Irish economic growth is set to fall to near sustainable levels, according to the Economic & Social Research Institute (ESRI).
The Government will be able to content itself with having done an excellent job if that goal is achieved, it said. But the outcome is not guaranteed and will depend on the choices made by the Minister for Finance and his colleagues in framing budgetary policy.
In its latest quarterly commentary, the ESRI is fairly sanguine about the economy's prospects. The report's editor, Mr Danny McCoy, admits that the forecasts are based on the assumption that the US recovery will kick-start towards the end of this year. It also assumes that as imbalances in the US economy come into focus, the dollar will fall out of favour and the euro will reach parity with the dollar in the first months of next year. But currency forecasting is notoriously tricky and there can be no certainties.
Whatever the likely outcome, the economy is still growing at slightly above the 5 per cent that is sustainable in the long run. For evidence of this, the ESRI points to continuing high inflation and the first current account deficit for eight years. Domestic demand is now exceeding the economy's ability to supply it.
The appropriate action to rein in the growth depends on what factors are driving it. If it is external demand, then the recipe is to allow wages and prices to grow to reduce competitiveness and bring the economy back in line, the ESRI says.
However, if the economy is mostly growing because of domestic stimulus and a cyclical boom, the recipe is to use fiscal or tax and spending policy. That is the approach which the European Union and others have been prescribing for some time.
According to Mr McCoy, the economy has been receiving an almost equal stimulus from both sides. However, with the slowdown in the rest of the world underway and the euro set to appreciate, the stimulus from abroad is diminishing. That means that fiscal policy is becoming increasingly important.
In addition, Ireland is now ending its so-called "transition phase" where it has been catching up with the larger countries in western Europe. Stimulus has also come in the last year or two from the weak euro which has given a competitiveness boost to exports. That too is under threat.
As a result, a policy of mild fiscal restraint is now called for, according to Mr McCoy. However, he is not seeking tax hikes. "Given our high budget surpluses, the need for large fiscal contractions is not compelling, but expansionary policies are unwarranted," he says.
In addition, the transition to average European income levels means that a number of bottlenecks have emerged. Thus, the focus has to be on spending to relieve these supply constraints while controlling demand in the economy.
With the economy at full employment, tax cuts would boost demand rather than lead to any increase in supply. So the appropriate medicine for the economy, according to Mr McCoy, must be capital rather than current spending with only a modicum of tax cuts.
