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Committee on Budgetary Oversight debate -
Wednesday, 17 Nov 2021

Inflation: Discussion (Resumed)

Members and all in attendance are asked to exercise personal responsibility in protecting themselves and others from the risk of contracting Covid-19. They are strongly advised to practise good hand hygiene and leave at least one vacancy between them and others attending. They should always maintain an appropriate level of social distance during and after the meeting. Masks, preferably of medical grade, should be worn at all times during the meeting except when speaking. We are actively encouraging members to attend remotely if possible. I ask for their full co-operation in this.

Before we begin I wish to explain some limitations to the parliamentary privilege and the practices of the Houses with regard to references that witnesses may make to other persons in their evidence. The evidence of witnesses physically present or who give evidence from within the parliamentary precincts is protected pursuant both to the Constitution and statute by absolute privilege. If, however, they are giving evidence remotely, from a place outside the parliamentary precincts, as such they may not benefit from the same level of immunity from legal proceedings as a witness physically present does. Witnesses are again reminded of the long-standing parliamentary practice that they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable, or otherwise engage in speech that might be regarded as damaging to the good name of the person or entity. Therefore, if witnesses' statements are potentially defamatory in relation to an identifiable person or entity, they will be directed to discontinue their remarks. It is imperative they comply with any such direction.

Members are aware of the note on privilege. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise, or make charges against a person outside of the Houses, or an official, either by name or in such a way as to make him, her or it identifiable. I remind members of the constitutional requirements that they must be physically present within the confines of the place where Parliament has chosen to sit, namely, Leinster House, to participate in public meetings. I will not permit a member to participate where he or she is not adhering to this constitutional requirement. Therefore, any member who attempts to participate from outside the precincts will be asked to leave the meeting.

On behalf of the committee I welcome Dr. Karina Doorley, Dr. Niall Farrell and Dr. Kieran McQuinn. I thank the witnesses very much for attending today. The purpose of today's meeting is to examine the topic of inflation. This is the middle session of three sessions during which we will look at this very current issue. The committee would like to discuss the drivers of inflation, policy responses and budget 2022, and the impact of inflation in that context. I will now turn to our witnesses to give their opening statement.

Dr. Karina Doorley

I thank the Chairman for the invitation to the Economic and Social Research Institute, ESRI, to appear before the committee. I am joined by my colleagues Dr. Niall Farrell and Dr. Kieran McQuinn. We are grateful for the opportunity to appear before the committee today to provide our views on inflation.

The post-pandemic circumstances that we are currently facing are just as unprecedented as the pandemic itself. Understanding the inflationary pressures currently being experienced across most western economies requires us first to recount the deflationary pressures of last year. These base effects combined with the uneven responses of global supply and demand, along with the pressures in international energy markets, are the main drivers of the inflation currently being experienced.

At the onset of the Covid-19 pandemic and its accompanying public health restrictions, a significant portion of the economy came to a halt as households remained indoors and paused normal activities. This disruption led to a sharp contraction in the demand for goods and services typically consumed by households and, consequently, prices declined in 2020 and early 2021. These declines are key to understanding the magnitude of inflation now. After a period of deflation, even a modest increase in prices due to increased demand can result in significant rates of inflation.

It is worth plotting the annual change in the consumer price index, CPI, of all products, as well as the CPI excluding energy products since 2017. It is useful to see the effects energy products have had on the CPI throughout 2021. Since March, the CPI excluding energy products has remained significantly lower than the overall CPI. In October, the CPI excluding energy products stood at 3.4% compared with 5.1% for the overall CPI.

Prior to 2021, two issues which immediately stand out from the graph are the relatively low and stable rate of inflation over the period 2017 to 2020, at a time when the Irish economy was growing strongly, and the sharp deflation which took place during 2020. The underlying strength and resilience of Ireland’s domestic economy throughout the Covid-19 pandemic has made it uniquely vulnerable to inflationary pressures. Ireland alone across the EU registered positive GDP growth in 2020, while the more indicative measure of Irish economic activity of modified domestic demand is set to grow at a faster pace than output growth across most other European countries. The strength of the underlying economy means demand is growing more rapidly in Ireland, resulting in greater inflationary pressures.

Meanwhile, the rebound in demand is coinciding with a sluggishness in international supply. For example, shipping firms, expecting a slowdown in trade during lockdown periods, idled the global fleet by more than 10%. When households, especially in America, began to spend their pent-up savings and government-provided pandemic payments, shipping firms and manufacturers were ill-prepared to meet the global surge in demand. Instead, producers have found themselves unable to keep up with orders, container ports have faced significant backlogs, and shipping rates have rocketed. These strains on supply chains are another pandemic-induced pressure point on price inflation.

While these issues are being felt globally, one area in which inflationary pressures are particularly pronounced in Ireland is the property market. After transport costs, housing and fuel costs were the second largest increase in the CPI according to the latest CSO data. Much like other goods and services, the housing market has experienced robust demand along with a slowdown in supply during the pandemic. Housing demand was largely unaffected during Covid-19 due to the provision of significant Government welfare assistance. Indeed, the perceived increase observed in the savings rate of Irish households may have actually contributed to an increase in housing demand. Consequently, house price inflation in August of this year is just under 11% per annum. It should also be said that rental inflation is experiencing increases. With more and more people expected to return to urban areas as workplaces reopen, it is likely that rental pressures will continue to grow over the next six to nine months.

Unfortunately, issues concerning the supply side of the housing market stem from pre-Covid vulnerabilities in the Irish economy as well as the effects of the pandemic. Housing supply, already falling short of demand before 2020, suffered additional slowdowns as the public health measures contributed to a physical delay in housing construction. The slowed pace of construction is further hampered by a marked increase in the costs of construction inputs due to supply chain disruptions. These factors are constraining housing supply at a time when a significant imbalance already existed between supply and demand in the Irish market.

I now turn to energy. European commodity prices have experienced unprecedented growth in recent months. While oil prices have risen, primarily due to production lagging growth in demand, rising gas prices have been the primary driver. Gas prices in October 2021 were 400% more expensive than April 2021, leading to European wholesale electricity prices rising by an average of 200%.

This growth has been driven by rapid increase in demand due to economic recovery, which has been met with constraints on supply. A number of factors have contributed to European supply constraints. International investments in oil and natural gas have declined in recent years as a result of two commodity price collapses, while policies to scale up clean energy sources and technologies to fill the gap have been lagging. In addition, supply has been further constrained by maintenance work which was shifted from 2020 to 2021. Large-scale storage facilities usually provide a buffer during tight market conditions. However, a cold winter in 2020-21, and planned closure of certain storage facilities, resulted in depleted European stocks leading into autumn and winter 2021.

