ESRI warns domestic property price bubble may destabilise economy

IRELAND’S property bubble has the potential to destabilise the economy, the Economic and Social Research Institute (ESRI) warned last night.

But, according to ESRI economist Danny McCoy, tax policy can be used to limit the problem.

Fiscal policy can be used to control the excess demand built up in the domestic labour and housing market, he said.

In a paper delivered to the Dublin Economic Workshop in Kenmare, Co Kerry, Mr McCoy said that EMU membership has enhanced the potential problems posed by excessive wage inflation and inflexibility in regional labour markets.

Bubbles in domestic asset prices, primarily in domestic property markets, still have the potential to destabilise the economy, he said.

But while monetary policy is no longer available to national policy makers, suitable fiscal policy instruments can be deployed to target these specific problems.

“The failure to deploy such an instrument in Ireland has greatly enhanced the economy’s potential exposure to outside shocks,” he said.

Stimulatory fiscal policy, that accelerates the rate of wage inflation, is unwise.

“It could expose the economy to unnecessary dislocation in the event of an unexpected external shock.

“Looking to the longer term, it is very much in Ireland’s interest that an appropriate mechanism is developed for achieving the necessary co-ordination of fiscal policy with the euro area.”

Developing such a mechanism, he said, was likely to be particularly important for the smaller members of the euro area.

Co-ordination, however, need and should not involve extensive restrictions on domestic fiscal freedom.

It could leave individual countries freedom of action to determine the appropriate mix of tax and expenditure changes needed to achieve a given national target surplus or deficit.

“While the EMU project still remains in its infancy, it is clear that after six years it has changed significantly the macroeconomic policy landscape for economies like Ireland.”