Fergal O'Brien: No reason for inflation to derail economy if we take joined-up action

Ireland is a very different country and economy from that of the 1970s and 1980s and the response this time around will need to be very different

Tue, 19 Apr, 2022 - 09:33

Fergal O’Brien

For the vast majority of people, this is the first time in their adult lives to experience worrying inflation rates, and most policymakers and business leaders are also now dealing with the challenges of inflation without the comfort of direct professional experience.

Ireland is also a very different country and economy from that of the 1970s and 1980s, and the response this time around will need to be very different from that in previous generations.

Right now, there is a sense that globally we are all in this together. The drivers of inflation are clearly international in nature and most countries are experiencing similar price increases, as energy, food, and other commodity prices rise sharply on global markets.

Our inflation problems, however, didn’t just emerge on February 24 when Russia launched its dreadful invasion of Ukraine. Prices were already rising well ahead of target throughout 2021, with many identifying the demand recovery and global supply-chain challenges after Covid as the primary causes.

In reality, however, the origins of our inflationary woes go back much further, partly to the exceptional and extended monetary policy responses to the financial crisis, but more specifically to the unprecedented expansionary policy measures of central banks during the Covid crisis.

Interest rates in most developed countries were already close to zero when Covid hit, so unlike at the onset of the financial crisis there was limited opportunity for central banks to cut further.

Their main policy tool, therefore, was to expand the supply of money through bond-buying programmes or quantitative easing. This was done with exceptional gusto, and the scale and pace of money supply increase since March 2020 is unprecedented.

It was, therefore, inevitable that what was a largely appropriate response to the Covid challenges of 2020 and 2021 would result in inflationary pressures.

However, when added to the period of ultra-low interest rates which preceded Covid, the supply disruptions of recent years, and now the impact of the war in Ukraine, the result is a perfect storm of inflationary factors.

So what can be done domestically to address these largely external issues? We need to view inflation and its impacts from both a medium-term and an overall price and output level perspective, and not become excessively fixated on the short-term spikes. Ireland can weather these challenges better than many other countries because the economy is facing them in exceptionally good shape.

Employment, incomes, and household savings are all at record highs, and our overall standard of living is dramatically ahead of what we had when previous bouts of inflation derailed the economy.

Of course, not everyone in society will have the benefit of such buffers, and some households and businesses will feel the impacts of price rises much more sharply than others.

It is vital these households and businesses should be supported appropriately. However, the impact on standard of living and competitiveness must be viewed from a perspective of how it has developed over the past five to 10 years of strong economic growth.

It is vital that we recognise that while the first-order inflationary factors are largely similar across the globe, how we respond domestically will have a big impact on second-order impacts and, ultimately, our overall competitiveness position when we emerge from this global inflationary phase.

It is inevitable the current price pressures will see some short-term reductions to our standard of living and neither Government nor employers can fully offset these. Both reckless fiscal policy and wages chasing inflation would undoubtedly lead to much more severe economic problems further down the road.

Fergal O'Brien, director of policy and public affairs at Ibec

Finally, we must ensure that all policy responses, both those targeted at the current inflation pressures and at a wider level, are better joined up and co-ordinated.

In the labour market, businesses are facing a plethora of increased costs in the coming months and years from additional statutory leave, sick pay, remote working, universal pensions, and living wage proposals.

Ibec is calling on the Government to intensify work through the Labour Employer Economic Forum to ensure better co-ordination of tax, social welfare, and other social wage policies that can address these inflationary pressures.

We are also seeing the challenges of commodity inflation starting to hurt our capacity to deliver much-needed housing and infrastructure.

It is vital that the Government works with industry to ensure that contracts are adaptable to the challenges of inflation and that it remains viable for much-needed infrastructure projects to continue in order to address the multiple quality of life and sustainability issues the country faces.