Finally, international competition for gas imports has further compounded fuel price growth in Europe. International trends are likely to lead to sharp upward pressure on energy prices in Ireland. For gas and electricity, current information suggests this will persist during winter 2021-22, and that prices may fall in spring 2022. Oil prices will be primarily determined by the production decisions of international producers.

Budget 2022 can take measures directed at maintaining household standards of living. On the taxation side, tax credits and bands were increased by more than forecast inflation. While the standard rate band has been raised in some recent budgets, this marks the first increase in the personal and PAYE tax credits since 2008, and means that the after-income tax purchasing power of those earning enough to pay income tax will rise slightly in real terms, as long as the inflation outturn is similar to forecast levels. Unlike income tax credits and bands, most of the corresponding thresholds for PRSI and the universal social charge, USC, were held fixed in nominal terms, amounting to an effective PRSI and increase for many taxpayers. Although most excise duties were frozen in cash terms, amounting to an effective cut, given rising prices, tobacco products tax was increased. There was also a well-flagged increase to the carbon tax. A carbon tax is the most efficient way of incentivising carbon abatement, with the larger literature finding that such taxes would reduce emissions in Ireland, with few wider economic costs. However, there is also widespread recognition that carbon taxes can have distributional consequences because lower income households spend a disproportionate share of their incomes on carbon-intensive goods, in particular, heat and fuel. As a result, a carbon tax can have a regressive impact in the absence of an accompanying package of compensation measures. One should, therefore, consider the impact of the carbon tax increase on households' income in conjunction with other changes to the tax and welfare system.

On the welfare side, budget 2022 saw increases to most social welfare payments. There were significant, above-forecast inflation increases to the fuel allowance and the additional payments made to those living alone or with dependent children in receipt of social welfare payments. Recipients of these benefits are more likely to be at risk of poverty and to spend a high share of their income on fuel than social welfare recipients living with other adults, making the measures well targeted to mitigate the adverse impacts of the carbon tax increase on vulnerable, low-income households.

There were smaller increase in the main social welfare payments for working age couples without children. There was also a substantial increase in funding for the providers of registered childcare, accounting for around half of all childcare in Ireland, who commit to freezing their prices. Changes to the national childcare scheme, NCS, which subsidises registered childcare, were also announced. The universal subsidy, which currently pays 50 cent per hour for children under three, will be extended to cover children up to the age of 15, and the hours covered by the NCS for children in school or preschool will be increased.

In its post-budget analysis, the ESRI compared the direct and indirect tax and welfare measures announced in budget 2022 to a price-adjusted set of policies, which would have kept household purchasing power constant in real terms. Figure 2 illustrates the impact of budget 2022 across the distribution of household income, adjusted for family size, with the population divided into ten equally sized groups or deciles, ordered from lowest to highest income, left to right. The effect of direct tax and welfare measures, indirect tax measures and changes to the NCS are shown separately, with the total effect represented by the solid blue line. The overall effect of budget 2022, compared to price-adjusted policies, is that, on average, disposable income is virtually unchanged. There are small and average gains in the lower two deciles and upper four deciles, which are counteracted by small income losses in the middle four deciles. Although increases to the carbon tax and tobacco duty disproportionately affect lower-income households, these also gain from above-inflation increases to core social welfare payments and supplements for those living alone or with dependents. These increases are sufficiently large to offset the impact of increases to indirect taxes for the lowest-income fifth of households and will leave poverty slightly lower than had all welfare payments and tax bands kept pace with inflation. While the above-inflation indexation of income tax bands and credits will also compensate higher-income households for the increases in indirect taxation, most USC and PRSI bands were not changed. The effect of that is to reduce the after-tax purchasing power of lower earners who do not earn enough to pay income tax, though some of those will gain from an increase to the minimum wage.

From a policy perspective, it is important to recognise that the current and forecast inflationary pressures are essentially of a temporary or transitory manner. The surge in demand will abate as consumers unwind savings and slowly regress to their pre-pandemic savings ratio. Firms will continue to improvise and navigate through the supply chain disruptions until global trade returns to normal levels. While monitoring authorities and forecasters generally may underestimate these inflationary pressures, this does not mean that the same authorities should react in a somewhat hasty manner by prematurely increasing policy interest rates. That, as noticed by Charles Goodhart and Manoj Pradhan, could result in monitoring authorities threatening the nascent economic recovery which is apparent across countries.

If inflation in 2022 is in line with forecasts, the direct and indirect tax and welfare measures announced in budget 2022 will compensate most households for rising prices. If inflation exceeds forecasts, the increases to some targeted welfare measures, such as the fuel allowance, living alone allowance and qualified child increases, may not be enough to insulate low-income households from rising prices. The European Commission has published a toolbox discussing measures of support for consumers in the face of a temporary rise in energy prices. Suggested interventions include the temporary deferral of bill payments, adjustments to VAT and levies and short-term adjustments to social payments to aid the vulnerable. In an Irish context, short-term adjustments to social transfers and facilitating the deferral of bill payments are likely to be the most effective policy options, as taxes and levies comprise a lesser proportion of total electricity expenditure in Ireland relative to many EU countries and many social payments are already targeted towards vulnerable households.

I thank Dr. Doorley. I am now going to open the floor to members, who will have nine minutes each for questions and answers. If time allows, we can open for a second round of questions thereafter.

I thank Dr. Doorley for the presentation, which had a lot of information in it. The rising costs of everyday household budgets are putting pressure on many people I deal with. An awful lot of people are going to be paying extra for diesel to get in and out of work where public transport is not available. The costs of electricity bills and so on are also rising. The carbon tax is a visible measure and people will see it coming through on a tank of diesel. How much of an impact do our guests think that will have on the overall picture of inflation? Dr. Doorley also pointed to external influences. Energy and gas, in particular, have been identified as drivers of inflation. Which will have the bigger influence and what extent of influence will the carbon tax and international prices have?

The ESRI examined the possibility of those prices levelling off, possibly by spring 2022. Is that going to be enough to ease pressure here or is it already going to be driving other costs across the household budget at that stage? How comfortable are our guests that this inflation pressure is temporary? Is there a longer-term element to it?

Dr. Doorley pointed to housing, whether buying or renting. We have seen a continued increase in pricing there. Would our guests expect that to drive further pressure across the economy through increased wages and so on?

The witnesses highlighted that Ireland has been more resilient here than across the EU and that there is more of a bounce-back. They suggest there is almost a mismatch. Would they expect that such a mismatch would continue? If it did, and there were measures taken across the EU to deal with inflation and we are already mismatched with Europe, how would that affect us here? What would be the long-term outlook of something like that?

