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.