The Irish economy is overheating, and the Government's plan to reduce taxes will exacerbate the problem by stoking demand, the European Commission said yesterday.
Mr Pedro Solbes, the Commissioner for Economic Affairs, said that while the Commission was taking great interest in the matter, the decisions on anti-inflationary measures would have to be taken by the Government.
While expressing reservations about future tax cuts, Mr Solbes would not be drawn on whether the Commission believed the Government should suspend or postpone large capital projects, such as the Luas light rail system or the Dublin Port tunnel. Speaking at a conference in the Institute of European Affairs in Dublin, Mr Solbes said these issues were also matters to be addressed by the Government.
At the weekend, the Minister for Finance, Mr McCreevy, played down fears that the Republic's 4 per cent inflation rate could damage the economy. He said that while inflation could rise in the short term, it would drop back to 3 per cent for the year.
Meanwhile, the European Commission has written to the Government welcoming the broad thrust of the National Development Plan as a basis for the forthcoming negotiations on the next Irish structural funds programme.
A Commission spokeswoman said yesterday that a letter from the Regional Affairs Commissioner, Mr Michel Barnier, to Mr McCreevy late last week refers to problems of overheating in the Irish economy. But the letter says that the Commission is happy to note in the Plan that the Government has taken this into account in a balanced and reasonable way.
The National Development Plan, which was launched in December, sets out a programme for up to £40 billion (€51 billion) in infrastructural spending. The contribution from the EU structural funds budget in the next six years will be some £2.9 billion.
Mr Solbes began his address yesterday by praising the Irish economic success story, describing it as "a sparkling example of how EMU has brought about a sea-change in the economic culture in Europe".
"Of course, the bulk of the credit for Ireland's economic transformation must go to the Irish authorities and to the Irish people as a whole. But, I wonder how much of this would have been possible without the positive incentives, the peer pressure and framework of discipline provided by the EMU project," he said.
One of the challenges facing EU policy-makers, Mr Solbes added, was to get the mix right despite the different cyclical conditions of the 11 member-states.
"In this regard, the experience of Ireland is a striking case-study. The growth rate in the Irish economy in 1999 was four times the euro-area average, while the inflation rate is currently twice the average. The small weight of Ireland limits the implications of this growth and inflation divergence for the euro-area economy and for the conduct of ECB monetary policy in particular," he said.
However, it posed a major dilemma at the national level, the Commissioner told the conference.
"The Irish economy is clearly overheating as the supply-side of the economy is increasingly constrained. The Government has responded by proceeding with their well-established tax cutting agenda in the hope of easing supply constraints - particularly in the labour market," he said.
"Whatever the merits of this approach may be in a medium-term perspective, the short-term risks cannot be ignored. Inflation rates are accelerating - especially in the sheltered sectors of the economy, for instance the housing market. The decision to pre-commit tax reductions in the next three years - as a supplement to an already generous wage agreement - risks exacerbating the short-term problem of overheating by further stoking demand," Mr Solbes warned.
Speaking afterwards, Mr Solbes said there was "a preoccupation" at Commission level about the risk of overheating in the Irish economy. He acknowledged the Government's view that inflation will fall, but reiterated his opinion that reductions in income tax rates could contribute to excessive demand.
