In this blog, NERI Co-director Tom McDonnell discusses his NERI Report Series on the outlook for Ireland's economy.
The recovery has been much faster and more robust than that of previous recessions. Thanks to a strongly countercyclical stance, household incomes largely held up, the economy’s productive capacity was broadly protected, and private sector debt remained low. Output already exceeds pre-pandemic levels in the majority of economic sectors. The labour market is now close to full employment with labour shortages in some sectors and good prospects for nominal wage growth.
However, the invasion of Ukraine has created an unfolding humanitarian disaster. The war has also led to a surge in global energy and food prices and triggered a cost of living crisis in many countries.
Inflationary pressures will lead to a decline in real disposable incomes this year and consequently a slowdown in household consumption. Central banks will increasingly tighten monetary policy as a response to high inflation, and rising interest rates will further depress demand. Even so, our baseline assumption is that the Republic of Ireland’s economy will avoid a year-on-year recession in 2022 due to base effects. Inflation is likely to average close to 8% this year and to only decline gradually to around 4% by the middle of next year. So it will certainly feel like a recession to many.
Budgetary policy should avoid exacerbating inflationary pressures and concentrate on targeted measures to protect low income households as well as measures to enhance the social wage via reductions in the cost of childcare and public services such as education, health and public transport. The many medium-term fiscal challenges and costs (e.g. ageing, net zero transition), fragility of corporation tax receipts, and the risk of further stoking inflation suggests there is no scope for cutting taxes on a net basis.