Dr. Karina Doorley

I will respond on the carbon tax and let my colleagues speak on the temporary nature of inflation. Our post-budget analysis included the carbon tax. We looked at the effect of direct and indirect tax measures on household incomes. That included the increase by the carbon tax. Even accounting for the increase to the carbon tax next year, households are on average no worse off as a result of tax and welfare measures in budget 2022. That is because the carbon tax disproportionately affects low-income households because their fuel bill is a larger share of their overall consumption but there were well targeted increases to some social welfare payments that manages to compensate those households for the extra expenditure that they will incur as a result of the carbon tax. Taking the impact inflation on top of the carbon tax increase, if it does not exceed the forecasts which are around 2% or 3% next year, then low-income households should be reasonably well insulated from the impact of inflation and from the carbon tax increase. In other parts of the income distribution, depending on how much inflation exceeds forecasts, some households may be left worse off. However, for the lowest income households, the direct tax and welfare measures announced in budget 2022 should compensate them from carbon tax increases and forecast inflation.

Dr. Niall Farrell

On carbon tax, the vast majority of the increases in prices are internationally driven. On a litre of fuel, carbon tax accounts for around 10 cent per litre. The vast majority of the increase comes from the international price increases. Gas is similar. On whether this will last forever, the current projection is that the price being paid on international markets for delivery of gas in spring tends to fall back to what one would expect outside the current increases in fuels. Given what we know now, we would expect the prices the resolve around then. What happens in the longer term is predicated on how European supply channels become resolved.

By the time it might ease, will it already have had an impact across other sectors, driving pressures on other parts of household budgets?

Dr. Kieran McQuinn

On the temporary or transitory issue versus permanent, taking the broad overview of the kind of inflationary pressures in the Irish economy now, there are four main issues: the energy costs, which Dr. Farrell spoke about; supply chain issues; the base effects; and the housing costs. Those are the four ways that we look at it in overall terms. The base effect issue will resolve itself over the next period. Most people seem to think that supply chain issues will be resolved in the next six to nine months as economies come back on stream and normal economic activity begins to convene across most countries. Dr. Farrell spoke of easing of pressures around energy costs. The vast majority of the pressures there at present should begin to resolve themselves quite considerably over the next six to nine months. The housing issue is where you could see a lingering effect beyond that. Ireland is not the only country experiencing this phenomenon. Housing costs are increasing across Europe and even in North America. Those relate to a lot of factors, some of which are connected, such as the build-up of savings during the pandemic. However, between house prices and rents you will see upward pressure over the next six to nine months and even beyond that. We would be reasonably confident that the other pressures will begin to abate. Initially, policymakers were quite confident in asserting that they felt it was a temporary transitory issue and giving dates for when they saw the inflationary pressures ease. I think there is a little less confidence now and people are coming around to the view that the pressures will last a little longer than initially thought and that the inflation rates will be a little higher. However, I think the basic core drivers of inflation are issues which should be resolved in the next six to nine months.

Briefly, what about the bounce back?

Dr. Kieran McQuinn

It has been an issue for Ireland, one could argue going back to when we joined the euro area. Very often we found over the last 25 years that the economic cycle in Ireland has been slightly different from that in other countries across Europe. Interest rates and monetary policy are set at a euro area-wide level so it is what the euro area economy in general or in aggregate is doing, and very often we have been out of sync with that. We grew very fast in the initial part of the 2000s and have grown very strongly over the past five or six years at a time when most euro area countries have had sluggish growth. It is a phenomenon that we have had in the Irish economy. We expect very strong growth next year as well as very strong growth this year. That would put us at the higher end of the growth table, as far as most euro area countries are concerned. The bounce-back effect will be somewhat stronger in Ireland than in most European countries.

Deputy Healy-Rae is next but he is taking a phone call so we will go to Deputy Canney.

I was listening to what was said there. The thing that I really want to get on top of is carbon tax. I know that the ESRI factored that into its analysis, but the cost of living is going up. The weekly shopping is going up as are travel costs. How sustainable is that? I know we say that there are international reasons for the fuel costs going up but fuel costs drive up every other cost. There is a ricochet effect. How will that be dealt with? With carbon tax, it is costing some people more now because they do not have access to public transport. They have no alternative methods of travelling to the car. There does not seem to be any just transition for that. People say that it is only a small fraction of the overall cost of the fuel but fuel is expensive anyway and this is just adding more cost to it. People are paying the carbon tax but they are not realising any of the benefits. How do we approach that?

I want to raise another thing. I do not know if it is in the ESRI's remit. There are discussions around fiscal restraints coming back in from the EU. How does the ESRI see Ireland being positioned with the level of funding and debt that we have in the medium term?

My last question is on interest rates and the cost of borrowing from the point of view of the State and businesses. Does the ESRI see any issues with that? It said Ireland is in a very good position to bounce back and that is probably based on the prudent measures taken since the previous recession. How do we create resilience and build capacity without driving inflation out of control? That is my concern. It is about overheating the economy, in other words.

Dr. Kieran McQuinn

Dr. Doorley will address the question on the carbon tax.

Dr. Karina Doorley

We should view the carbon tax from a long-term perspective. There is a commitment to increase the carbon tax by a certain amount every year for very good reasons, namely, because we want to invoke behavioural change to help with the climate crisis. The purpose of the carbon tax is to increase the price of carbon in certain fuels, diesel and petrol in order to invoke this behavioural response. What we are seeing currently is a bit different from that. Obviously, we have supply-side pressures driving fuel price growth. With the two of these together, it is unfortunate there is a carbon price increase and then these other supply-side effects at the same time. However, the European Commission has come out with a sort of toolbox to help with what it perceives to be transitory changes to fuel prices at the moment. The steps policymakers can take to help with the current pressures involve allowing bill deferments, perhaps increasing some social welfare payments temporarily and other measures like that. The Commission does not advocate rolling back on carbon taxes because that is a long-term policy with well-stated objectives. I suppose the issue is how to deal with the current inflationary pressures that come on top of the increased carbon taxes. Perhaps Dr. Farrell will say something on that.

Dr. Niall Farrell

It is worth thinking of carbon tax and environmental policy as a suite of measures and thinking of the combined effect. If we think about carbon tax plus changes to the tax and welfare systems plus planning and other infrastructural changed, they all help each other. In a scenario where we have a carbon tax that would help somebody to adopt a better alternative means of transport, for example, where one is available, that needs to work in conjunction with good development planning to help ensure those options are available. In circumstances where people cannot change, vulnerable households will be left no worse off provided good distribution policies in place, and carbon taxes have been accompanied by such policies in the Irish context in many cases. The ideal scenario is to adopt the policies and provide an option so that the policies work well together in combination.

