The economy is making tentative steps towards recovery suggests Danny McCoy of the ESRI. However, the current volatility of the markets could begin to have an impact on the real economy.
As this week's preliminary results from Census 2002 confirm, population growth has mirrored the impressive economic growth recorded over the last six years in Ireland.
On balance, we at the Economic and Social Research Institute believe that the short-term economic prospects remain good, based on the forecasts contained in the ESRI Quarterly Economic Commentary published today.
The forecast is for output to grow by 3.4 per cent in 2002 and by 4.7 per cent in 2003, measured by gross domestic product. There are, however, significant downside risks for this benign outlook.
In line with the international economy, Ireland has made a tentative recovery from the sharp slowdown experienced in the latter half of 2001. However, the strength of the international recovery remains fragile. Business and consumer confidence has been rocked by the sharp decline in the world's equity markets over this summer.
The uncertainty about the true financial state of many corporations amid concerns about accounting practices is the proximate cause of this confidence slump, yet the economic fundamentals in the leading world economies are still strong.
There is a real danger emerging that the tail could end up wagging the dog, with the stock-market falls impacting upon the real economy as the deterioration of consumers' wealth translates into less spending, leading firms to be more cautious about investing to expand their businesses.
We anticipate that, despite this threat from a stock-market spillover, the low interest rate environment internationally will remain in place for 2002 and that along with the substantial government pump-priming already in progress the US and European economies will continue to strengthen in 2003.
The boost to world trade from a return to trend growth by the large economies is significant for an economy as open to external demand factors as Ireland. The expansion in the size of the trade pie is critical for Ireland's growth prospects as competitiveness has suffered two serious setbacks.
The first arises from the recent swing in the fortunes of the euro towards a sustained and possibly a substantial appreciation against other currencies. This has the effect of reducing the competitiveness of the export-oriented Irish economy that has significant non-euro area trade.
The second comes through the sharp rise in the domestic cost base, as evident in the rising prices and high wage growth over the last two years.
While the headline inflation rate prospects will be improved somewhat over the next year as a result of the continuing appreciation of the euro, the persistently rapid rate of increases in the prices of many domestically provided services, such as electricity and medical insurance, will mean that Ireland continues to have the highest inflation rate within the European Union.
Our forecast is for inflation in consumer prices to average 4.5 per cent in 2002 and 3.7 per cent in 2003. The challenge at this juncture for the Irish economy is to bring the growth in the domestic cost structure under control while simultaneously managing to balance the public finances without compromising the effective delivery of the much-needed investment in infrastructure.
THIS is a tall order. Too often in the past, the stop-go nature of budgetary arithmetic has postponed necessary public investment only to store up difficulties down the line. The pressures on the public finances from unrealistic expectations about simultaneously having lower taxes and rising public expenditure have become evident in the deteriorating budgetary position over the past year.
Reining-in expectations about what a small open economy can sustain beyond the short term in terms of wage growth and public expenditure increases is crucial. If there is to be one, a successor social partnership agreement will have to be negotiated in a context where the tax-cutting element of previous arrangements is no longer viable.
Recognition of this reality will mean that the role of government, other than as an employer, in any future partnership arrangement should be focused on the delivery of improved standards of living through efficient public-service expenditure. The process will need to link pay restraint with sustainable public finance balances to ensure that better infrastructure and public services are provided.
If the Government is to make a credible commitment to any such future bargain, it will be necessary to define suitable rules to achieve agreed public expenditure targets while ensuring the durability of sound fiscal positions.
The public finance rules provided by the EU Stability and Growth Pact, and underpinning the current Programme for Government, are too broad to fulfil this role.
The stability pact is coming under pressure for reform, making the case for a domestically designed framework to suit the needs of the Irish economy all the more desirable.
The adoption of fixed expenditure rules that allow borrowing only for clearly defined investment purposes may be the best way to proceed on this front. The UK currently operates two such rules.
The first is the so-called "golden rule", which stipulates that over the economic cycle the government will borrow only to invest and not to fund current spending. This commits the government to run a surplus on the current budget while allowing the capital budget to be in deficit.
The second rule is the "sustainable investment rule", which is that over the economic cycle the ratio of net public sector debt to national output will be set at a prudent level, currently defined as 40 per cent.
The use of rules for public finance management is no panacea, but they can help improve credibility in the process. They will not, however, obviate the need to make hard decisions on reduced expenditure or increased taxation, particularly if the growth forecasts envisaged are not met.
Slower global economic recovery or a more substantial appreciation of the euro than we are anticipating are the main threats to our forecast for Irish economic growth.
Danny McCoy is editor of the ESRI's Quarterly Economic Commentary