Wednesday 25 April 2018

Brendan Keenan: Is a 'Goldilocks' economy - one that's just right - a fairytale?

'In its first quarterly bulletin of the year, the Central Bank said its own recent research and new labour market data suggest that, despite the remarkable increase in employment, the recovery has not yet fully absorbed the available supply of workers' (stock photo)
'In its first quarterly bulletin of the year, the Central Bank said its own recent research and new labour market data suggest that, despite the remarkable increase in employment, the recovery has not yet fully absorbed the available supply of workers' (stock photo)
Brendan Keenan

Brendan Keenan

How's poor old Ireland, and how does she stand? asks Napper Tandy in the old song. Well, not so poor any more, Napper, but the second part of your question is a bit tricky.

The issue of how exactly she stands has been exercising economists of late. Just how fast can the economy safely grow? And with national income about 40pc bigger than it was in 2013, have we already passed the flashing red light?

If only there were such a light. The Central Bank and the Fiscal Advisory Council are among the most recent to attempts to figure out how we stand and how close we are to the fabled 'Goldilocks' position - neither too hot nor too cold.

With the Central Bank forecasting growth of another 8pc by the end of 2019, one might have thought the answer was obvious. There is plenty of worry around that things could get out of hand, especially with EU rules permitting more government spending from next year, which will help finance the new national investment plan, as well as the need for more house-building. But no-one seems prepared to say that we are danger just yet.

With good reason. Back in the genuine Celtic Tiger days of the 1990s, few would have thought the economy could grow at the stellar rates it achieved without obvious signs of price and wage inflation. But it did. The economy had more petrol in the tank than had been thought.

It had run out of juice by the crash in 2001 but, as we know, was sustained with injections of high-octane credit until the engine itself blew up. It must not happen again, everyone says, but there is no reliable gauge to say when the tank is empty.

Post-crash prognostications have also been generally wide of the mark. A common view as recently as 2012 was that the economy's capacity for growth was less than in the past because Irish output and income per person were already so high that such growth rates could never again be attained.

Further damage had been done by the loss of investment and skilled employees during the crash. Putting the two together made a plausible argument that growth of more than 3pc would lead to inflationary pressures and lost competitiveness.

It does not look that way now. There were few challenges to the assumption in last week's 20-year national plan that the economy would average 3pc growth over the next few years, falling to 2pc in the second half of the period.

The task is to maximise the benefits by making progress more smoothly than in past decades. That requires keeping an eye as best one can on the economy's capacity and performance and taking corrective action when required.

In its first quarterly bulletin of the year, the Central Bank said its own recent research and new labour market data suggest that, despite the remarkable increase in employment, the recovery has not yet fully absorbed the available supply of workers.

If that is the case, there is scope for unemployment to fall further - probably to 5pc - before more significant wage pressures emerge than those currently on view. That 'non-inflationary' unemployment rate is also lower than would have been thought possible a few years ago. The bank, as might be expected, takes particular comfort from the fact that growth has been driven by real economic factors rather than money supply.

The obvious objection to this optimism is the soaring price of property, with a further 13pc increase in the year to December. 'Deja-vu all over again?' is the question on every lip. In fact, the figures tell a rather different story - one which has no exact parallel in the past.

For a start, residential prices are still only three-quarters of their 2007 peak. Given that this was more than a decade ago, it shows what a lofty peak it was - and also how long it takes to recoup the losses if one buys near such a peak.

Had things been better managed, with no bubble and burst, house prices might have been expected to follow their long-term trend of tracking national output and to have pretty much doubled since 2005. They are more or less on track for that, but what a way to get there.

Things were not better managed, though, and what we have is a scarcity of accommodation combined with low interest rates which boost asset prices. It is no surprise that this combination is showing up more in rents than in prices because credit restrictions are reducing the capacity to buy.

Alan McQuaid of Merrion Stockbrokers points out that the rules are going to get tighter this year, especially for more expensive properties. The Central Bank had allowed up to a fifth of mortgages to exceed a loan-to-income ratio of 3.5 but only a tenth of those 'trading up' will be permitted to break the limit in 2018.

Whether by accident or design, the bank is doing its bit for the new national spatial strategy - putting Dublin properties out of the reach of more borrowers and obliging them to look elsewhere.

That is a new element in the equation and, talking of equations, in a technical paper for the Fiscal Advisory Council, Eddie Casey points out that every cycle is different, adding to the complexity of trying to figure out the state of the cycle.

This is not just a technical question. EU rules require a method of calculating potential to reduce booms and busts but their approach does not seem to work for the peculiar economy of Ireland.

The Casey paper tries different methods and finds that they produce more plausible and stable estimates than the more commonly used one. But, he adds, there is no panacea to identify cyclical developments and imbalances in the economy. Anything simple, alas, is unlikely to work.

While analysis may be complex to the point of incomprehension, remedies have to be simple, even crude, in the actual world of earning and spending. It is not at all clear what they can be, but without determination to find some and implement them, there is not much point in the analysis.

The most effective remedy is interest rate changes but, in the euro, that is no longer available. It had been asserted that restricting credit was also impossible but the Central Bank has shown this is not so - admittedly in unusual circumstances.

If the bank is to have any long-term role in managing Irish economic stability, it must develop find ways to influence lending when the financial institutions are healthy and competing for business.

The only other apparent lever is fiscal policy. It is a poor second to interest rates because of the magnitudes involved - sums on a scale which politicians would prefer not to think about.

As its name implies, the 'rainy day fund' is intended to ameliorate recession but a typical 'normal' recession might knock €10bn off output while it lasted. That is a lot of amelioration, although the bulk of the adjustment would be from extra government borrowing.

It is easier to keep dry than keep cool. The same applies if the problem is not rainy days but an over-heating economy. Then government borrowing must fall and large sums be paid into the fund instead of withdrawals from it.

It is nice to hear the talk of 'upside risks' instead of downside but the real danger is still that, if the upside risk materialises, there will be neither means nor desire to deal with it.

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