I think Dr. Doorley and Dr. Farrell are confusing two things. They may believe that people living in rural Ireland who cannot access public transport are all on social welfare. Many are working and paying their taxes and will not benefit from an increase in social welfare payments. The people I am talking about are the working people who, through carbon tax, must pay more to go to work to support the economy and their families. They have no alternative and will not have one for a good few years yet. Where is the just transition for them? It is argued that we should increase social welfare benefits but the people I know who are paying more in carbon tax to put fuel in their cars to go to work have no recourse. Perhaps an additional tax credit could be provided to neutralise the additional carbon tax for those who have to use their cars. They are the people who seem to be paying all the time.

Dr. Karina Doorley

That issue came out in our post-budget analysis. We looked at the effect of the direct and indirect tax and welfare measures across the income distribution. While the poorest households were well compensated, the highest income households were also well compensated because of the increases to tax bands and credits. It was really about the middle income households who were earning too much to benefit from social welfare but not enough to benefit from the increase in the standard rate band. Those households were not fully compensated for the increase in the carbon tax.

Dr. Kieran McQuinn

I will take the two points the Deputy raised about the fiscal rules and the ongoing discussion about what is likely to happen to them. Most people believe that if reverted to the exact rules in place before the pandemic, many countries could be in difficulty over the next couple of years. This idea of aiming for a 60% debt-to-GDP ratio when many countries have been increasing their debt would pose significant issues for countries such as Italy and others which have been increasing their spending. In an Irish context, the strength of our recovery is such that we believe we will have double-digit GDP growth this year and very strong growth again next year. We can talk about how valid the debt-to-GDP ratio is in an Irish context. However, if we take it as the measure, and it is the measure used with the fiscal rules, the economy will probably be in a better position by the end of even this year than it was just before the pandemic. Even though we increased our debt and borrowing, the economy actually grew by such an amount and is likely to grow by such an amount that we are in a better position than we were going into the pandemic. I think that will be a surprise to many people but that is the nature of the strength of the recovery. As I said, we could have a separate discussion on how accurate GDP is in this context but compared with most other countries in Europe, Ireland will be in a relatively good position going forward, from that perspective. Again, the strength and pace of our recovery are the key issue there.

On interest rates, the Deputy raised a very interesting question. Obviously, the interest rate is the key monetary policy tool used to curb inflation. It is what the ECB would typically use if it were trying to actively reduce the rate of inflation. The danger is that if interest rates were raised at this point, many countries are only beginning to recover and come back on track with respect to normal economic activity. European authorities, especially the ECB and the European Commission, probably learned from the mistakes of the financial crisis where the large institutions, whether it was the ECB or the Commission, did not really help the initial phase of recovery countries were experiencing after the financial crisis. There was too much of a focus on curbing expenditure and countries getting their fiscal policies back in shape. Those lessons have been learned. The major authorities are trying to accommodate the recovery as much as possible and that has been reflected in much of the commentary, even from the ECB in recent times. It notes the higher inflation, believes it will work itself out over the next six to nine months and will not start raising interests any time soon because of the dangers that could pose to the recovery across the euro area.

The Deputy raised the issue of overheating. It is a valid point in the sense that we would have been talking about the potential for the Irish economy to overheat just before the pandemic. Obviously, the pandemic has had its impact. As we come out of the pandemic and the economy grows very strongly, that will raise certain issues for us as well. The ESRI has, for instance, called for greater capital investment in areas such as housing. Climate change is another area. That is important and necessary going forward but it means that when increasing expenditure, particularly on capital, in the context of an economy that is growing very strongly, it will require showing discipline on the current expenditure side to ensure the economy does not overheat. That will become a key fiscal and broader macro challenge for the authorities over the next period.

I warmly welcome our guests and thank them for giving of their valuable time. We appreciate very much their considered opinions on all these matters. I have great concerns, as I am sure all those in the ESRI do, regarding where exactly we are going from an economic point of view in the context of small to medium-sized businesses and the effect of the ever-increasing cost of the basics and the knock-on effects that will have on those businesses. By basics, I mean energy and fuel costs, which relate to everything. As I continuously say, from the moment you get up in the morning, whether it is brushing your teeth or anything that follows, everything that you need comes on wheels. It does not fall out of the sky.

The majority of things in this country are imported in containers. I am acutely aware of the cost of containers. Not so long ago, you could get a container for between €1,800, and €3,500, whereas now you can pay €8,000, €9,000 or €10,000 for the same container. That is a startling fact. What is more, when you go looking for that container, there is a wait and a buy-in time that was not there before, which affects supply, of the basic necessities we get in or anything else.

I run a small shop and I see simple changes happening. It is not just in my shop, it is in every shop. To take a random example, you cannot at certain times get either grapefruit or grapefruit juice of any type or description in any shop in the country. That can go on for a week, ten days or two weeks, and then all of a sudden they will come in again. That is just one item out of what might be 10,000 items in a large shop or 2,500 items in an ordinary, small shop. We are going through these phases of not having items. Some of them we can do without and, to be blunt about it, there is a fear of us, but there are other staples we need from the building supplies point of view. We all know about the price of steel and timber and other basics.

I have to say this all the time because it is not as though I am somebody who has his head stuck in the sand. I am not a person who looks around me and says I am a climate change denier, that this is all a load of rubbish or that I do not agree with that. I am not for one moment saying that, and I hate it when people try to paint me as a character who says that because I do not. It is the exact opposite. What I am arguing against is the way in which we are driving this. For instance, we talk about it as a given that we have to tax carbon-related fossil fuels because we have to discourage people. I have never in my life voted for an increase in the price of tobacco at budget time because I do not think the right way to stop people smoking is by heavily taxing someone who feels he or she has to smoke, or who smokes for different reasons such as psychiatric problems. I do not agree with the idea of taxing and taxing certain items.

The Government has got it so wrong on certain issues. We are bringing in 4,000 tonnes of peat at the time - it is a well-known fact - but the carbon footprint of that is coming in from Latvia because we shut Bord na Móna. Our peat is staying in the ground but we are bringing in peat from Latvia. We are bringing in briquettes by the thousands of tonnes from Germany - they are selling very well - while we are closing our own Bord na Móna peat briquette factory. The Government does not have a monopoly on getting it right.

