by each member state to a standardised format to allow the comparison of consumer price trends across the EU.

Irish inflation on the HICP measure was 2.4 per cent, and as such exactly in line with the euro-area norm.

Moreover, this was no monthly statistical quirk, as Irish inflation for 2004 as a whole was less than 0.2 per cent above the euro average.

This convergence to the euro norm follows four years in which Irish inflation has consistently been higher than its euro peers (the differential averaged 2.1 per cent per year) and is all the more remarkable in that economic growth in Ireland was three times the EU rate in 2004. So Irish inflation has converged to the euro-zone average - for now at least - despite Ireland's relative economic outperformance.

Indeed, inflation in the Irish high street in 2004 was actually below the euro area.

Take clothing and footwear: prices in this category rose by 0.6 per cent in the euro area in the year to November, but fell by 3.2 per cent in Ireland.

The price of furnishings and household equipment also fell domestically, by 1.7 per cent, but rose by 0.8 per cent in the euro zone.

The differential in food price inflation was virtually zero (0.2 per cent in Ireland, against 0.3 per cent in the euro area) but striking in alcohol and tobacco - an 8.4 per cent rise in Europe against a 0.6 per cent increase in lreland.

Even in areas where Irish inflation is high, as in health (5.7 per cent), the euro-zone experience was even worse - a rise of 8.5 per cent in 2004.

Of course, there were areas where Irish inflation was higher, and these tended to be in the service sectors. Education prices, for example, rose by 5.4 per cent in Ireland, or 1.8 per cent above the euro norm. The inflation rate in Irish hotels and restaurants also outpaced that of Europe, by 1.3 per cent, as did miscellaneous goods and services, at 2.5 per cent against 2.1 per cent.

The conclusion is that the differential between the Irish price level and the euro average is not widening, despite Ireland's superior economic performance, and that the differential in terms of high street prices may be narrowing.

One explanation for the latter is that a structural change is under way by virtue of Ireland's membership of the single currency, which increases price transparency across the euro area, helping the price of readily tradeable goods to converge.

An alternative explanation involves the exchange rate, and as such is more cyclical in nature: Ireland is far more exposed to the external value of the euro than its peers within EMU, so the euro's appreciation over the last few years has had a much greater disinflationary impact on Ireland than elsewhere, contributing to the low inflation rate in goods, as most are imported.

It follows that stabilisation of the currency, or even a euro decline, would reverse this sequence and again put upward pressure on Irish goods prices, in absolute terms and relative to other euro countries who are less dependent on imports.

On this analysis then, last year's inflation convergence has nothing to do with membership of the single currency, and owes more to short-term cyclical influences than to any permanent shift in price trends,

In reality, the two explanations are not mutually exclusive, and both were no doubt at work.

A simple model of inflation based on the exchange rate would have predicted a fall in Irish inflation in 2004, but it is also difficult to dismiss the idea that Irish consumers are now more aware of prices elsewhere, and that price transparency has indeed become greater.

Unfortunately, services, such as restaurants, are not as tradeable as goods, so price differentials in this area can persist for much longer, implying that convergence in terms of service prices is a very different story.

The author is chief economist with the Bank of Ireland.