Inflation has now taken such a hold on the economy that estimates are being revised upwards on an almost weekly basis. Yesterday's news that the rate is now running at 5.5 per cent did not come as a surprise. The Taoiseach has already estimated that inflation could rise as high as 6.2 per cent and even that could be short of the mark.
The worry is that a wage-price spiral will begin. Labour market pressures are likely to intensify as employees seek wage rises to compensate them for higher inflation. The danger is that a sustained loss of competitiveness could result as Irish wages grow faster than those of our competitors. This would leave us increasingly vulnerable in the event of an economic shock or a rise in the value of the euro.
There is also concern that people will start building inflation into their expectations. Large pay rises this year will lead to an expectation of more to come. This is one reason why some observers are arguing that the current pay terms ought to be renegotiated with a firm emphasis on a once-off large pay rise.
The broad package of measures announced by the Government over recent weeks, certainly has its place and could lower people's expectations of future price rises. But in itself, the impact is unlikely to be impressive. Controls on drink prices have been introduced but there are huge problems with enforcement. Public bodies will be forced to hold down fees and the VHI has already been refused a price increase. But according to Irish Intercontinental Bank economist, Mr Austin Hughes, the impact on the inflation rate will be very limited. He has estimated that the measures may mean inflation will peak at around 6.25 per cent rather than the 6.5 per cent he is otherwise predicting.
The measures do not target the big public spending areas such as housing, which have seen large price increases. Mortgage interest rates are set to rise further this year and the Government does not appear ready to introduce rent controls on the private sector. Transport and fuel rises are largely due to the price of oil which is outside the Government's control.
The Fine Gael spokesperson on Finance, Mr Michael Noonan, has suggested the payment of a bond which would be cashable after three years in lieu of tax cuts. That would get over the problem of boosting the economy when it is already running at full throttle. It is not clear how practicable this would be but it merits further consideration.
But there is no quick fix that the Government can apply. It may be worth considering some reduction in excise duties or VAT. The difficulty, however, is that while such measures would immediately benefit the consumer price index, they would also boost demand by putting more money into people's pockets. Cutting indirect tax is also, by its nature, a once-off measure. One obvious contribution would be to cut bus and train fares. That would have the double benefit of cutting inflation and encouraging the use of public transport. But the ultimate policy goal must be to encourage competition.
The Government may now be regretting the expansionary nature of the tax cuts in last December's Budget, which gave the largest benefits to the better off. It must now hold its nerve and ensure that the bulk of the benefits are targeted at the less well off this year. If higher inflation takes hold, then it could damage prospects for growth in the medium term and undermine hopes that the Irish economy can continue to outperform those of the EU.