Some might say I am pointing out the things that are wrong and ask me what should be done. There are actions the Government could take. For example, it could waive the increase in VAT from the carbon tax to alleviate fuel poverty. Similarly, because insulation products are so expensive, it could remove the VAT take on them. It is rubbish for the Government and the people who support it to say grants are available. I challenge them to apply for the grants and see how they get on. If they are an older person looking for the full, 100% grant, I challenge them to see how they get on. I deal with this every day. They will be faced with a wait of up to two years. Imagine if anybody at this meeting was told that he or she had to wait two years for assistance for anything. It might not be the end of the world to us but I ask members to think of one thing. They are all diligent and thoughtful people. I challenge them to let on they are almost 80 years old and want to insulate their home. Some bright spark will come along and say, "Oh yes, you can have this grant, but you know you must wait two years for it." Two years is a fairly long time when you are an older, perhaps vulnerable and cold person. Two years is a lifetime. The Government is ignoring that fact and blowing about how it is putting so much into grants. It should do something immediate that will reduce the cost of the insulation product immediately. It should do away with much of the tax take on it.

Those types of measures are sensible moves we could make straight away that would give credibility to what the Government is trying to do. People are only now starting to realise because it is hitting home when they see the increases in the cost of energy and how difficult it will be for them to heat their homes. People are told to change from using fossil fuels to, say, an air-to-water system, but does anybody know how much such a system costs? I do, and I know what it should cost. It should cost between €2,500 and €4,500 for the equipment, but €18,000, €20,000, €22,000 and €24,000 is being charged for an average house. Why? That is wrong. It should not cost so much.

Nevertheless, the Government is not examining that or doing anything about it. It just tells us this is what we should do. How can people afford to do it? They are told to change from using a petrol or diesel car to an electric car. What is the Government doing about giving us the provision such that we will have all this electricity? It is doing nothing. Our energy supply nationally is going into the red in a way it never did before in that we are bordering on facing power cuts. We will not have power cuts this winter, please God, but we will have them next year. That will concentrate people's minds. People who are very involved in the provision of energy in this country, who have been at this for a lifetime, have told me it is inevitable that there will be outages. They will be planned and organised outages, but we will have them next winter if we survive this one, yet the Government is not making any provisions.

I am talking about this in the context of our guests' presentation because I believe it has everything to do with it. When we talk about how we plan our finances, we do not know where we are going unless we know where we are coming from and what we are doing right now. I am afraid the Government is unsure about what it is doing. It is clamouring and trying to position us on the world stage. Last week, the Taoiseach went over and gave away a couple of hundred million euro as if it had been lying around on the ground to be kicked around the place. We are not thinking this through. I acknowledge that our guests cannot comment on this but, with the way the Government is hanging, between Fianna Fáil, Fine Gael and the Green Party, they are all holding on to one another and everyone is afraid to kick to touch on anything. All the people supporting them are tied in to this thing together. It is a case of them keeping peddling this as hard as they can to keep it afloat. At the end of the day, we are charged with representing voters, the people, whether they are vulnerable people, young couples or older people, and we are supposed to take care of their welfare. I refer to their financial matters, their health, their education and all the other aspects of their life. We are supposed to take care of that but we are not doing so. The Government is doing nothing to curb inflation and everything to increase it.

They are doing everything to increase inflation because they are hitting all the basics.

The Deputy is a little over time.

I am very sorry. I apologise.

That is fine. We will go back to our witnesses, if they would like to respond to some points.

Dr. Kieran McQuinn

The Deputy made a valid point about small to medium-sized enterprises and the outlook in future. Something that we have noted even during the pandemic is the varied impact that the pandemic has had on the economy. In general terms, we make the point that the economy has come through the pandemic well and is set to grow strongly next year and the year after. That masks substantial differences beneath the surface. Some sectors of the economy have been completely unaffected. Some have benefited, considering some of the exports last year. Other sectors of the economy have been practically wiped out and have experienced significant difficulties, including the hospitality and tourism sectors. There has been a different effect on different sectors of the economy. This also applies from a regional perspective. Some parts of the country have fared reasonably well and others have been badly affected. There are significant differences in how the pandemic has affected the country and as we hopefully come out of the pandemic, there will be significant differences regarding areas of the economy that will be impacted and other areas that may fare more robustly.

The supply chain is a relevant issue. Interesting work has been done internationally to look at the effect of the supply chain issue on inflation. The Bank for International Settlements looked at the effect of inflation in the eurozone and the USA. It is clear that the supply chain and difficulties associated with it are a significant factor which influences inflation rates in both the eurozone and the USA. Most people would expect that, but it is interesting to see it borne out by the figures and analysis.

The Deputy mentioned building supplies and steel. We have often talked about the housing issue in the institute. Housing is one of the main areas that has been adversely impacted by the pandemic because the demand has remained strong, and was almost bolstered by the increase in savings witnessed over the last year or so. As those savings begin to come back into the economy, much seems to be going into the housing market. The supply side of the market was especially adversely impacted through the restrictions and the building sites being shut down for a period, and through the increase in costs in key areas, including steel and labour. That will have effects that last for a time. As I said in response to an earlier question, the one area where I expect lingering inflationary costs for the economy in the medium term is the housing market, because of the specific nature of the difficulties for the economy at present.

Dr. Doorley might want to talk about the carbon tax again. I am not an environmental economist. My colleagues in the institute make the point about carbon taxes that to impact behaviour, it appears, insofar as there is ever unanimity in economic literature, increasing and levying carbon taxes is an important conclusion from much of the analysis and results, domestically and internationally. That is a fairly unanimous conclusion. It is a cornerstone of the Government's approach to meeting our emissions targets. I do not know if Dr. Doorley or Dr. Farrell want to add to that.

Dr. Niall Farrell

As Dr. McQuinn said, the literature suggests that carbon taxes are the most efficient way to reduce carbon emissions with the lowest cost to society's welfare. An interesting international analysis was to look at the effect of a subsidy on its own compared with a carbon tax. When there is a subsidy to make renewable energy cheaper, that is fine, but then everybody switches to renewable energy and the price of the unused carbon-emitting technology goes down again and people switch back. In order to make the change stick, carbon emitting things have to be made more expensive. One thing arising from the previous comment is that the middle-income cohort can be constrained or negatively affected. There are available redistribution options to target whoever is expected.

The Deputy mentioned supply constraints with regard to retrofitting. We need to have a lot of retrofitting and housing. Asking whether we will have the necessary capacity in the construction sector is a valid comment.

Regarding EirGrid and supply constraints in the electricity market, one thing to take into account is that tighter constraints are projected in the future. There is perhaps an increased risk of something happening but it does not necessarily mean that something will happen.

I thank the ESRI. I apologise for not being here at the beginning. We are discussing many of the same issues with regard to the Finance Bill as we speak. Quite a few of us are double jobbing this evening. I read the witnesses' paper.

