Ireland is more exposed to external shocks than any other Euro zone economy

Global economic shocks have a potentially greater impact on Ireland than on the US, UK or euro economies, while the Irish economy is most exposed to US interest rate tightening and sterling exchange rate depreciations, a new paper has found.

In a new research paper, economists at the Central Bank examined the effects of large global shocks on the Irish macroeconomy using the global vector auto-regression (GVAR) model, and considering the economic response to five distinct shocks using quarterly data from 1980 - 2016.

It found that Ireland is relatively more exposed to US interest rate tightening, noting that a shock increase of 25 basis points to the US short-term interest rate is estimated to see Irish GDP decline by -0.56 per cent after eight quarters, with the loss estimated to be -0.6 per cent and statistically significant in the long run.

The economy is also vulnerable to a shock depreciation in the sterling-dollar exchange rate, equivalent to a currency devaluation of 15 per cent. This would see Irish output peak at an increase of 0.5 per cent after two quarters, declining to baseline levels over the next eight quarters.

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“Ireland would be strongly affected by depreciation, with small initial declines increasing in scale within four quarters of the shock,” the paper found.

A negative shock to UK output growth equivalent to one percentage point of GDP, would also hit Ireland hard, and is estimated to cause a “significant and permanent decline” in Irish output growth, with long run reduction in growth of 0.45 per cent estimated over the horizon period of forty quarters.

However, Ireland was found to be relatively less exposed to a rise in global oil prices, while a reduction in Chinese output was fouand to be “moderately positive but insignificant” initially.

The study also shows that the magnitude of the effects arising from external shocks is typically larger in Ireland (in absolute value) than in the UK, the US or the euro area.

“This is most likely reflective of Ireland being a small open economy, with limited ability to mitigate the effects of economic shocks, combined with a less diverse economy than the other three countries/regions,” the report states.