A Lecture From Mr Duisenberg

 

What would the president of the European Central Bank be expected to say when visiting one of the smaller euro zone economies suffering from an inflationary surge? Warn that Budgetary policy needs to be tightened, of course. And this is precisely what Wim Duisenberg said when he visited Dublin this week. The Government has ceded control of interest rates to the ECB. This leaves Budget policy as the only lever which it can pull to influence the overall level of economic activity; the ECB clearly believes that it should use it. Mr Duisenberg hit a raw nerve in the Department of Finance. The Minister, Mr McCreevy, responded saying that the Government was working to tackle inflation. He pointedly added that those commenting on our current circumstances "should bear in mind the economic and social achievements of the last decade."

So what should we make of the lecture from Mr Duisenberg? There can be little doubt that a cautious Budget is in order. The Government needlessly boosted demand in last December's Budget by giving large tax concessions to the better off.

Lower taxes have been a key factor behind our economic success, but last December, with the economy already booming, a more cautious package would have been in order. Significantly, the Taoiseach, Mr Ahern, indicated last night that tax cuts this year would be directed at the less well-off. This would be the correct course.

However it would be misleading to say that budgetary policy is the major factor behind rising inflation. Higher prices have been stoked by factors outside our control, including the falling euro and rising oil prices, and by pressures developing in an economy growing fast and reaching full capacity. Budgetary policy is a factor in the inflationary mix, but not the dominant one.

The president of the ECB is, no doubt, well aware of the limitations of Budgetary policy in a small open economy. It suits the ECB agenda, however, to push the blame on to factors within the control of the Government here. They pay little notice to Irish inflation in deciding on what interest rate level to set, but would prefer not to focus on the shortcomings of the "one size fits all" monetary policy run from Frankfurt.

The other factor to which Mr Duisenberg paid little heed in Wednesday's speech was the falling euro. The ECB's latest interest rate increase has appeared to backfire, leading to selling of the currency for fear that higher rates will choke off growth in the big Continental EU economies.

Mr Duisenberg and his colleagues face significant problems in building the credibility of their policy. Meanwhile loose comments from around the EU - the latest an apparent endorsement of the weak euro from the German chancellor, Mr Gerhard Schroder - continue to sow confusion.

Managing a single currency across 12 different states is no easy task. The success of the ECB in grappling with this challenge will have much more impact on the inflationary outlook for Ireland than anything which might be done in the December Budget.