I wanted to ask about the carbon tax and the commitment that people seem to have to it. Perhaps there is a failure to distinguish between different types of carbon taxes. I am in favour of carbon taxes on people who are profiting from polluting the environment with carbon dioxide. I do not accept that it changes behaviour if financial penalties are imposed on people for using fossil fuels where they have no choice. There has to be a distinction. If the witnesses suggested taxing the profits of the aviation sector and companies such as Ryanair, or Larry Goodman and the big beef processors, I would say to load it on. If the tax is going to be applied to the small farmer or the family living in social housing, it is a different matter. For example, if the council will not insulate a family's home for the next decade and they have to increase the heat. People who are well-paid do not have to because their homes are well-insulated or they can afford to make up the difference between grants and the cost of retrofitting, while a family in private rented accommodation or social housing would not be allowed to do it even if they could get the money. Those people will not change their behaviour because they cannot. They are prohibited at every level from changing their behaviour and they are being punished in a situation where they are doing nothing wrong. That is the misapplication of carbon taxes. We have to speak out strongly about it.

If we do not challenge that type of carbon tax, there is a danger that we will make the least well off, the most vulnerable and the people who are least guilty of carbon pollution, hostile to the climate action agenda. There is no doubt in any study, globally, domestically, or anywhere else, that the rich emit far more carbon than the poor. This will punish the least guilty.

They will be made hostile to it and pushed into the hands of climate sceptics. I therefore appeal to the economists in the ESRI to distinguish between carbon taxes that punish people who are not in a position to change their behaviour because of price signals and those who essentially make money from polluting, carbon-heavy industry.

The witnesses say some of the inflationary pressures we see at the moment are specific to Covid, with people saving money and then starting to spend it again because things reopen, if I understand correctly, and are specific to slowdowns in particular sectors in which demand fell off during Covid. Are there any lessons to be learnt about our vulnerability to these kinds of inflationary pressures from Covid? To me, the lesson that has to be learnt from it, particularly when looking at energy but also in any other area, is that the more you plan and the less you depend on the swings and roundabouts of markets responding in particular ways to particular situations, the more you are able to cope with these kinds of situations. I ask the witnesses for their opinion on that. You are more vulnerable to these swings or moments of inflationary surge if there are areas which are completely dependent on private market actors to determine supply at critical moments, particularly when that supply is of things that are critical to the sustaining of the economy.

I have one last question. I want to give the witnesses time to come back in. Dr. McQuinn said we need to ramp up capital investment in a whole range of areas - and I agree with him - such as housing, retrofit, public transport, forestry, to mention another thing that has come up a lot this week, and many other areas. I would add third level education because if we do not have the skilled, trained workforce to do a lot of the things we need done, apprenticeships and so on, that will create bottlenecks and inflation. Dr. McQuinn says, however, that if we are to do that, we have to be careful about current spending. Could he identify where we should cut back on current spending? I worry about that. It sounds a little like austerity. Should we not at least point to the other possibility rather than cut back? Often even the distinction between current and capital is lost on me a little in certain areas. With increased investment in education, where does capital and current begin and end? I am not quite sure. We need more teachers and more school buildings. Maybe the witnesses could comment on that. It seems to me that there is an alternative, which is to look at the distribution of income and wealth in our society and tax policies that will give us more revenue by redistributing wealth and profits, which we have seen grow very significantly over the Covid period but which tend to be concentrated among small groups at the top of business and the top of our society.

Dr. Kieran McQuinn

I will come in on the last couple of points the Deputy made about the inflationary pressures specific to Covid. Then I will comment on vulnerabilities to swings and roundabouts and international markets. Dr. Farrell might jump in on the energy side, and I will deal with the capital expenditure issue. Then, in the absence of our environmental colleagues, maybe we will all talk a little about the carbon tax issues the Deputy raised.

Earlier I made the point that the way I look at this is that there are four different factors influencing the inflationary pressures we are experiencing now. Some of them are specific to Covid, some may be less so and some involve existing issues we have in the economy being exacerbated by Covid. Energy costs are clearly an international phenomenon. The supply chain issues are very much an international post-Covid situation. As for the base effects, prices were very low last year and there was deflation in some sectors. Clearly, any increase in prices this year will result in fairly large swings in inflation. Again, that is Covid-related.

Housing issues are a classic example of Covid compounding difficulties that were already in the market in terms of the imbalance between supply and demand. If anything, Covid seems to have provided almost a stimulus to the demand side of the housing market in the form of the increase in savings we have seen. There seems to be preliminary evidence to suggest that some of those savings will come back into the property market rather than into other areas of consumer expenditure. That will stimulate to a certain extent the demand side of the market. The supply side of the market was particularly impacted by Covid between the lockdowns and then the sharp increase in costs in certain sectors of the supply side of the market.

That is our overall viewpoint. As I said, some of these issues are more Covid-specific, some are international and some involve the interaction between Covid and existing vulnerabilities or weaknesses in the domestic economy.

Does Dr. Farrell wish to talk about energy? Then I will come back to the capital issue.

Dr. Niall Farrell

Sure. A lot of our energy, in terms of electricity generation and heating, is sourced from gas. Exposure to international gas prices is a function of what the price is and how much gas is used. At the moment we use quite an amount. To reduce that exposure, accelerating renewables and the environmental transition is perhaps the greatest long-term solution. Regardless of any way to shield people from these prices, if we are still dependent on gas, we will still face this issue. The renewables transition is perhaps the long-term solution in reducing our exposure to fluctuations in gas prices. When it comes to households and carbon taxes, Dr. Doorley is probably more familiar with this, but I suggest thinking about it in terms of a combination of policies - not only with regard to carbon tax but also with regard to compensation in the form of changes to the welfare system that may help the vulnerable households the Deputy discussed.

Dr. Kieran McQuinn

On the point about capital expenditure, the broad point is that we agree and we have put forward the case for significant investment in areas such as housing. It is clear now that the carbon and environment area will require a significant increase in expenditure as well. In investment terms we see big increases, or certainly sizeable increases, in capital expenditure coming over the next few years. The issue from a macro point of view is that the economy is set to grow quite strongly. Our expectation is that it will grow very strongly this year, next year and probably for a year or so afterwards. The danger in that context is that we see a significant increase in capital expenditure, or expenditure generally, at a time when the economy is performing very strongly. That can lead to overheating pressures. I take Deputy Boyd Barrett's point that at times there is a blurred distinction between capital and current. We are certainly not calling for any reduction in current expenditure. What we are talking about is being disciplined about the rate of increases in current expenditure we see going forward. As to which areas we would look at - and this may chime a little with what the Deputy says - I do not think there is much scope for any significant reductions in, for example, taxation such as personal income tax. Greater taxation may even be called for as a way of taking the heat out of the economy. That is the point about current expenditure. If we see significant increases in current expenditure on top of significant increases in capital expenditure, the danger, in the context of a very strongly growing economy, is that there will be an overheating problem. As I said, sometimes our economic cycle is not quite the same as the European one. That has implications for monetary policy and the kinds of actions of the European authorities to control inflation. It may well be that our inflation will be out of whack with what is going on in Europe.

