The 1990s were a decade of low inflation in Ireland. However, inflation has risen from 1.4% in April 1999 to 4.9% in April 2000, which is the highest level since the 1980s. This compares with an average of 1.9% in April 2000 for the 11 EU countries which are participating in the third stage of Economic and Monetary Union and the single currency (the "euro zone").
Rising inflation, and an economy that is showing distinct signs of overheating, are emerging as a key concern for the Irish government and the social partners in 2000. As a result, the new national agreement, the Programme for Prosperity and Fairness, is coming under pressure. It remains to be seen whether inflationary pressures will ease later in the year.
The 1990s were a decade of low inflation in Ireland. However, inflation has risen from 1.4% in April 1999 to 4.9% in April 2000, which is the highest level since the 1980s. This compares with an average of 1.9% in April 2000 for the 11 EU countries which are participating in the third stage of Economic and Monetary Union and the single currency (the "euro zone").
Signs of overheating
The Irish economy is undoubtedly showing signs of overheating. In terms of "external shocks" which are beyond the control of Irish policy-makers, rising world oil prices and the weakness of the euro have greatly contributed to inflationary pressures. Although the Organisation of the Petroleum Exporting Countries (OPEC) recently announced an increase in oil production, this may take a few months to feed through into a fall in oil prices. The euro meanwhile is currently showing few signs of appreciation against the US dollar and UK sterling, although this too may eventually change. The weakness of the euro, combined with the overvaluation of sterling, is pushing up the prices of certain imported goods from the UK, which is Ireland's main trading partner. Furthermore, low interest rates in the euro zone have partly contributed to an Irish housing boom and a substantial increase in borrowing. As a small open economy, Ireland is particularly vulnerable to these external shocks.
Various internal factors, some of which are within the control of policy-makers, have also contributed to rising inflation. The unchecked housing boom has resulted in rising house prices. Prices in the non-traded service sector - for instance, restaurants - have also increased. In addition, increased labour and skill shortages are pushing up wages in sectors such as information technology and pharmaceuticals. In relation to the government's budgetary policy, the targeting of tax cuts at the higher paid in the 2000 state budget further fuelled inflationary pressures, as did the decision to increase substantially the price of tobacco products.
The European Commission has recently been somewhat critical of some of the Irish government's fiscal policies - such as the cut in the higher tax rate in the 2000 budget - suggesting that they are inappropriate for an economy showing signs of overheating. The Commission has recommended that a degree of fiscal tightening is required to dampen the demand pressures that are fuelling this overheating.
Social partner concerns over inflation
In recent months, there has been increased concern amongst the Irish social partners about the impact of mounting inflation. Trade unions and workers are worried that rising inflation will cancel out the pay increases of 5.5% for the coming year set out in the new national agreement, the Programme for Prosperity and Fairness (PPF) (IE0003149F), and erode workers' standard of living. As a result, the PPF is coming under increased pressure. Various trade union leaders have warned that the PPF could face "serious problems" if inflation were allowed to rise without any attempt by the government to intervene. At this juncture, however, there is no great desire to return to the negotiating table to revisit the pay terms of the PPF, because there is a fear that this could provoke a wage-price spiral reminiscent of the "stagflationary" 1980s.
The government's response
In response to the concerns of the social partners, the government has agreed to monitor inflation on a monthly basis. It has also promised to identify various policy options to curb inflation for the social partners to consider. However, in the context of membership of the euro zone, the government has few options available to tackle inflation. It has no control over interest rates. It does have control over taxation, but has already opted to reduce the taxation revenue from peoples' incomes. In view of the contribution of high petrol prices to increased inflation, the Irish Congress of Trade Unions (ICTU) has called for the government to reduce tax duty on petrol and diesel as an interim measure to reduce inflation. However, the Irish Business and Employers Confederation (IBEC) feels that this may run counter to international environmental commitments. Rather, IBEC feel that inflation might alternatively be curbed in the short-term through reductions in VAT on goods and services.
Commentary
The future outlook for inflation is not entirely clear. Predictions vary as to what the average rate of inflation will be for 2000. The prediction of the Minister for Finance in the 2000 budget that it will average 3% looks excessively optimistic. If, as many economists suggest, inflation begins to decrease in the second half of 2000 - particularly if oil prices fall and the euro appreciates - it would seem that the average rate for 2000 could lie somewhere between 4% and 4.6%. The figure is likely to be lower if the government acts on the concerns of the social partners and intervenes by lowering indirect taxation in some way.
The PPF projects an average inflation rate of up to 4%. If inflation were to average around 4% in 2000, the combined PPF "package" of pay increases, tax reforms, a new national minimum wage, and the budget "rebalancing" measures, should still bring gains for many workers. However, if the average inflation rate is significantly above 4%, the terms of the PPF are likely to come under strain. The social partners are fearful that a major breach of the agreement could provoke a wage-price spiral reminiscent of the "crisis" years of the 1980s. As a result of these fears, if there is no indication in the next couple of months that inflation is falling, the government is likely to come under mounting pressure to intervene. In the short term, this may potentially incorporate a reduction in indirect taxation, such as VAT on goods and services. In the medium to long term, it may require action to reduce demand so that economic growth falls to a more sustainable level. (Tony Dobbins, UCD)
Eurofound recommends citing this publication in the following way.
Eurofound (2000), Social partners concerned about rising inflation, article.
