Sunday 11 December 2016

Irish inflation: the good, the bad and the ugly

The downturn has brought a reshuffle in cost structures -- but not all sectors have responded, writes Austin Hughes

Published 14/11/2010 | 05:00

Irish inflation figures for October published last week show that the sharp fall in consumer prices of the past couple of years may be coming to an end.

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The headline inflation rate has now risen for the past three months. This is not to say any threatening rebound in prices is under way. Indeed, inflation would still be in modestly negative territory but for increases in some mortgage interest rates. While the impact of low borrowing cuts has provided much-needed relief to many household budgets, it may be worth examining how non-mortgage consumer prices have behaved since the downturn intensified in

late 2008. This allows for easier international comparisons and it also gives a clearer indication of how Irish consumers and businesses (as opposed to the ECB) have responded to the economic crisis.

Current situation

Since late 2008, falling consumer prices have helped many Irish families stretch fewer euro further. During this time the key drivers of their living standards have been some combination of job loss, cuts in incomes and benefits and increases in taxes. Measured against this formidable array of "feel bad" factors, a drop in the prices of many of the goods and services that consumers buy regularly may have provided little consolation but it did prevent a bad situation from being worse.

The fall in consumer prices has been notably greater in Ireland than in most other countries in the past couple of years. This tells us two related things about our economy. The first (rather obvious) point is to emphasise how severe the deterioration in Irish economic conditions has been. With demand collapsing, prices here did what the textbook says they should and fell significantly.

Of course, you can see a glass half-full or half-empty. A more positive reading that also has some validity is that the fall in Irish prices testifies to the flexibility of the economy. In the past two years Irish consumer prices have fallen by about 5 per cent relative to those elsewhere in the eurozone, and by around 8.5 per cent relative to those in the UK. This hints at an improvement in Irish competitiveness that will go some way towards assisting an eventual recovery in activity and incomes in the Irish economy.

A quick look at the detailed consumer price numbers shows some notable differences in price trends in Ireland and elsewhere for various goods and services. Importantly for household budgets, Irish food prices are still nearly 8 per cent lower than they were two years ago, where across the rest of the eurozone area they are broadly unchanged (in the UK, food prices have increased by 6 per cent). While Irish consumers are buying slightly less food now, the fundamental change has been towards more keenly priced items and suppliers. This has led many retailers and producers to change their offerings radically in order to survive. Much the same is true of clothing, where Irish prices are down 19 per cent in the past two years, while across the eurozone clothing prices have risen marginally. On a slightly smaller scale, restaurant and hotel costs fell nearly 4 per cent here, compared to an increase of almost 3 per cent in other eurozone countries.

The downturn has forced a radical re-orientation of cost structures in many sectors of this economy as businesses and households adjust to the reality that we will need to get a lot more for less in a post-boom Ireland. Judged in this light, there is clearly some element of "good deflation" in the behaviour of Irish prices and costs in the past two years as well as "bad deflation" that reflects the crisis itself. Unfortunately, it is clear that not all sectors have responded in the same way and there are few grounds to believe the less responsive areas will adjust any time soon.

As our calculator reveals (visit www.kbc.ie/colcalc and see), not everyone is equally affected when prices rise or fall.

Deflation creates clear winners and losers. Those on fixed incomes -- such as pensions -- tend to fare best, but it would seem that prices of the typical basket of goods and services a pensioner buys have not fallen quite as fast as for other consumer groups.

Falling prices also imply a redistribution from borrowers to savers. This stems from the fact that deflation increases the "real" value of money. As a result, there has been a curtailment of consumer spending and a substantial rise in the savings ratio in Ireland of late.

The Irish economy is moving from circumstances in which money was cheap and freely available, to one in which it is more scarce and (to judge from the borrowing costs now facing the Irish Government) hugely more expensive.

A particularly ugly aspect to deflation is its impact on the public finances. Cutting government spending in areas such as pay and social welfare causes more pain when significant cash cuts are needed than was the case in the 1980s, when government outlays didn't keep up with rapidly rising prices. In addition, the revenues the Government takes in are far more sensitive to deflation than is public spending.

Falling prices depress tax revenues and the economy. So the Government has to make even larger adjustments to reach goals expressed in money terms or as a share of GDP. For this reason, current indications that we will return to low but positive inflation in the next few years would be a welcome development. So too would clearer signs that prices in all sectors now reflect Ireland's hugely changed economic circumstances.

You can calculate the change in your personal cost of living at www.kbc.ie/colcalc

Sunday Independent

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