That is a kind of by-product of our membership of the euro area. That is the broader point.

On the carbon tax, I do not know if Dr. Doorley would like to jump in. Again, going back to the earlier point, we do not have our environmental colleagues with us. If they were here, I am sure they would echo the point we made in respect of Deputy Michael Healy-Rae’s questions. The evidence seems to suggest that carbon taxes are an important way of changing behaviour. I take the Deputy’s point about the distributional issues. Clearly, if people do not have an alternative, then that is that is a major issue. The research seems to point fairly conclusively to the fact that if you want to change behaviour in this area, carbon taxes are the way in which to do that.

I apologise to the Chair for arriving in such haste and for having to dine on the way.

That is okay, Deputy, we understand the constraints of the Finance Bill at the moment.

I must have affected Deputy Boyd Barrett because he seems to have wandered off the script. I was listening to him while dining at the same time. First, I thank the Chair. I also thank our witnesses for their presentation. I listened to as much of it as I could. I was trying to do two things at the same time.

There are two things that come to mind. I had agreed all day almost with Deputy Boyd Barrett. I worry about my ideological trends when that happens. However, he wandered off anyway so I am glad to say I am back on track again now. The Deputy is suggesting one thing that I strongly disagree with, namely, dividing society. In the battle that is ahead, we cannot afford to divide society between rich and poor and urban and rural. We have to include everybody. Climate change affects everybody. If we all stay together, we will succeed.

On carbon tax, it is hard to say to people that it is in their own interests and that they should swallow their medicine and it will be okay. Carbon tax is not an end in itself. It is a means to an end, and we have to realise that. However, we need to have alternatives in the intervening period. We have just spoken about that. We cannot afford to say to people that this is it for the good of society and for the good of humanity. We need to be able to show them graphically that we are on their side on this and that we are aware of the difficulties that this creates for some people. The Government is trying to do that. It is trying to address those issues through the medium of social welfare and other measures. That is being done. Whether it will be done sufficiently to meet the needs of the people remains to be seen. I referred to this at another committee just a short while ago. There is a necessity to have a plan B, should there be a sharp deterioration in weather conditions, for example, this coming winter or in the spring. We should have some way of showing the people how we can get to where we need to go, for example, in the context of keeping them in some degree of comfort and ensuring that they have the ability to heat their homes and so forth. At the same time, we should not create a further burden in the context of emissions. That can be done.

I do not know if this matter has been debated, but I suspect it has. Everybody believes that the farming community is totally responsible. That is not true. People believe that climate change only affects the farming community and that if they make the sacrifices, everything would be all over. That is not true either. This affects all of our society, urban and rural. When distribution issues arise - they have already begun to do so - it will fall to us to find some other way of bringing everybody on board. Incidentally, the jobs in the agrifood sector are not all rural based. Many of those jobs are urban based. If, for instance, we were to lose the jobs at the scale that has been suggested, we would have a serious breach to our economy that we could not afford.

What we need to do now in order to ameliorate the problem is no far as we can is sequestration. We can do that straight away. We can start next week, next month or next year, or we can avoid it all together, do nothing and say "It’s not going to happen. I do not agree with it. It is a conspiracy." and all that kind of stuff. If we follow that course, then in five or ten years we will have achieved nothing. We need to concentrate now on sequestration in respect of forestry, the means by which we heat our homes, the way we drive our cars and so on. We must also consider the degree to which modern science can come to our aid as well. For instance, the use of hydrogen has not been pursued to any great extent. Insofar as I am aware, an internal combustion engine can be fairly readily converted to run on hydrogen. That is not big task at all. It just requires the will among the scientists and the engine manufactures globally. That matter needs to be examined.

I apologise to the Chair for going off on a rant. I want to highlight the fact that we will achieve what we are seeking to do if we proceed together. We should examine all the aspects regarding how we can deal with the sequestration; how we can change over to electric or hydrogen cars; and how we can change over to hydrogen trucks and hydrogen transport. We cannot get on without transport. We have to transport. We cannot do it all on rail. If we were to do that, we would end up having more rail infrastructure than roads. That would not serve any useful purpose. We need to proceed in the right fashion and keep in mind the need to ensure the maximum return on our every move. Let us not forget this: we are lucky to have been able to come Covid-19. Covid-19 has been very expensive. The disease is not unique to Ireland. The manner in which Covid-19 was dealt with in countries across the globe has been no different. Everything has been tried but, so far, a magic bullet has not been found.

To go back to the original issue, I am of the view that we are on the right track. We need to make sure that it happens. I made the point in the past that if we had started 15 years ago to manufacture the alternatives, we would not have a problem now. That is the issue. We would not have a problem now. If we continue to blame each other for what is happening - whether it is rich blaming the poor or those in urban areas blaming their rural counterparts - we will not achieve anything. We will arrive at stalemate. Stalemate is easy to produce and difficult to sequester, no pun intended. We should follow the instructions. We should also do that in the context of Covid-19 as well of course.

I want to finish with this point. I mentioned it at another committee. In the 1970s, in my constituency we built many houses without chimneys because we were told at that time that the climate was getting warmer and that we would not need as much heat in the future. That was one of the reasons that no chimneys were put into houses. The Government of the day had to give a grant, I think it amounted to £750 or £1,000, to householders to put chimneys into their houses on foot of an increase in fuel prices rising across the globe. Everybody affected had to avail of the grant because, otherwise, they would have had no heat. Needs must, as we say.

I thank the Chair for allowing me in at this stage. I am sorry that my contribution happened to take the form of a rant. However, I look forward to the odd rant now and again.

You are entitled to that Deputy Durkan. Thank you for your contribution. I will hand over to our witnesses. Would they like to comment on any of the Deputy's points?

Dr. Karina Doorley

I might make an observation on the carbon tax in the context of the point made by Deputies Durkan and Boyd Barrett. When we think about the impact of carbon tax on rich households versus poor households, the recommendation is that in order to achieve behavioural change, carbon tax must be applied across the board. However, there are obvious distributional impacts. Poorer households spend more of their income on fuel and, as a result, they are disproportionately affected by carbon tax increases.

Poor households are also less able to switch. They do not have the disposable income available to buy an electric car, retrofit their houses or even delay consumption if there is a temporary increase in fuel prices. The idea is to compensate the households who cannot switch and make sure they are at least no worse off. That was done in last year's budget and this year's budget at least for the poorest households but maybe not so much for the middle income households. This year, there has been a slight reduction in the disposable income for middle income households compared with a price index budget, which does not quite compensate them for the carbon tax increase and something similar happened in last year's budget. There are ways to compensate middle income households. They might not receive social welfare but indexing the universal social charge, USC, or PRSI rates can go a long way to alleviating some pressures on those households due to an increase in carbon tax.

