Describing the Irish economy as a Celtic Tiger in late 1994, we guessed that the risk would lie on the side of higher inflation, not a shortfall in growth. We stuck to this view in subsequent updates. Well, we were right, eventually, but it's taken much longer for inflation to materialise than we envisaged. Meanwhile, we were far too conservative in our assessment of Ireland's likely growth rate.
With Irish inflation pushing beyond 6 per cent, the Tiger is now roaring a little too loudly for comfort. International investors' nervousness at this, and at the failure to translate strong economic growth into fatter domestic profit margins, has been partly to blame for the Irish equity market continuing to lag behind the wider European market. However, some of the proposed solutions are far from riskless, and Ireland's relatively high inflation might yet prove to be a chronic irritant, rather than a terminal economic illness.
Others clearly disagree. Last week Mr Wim Duisenberg, president of the European Central Bank, warned that such inflation cannot be sustained indefinitely without a "painful" response by the markets, and he advocated that the government take avoiding fiscal action. In August, Prof Patrick Minford, a British academic and one-time adviser to Margaret Thatcher, argued that the single currency would precipitate Ireland into the sort of hard landing seen in the UK in 1990. He went as far, in a radio discussion, as to advocate Irish withdrawal from EMU.
Few analysts would argue that an inflation rate of more than twice the euro-bloc average is desirable. It is excusable, and was probably unavoidable, but it is always preferable to see strong demand reflected in real output and domestic living standards rather than faster price rises.
Moreover, I suggested in these pages almost two years ago that some thought should be given to a contingency plan for tackling the unfair effects of rising inflation. After all, it is one thing for the benefits of the boom to have been spread unevenly, but it would be quite another for the costs of dealing with it now to fall disproportionately on people dependent on fixed nominal pensions, State benefits or savings income (real interest rates, as feared, having now become sharply negative).
However, the reason for not urging any drastic action by Irish policy-makers, and for not issuing a wholesale rejection of the Irish experiment with EMU, is that Ireland's - and the single currency's - current circumstances are unique. Nobody knows, even approximately, how things are going to turn out.
There hasn't been a currency union involving such a large and disparate group of independent nation states before, and the architects who designed EMU didn't give much thought to the possibility of catch-up effects among the smaller entrants, or to the possibility that supply-driven growth might warrant a rethink of the traditional textbook convergence process. In terms of the immediate inflation cost, output growth was bought four times more cheaply over the five years to 1999 in Ireland than in the EU, and three times more cheaply even than in the US: for each unit of Irish growth there was just one-fifth of a percentage point of inflation. This stellar performance is deteriorating sharply this year, and will likely continue to do so in 2001 too; but talk of recession, or of double-digit inflation, seems premature. Why rush into dramatic action now?
After all, politicians in general, and even central bankers, have a decidedly patchy track record on short-term demand management. Indeed, the financial markets' collective judgment on the ECB itself, for example, has been less than whole-hearted in recent months. The bank has missed both its (self-selected) targets within little more than 18 months of its inception. The euro has now lost more than a quarter of its value against the dollar.
Admittedly, the vibrant US economy has bounded from strength to strength, and this has helped push the dollar up, but some of the euro's recent weakness may have been made at home, and one of the by-products of this weakness, of course, has been a little more upward momentum in, among other things, Irish inflation.
One of the problems with using fiscal policy to tackle excessive demand is that it is a blunt weapon: tax changes often need to be large to have any noticeable impact on inflation. At the micro level, low corporate taxes, in particular, have been one of the cornerstones of Ireland's economic success and any backtracking here could do more harm than good. Reassuringly, writing in these pages yesterday, Charlie McCreevy reiterated his promise to continue to keep business tax at competitive levels.
Nor is there much room to consider reducing public spending - much Irish infrastructure is still lagging far behind the rest of the economy. Better transport and distribution capabilities, though they might add further to demand in the short term, will eventually play an important role in reducing future capacity bottlenecks.
At the aggregate level, the economy does not need an added stimulus from looser fiscal policy now - nor has it over these last five years. This conflict between perceived micro and macro economic goals is a difficult one to resolve, particularly with your monetary hands tied, but I think Mr McCreevy's strategy of strengthening the social partnership agreements and tailoring tax cuts to minimise their impact on inflation, is understandable.
The social contract is often overlooked by outside observers, but has been a key component of Ireland's success in restraining inflation.
I believe the strategy is clearly preferable to more precipitate and dramatic action that could be damaging, and probably unnecessary. A more stable exchange rate, lower oil prices and a global slowdown is likely, independently, to produce some natural cooling during 2001.
The threat to average Irish living standards from the inflation rate can be overstated. A gap of several points between Ireland's inflation rate and its neighbours' needn't precipitate an immediate competitive collapse.
Much of Ireland's recent success has been driven from the supply side. The many foreign-owned companies that have set up operations here have done so to take advantage of the low tax rates, the educated and flexible workforce and the business-friendly environment (relative to the rest of Europe). Their calculations are not going to be altered drastically by today's inflation differential, even if sustained for several years.
Some London-based commentators are drawing comparisons with the UK boom of the late 1980s, but the similarities can be overstated. The payments imbalances that marked that boom are missing, and inward investment - and perhaps the supply side in general - has been much stronger in Ireland than it was in the UK. Others argue that the boom itself is entirely attributable to EU support, or to EMU, whereas both these factors played only supporting roles.
In 1994, for example, Ireland joining EMU was not a central component of our analysis. Indeed, at that stage it was still a moot point as to whether a monetary union would even occur.
A third group of critics has a different motive, namely a passionate dislike of the single currency and a wish to ensure the UK stays out. But Ireland's economic renaissance is unlikely to be sharply reversed by a period of moderately above-average inflation. Perhaps more pertinently, in choosing to focus on the economics of entry, these commentators forget that Ireland's positive approach to the European integration project long predates the single currency, and has been very different from successive UK governments. There is a good case against UK entry but it owes only a little to Ireland's current economic circumstances.
Soft landings are notoriously rare, but Ireland has a better chance than most countries of securing one, and of avoiding much of the pain to which Mr Duisenberg referred. And it would take a mammoth hangover now to invalidate the exuberance of these last five years.
Kevin Gardiner is Head of European Equity Strategy at JP Morgan Securities. The views expressed are his own.
