Ireland’s painful adjustment

After the benefits of EMU, now come the costs. I discuss economic adjustment mechanisms in EMU and what they mean for the near-term outlook for the Irish economy in a new EMU Monitor piece. You can find it here.

The main point is that recovery here depends on the so-called “competitiveness channel” working. For this mechanism to work properly, two things must happen. First, wage and price inflation have to ease to rates below those in our largest trading partners. That probably implies deflation in this country. Second, the improvement in competitiveness must affect trade performance.

The problem is that recovery will be complicated by the depressing effects of the “interest rate channel” of adjustment. Deflation implies high real interest rates, which will further depress domestic demand, assets prices, and the property market.

3 thoughts on “Ireland’s painful adjustment”

  1. As Alan says in the piece, migration will also be an important adjustment mechanism, and one suspects it will be the most important one. If we have a lot of emigration, we will be lucky, given the alternatives.

    This will however be a shock to policy makers. I was struck during the boom by how they seemed to be targetting growth in overall GDP rather than GDP per capita.

    On the deflationary strategy: Alan does a good job of showing both the benefits and the costs of this. But let us hope that we would not find ourselves chasing a moving target. We should all be praying that Frankfurt will end up pursuing monetary policies as expansionary as those of London and DC. Otherwise Mundell-Fleming tells us that we are in big trouble.

  2. Rather than a national wage deal I would rather see liberation of labour – ministerial expressions like ‘saving jobs’ doesn’t fill me with faith.

    Unemployment has gone beyond expectations, but if I wanted to hire a person for €6 an hour and there is a person willing to do the job at that price we can’t transact because of minimum wage requirements, so instead they will (potentially) have to remain on welfare.

    Competitiveness in Ireland (to my way of thinking) has wage deflation as a prerequisite. And while real interest rates even at 2 or 3% would be high in an example like this, they are at least being eased centrally be the ECB.

    The move away from construction is a painful but necessary adjustment, every euro spent on a building is a euro not being spent on an export business or on an education system that will create a world class labour market, and the high cost of living was behind much of the wage inflation we saw in the last decade anyway.

  3. The imlications of a return to net emigration for the housing market have been neglected. I drew attention to this in the context of the CSO’s population projections, whose lowest scenario was a zero net migration assumption. Even under this assumption, the numbers in the key household formaiton age groups will fall – with net emigration they will fall quite sharply. So much for the demographic “fundamentals” that were suposed to underpin the housing market.

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