Dr. Niall Farrell

There is ongoing research in Ireland on bringing in hydrogen but it is very much at pre-commercial stage. Hydrogen will be a very important resource in the long term. It could be a very important resource in Ireland because if we get a lot of offshore wind and things like that, so have more energy than we can use, then that can be combined with hydrogen production facilities as a form of storage. That aspect is on the horizon if the technology develops.

What course of action do the witnesses suggest to negate the effect of funding in households in terms of the inflation rate?

In terms of fuel prices, do the witnesses think that the Government should temporarily reduce its tax take? If so, what action can the witnesses suggest to prevent the knock-on inflation on the likes of food and other goods?

Finally, I wanted to talk about energy increases but the witnesses have covered the subject. That is good and I appreciate their comments. Does increased Government expenditure, in particular capital expenditure, increase the risk of further inflation? If so, how can this be mitigated?

Dr. Kieran McQuinn

I will take the first question on household savings and the question on capital expenditure. The big question for macroeconomists in the aftermath of the pandemic has been, in terms of the strength of the likely recovery and bounce-back in economies, what will happen to the savings levels that people have accumulated. There is no doubt that savings levels did increase significantly during the pandemic for a number of reasons. At this stage it is hard to say definitively because we do not have the actual data. We are still forecasting and it is a very unprecedented situation that we have this kind of increase in savings to the extent that we have had. Preliminary evidence at an international level seems to suggest that people are looking at the housing market as an area to increase their expenditure levels and, possibly, to divest some of their savings into. We would see that as being something that is likely to occur in the domestic market for a number of obvious reasons. We have talked about the imbalance between supply and demand and the market. This was an issue before Covid and Covid has clearly had an impact on the supply side of the housing market. There is a danger going forward. I mean that people will now feel that there is a bigger imbalance but people are also aware of that. I will not say that there will be frenzied behaviour but the expectations that people have in this regard are important. I mean if people think there is going to be a shortage of housing then people will start to try to buy housing today because they are afraid that in six months or 12 months time that housing will be even more expensive. That is where one could see a considerable amount of these savings going into the housing market.

In terms of what to do about that, like everything to do with the housing market, the ultimate solution to the problem is to increase supply. The bottom line is that we need to significantly increase the supply of housing over the coming years as a way of dealing with the problems; in particular we must provide more social and affordable housing. We have extensively talked about the big problem that is the high cost of housing here when compared with other jurisdictions.

Capital expenditure is the flipside of the increased expenditure on housing. Again, the points that I made to Deputy Boyd Barrett are relevant. The Government has committed to increased capital expenditure on housing. I think there will be increased capital expenditure to do with the environmental challenge and also possibly in other areas such as Sláintecare and the like. One needs to maintain discipline on the current expenditure side because, without doubt, the economy will grow quite strongly over the coming years. The employment rate has fallen quicker than any of us would have imagined so one will get to a stage where the unemployment rate could become very low again, which would indicate there is very little slack in the economy, and the danger of overheating could come into play. It is important the Government is relatively disciplined when it comes to current expenditure. That means taxation cuts would be very hard to justify in that context and it would need to maintain a certain discipline in terms of areas around public sector pay. Those are the kinds of challenges that we face from a macro point of view. If we are going to increase capital expenditure then we must ensure we do not overheat the economy.

Dr. Niall Farrell

On energy prices, the EU published a toolbox that presented the components of energy prices across Europe. On average, the components that are attributable to taxes and levies in Ireland are much less than the EU average so there was less headroom to compensate this effect. I have my ESB bill with me and the public service obligation or PSO levy, which is used for subsidies, comes to around €13 for two months or more than €6 for on month but recently the ESB announced an increase and that amounts to €9. Therefore, one hits the threshold so perhaps there is less leeway there.

If we changed the taxes and welfare systems then we can target those who are more vulnerable. That comes down to deciding whether we want to help those who are most vulnerable because that might perhaps give us more bang for our buck.

I asked about fuel prices.

Dr. Niall Farrell

Did the Deputy ask what would be the knock-on effect on food prices?

Should the Government temporarily reduce its tax take? What actions would the witnesses suggest to prevent that having a knock-on effect on the price of food and other goods?

Dr. Kieran McQuinn

Does the Deputy mean the tax rate on fuel?

Dr. Karina Doorley

That is one of the options for the European Commission. It can suggest that member states should consider whether the situation merits such action. Reducing tax on fuel prices certainly is an option that might be worth looking at. Given that we expect this to be a temporary increase then we should think in terms of temporary measures. During the pandemic older people were asked to cocoon so the fuel allowance was increased for an extra month and a measure like that could go a long way. A fuel allowance is only targeted at those who receive social welfare. Other measures might be needed to target middle income earners, around the middle of income distribution, who are still constrained from switching subject to these higher fuel prices.

Not all social welfare recipients receive the fuel allowance and certain cohorts do not.

Dr. Karina Doorley

That is right.

I will let Deputies in for a second round and ask Members to indicate their wish to do so. While they give that consideration I will ask a few questions.

I would like to return to discussing budget 2022. We have talked a great deal about the carbon tax and the impact on people's take home and discretionary income or money in their pockets. I would like to return to the middle income earners we discussed earlier. The average gains were counteracted by small income losses in the middle four deciles and I ask the witnesses to expand on that effect.

Is it that the people in question are receiving no welfare payments and were not earning enough to see any impact from those tax changes? Would a change to the working family payment have had any impact on those groups? Do the witnesses have a suggestion on how those particular groups could be targeted if there was a wish to do so?

Dr. Karina Doorley

The Chair is referring to those in the middle four deciles slightly losing out due to budget 2022 compared with price index policies. I stress that the magnitude of those effects are small. They range from -0.2% of disposable income to 0.2% of disposable income. What I say next should be taken in light of the fact that there is error in any sort of statistical procedure like that. They are not terribly different from one another but the pattern is clear. Those in the middle income deciles lose out compared with those in lower and higher income deciles. The reason for that is twofold. The lower income households benefited from above inflation increases to certain payments such as the fuel allowance, the living alone allowance and increases for qualified children. Households in the upper half of income distribution are benefiting from tax cuts. The standard rate band was increased by more than forecast inflation while tax credits were also increased by more than forecast inflation. The typical household in the middle income deciles is probably earning too much to be receiving much or anything in social welfare but it might not be earning enough to benefit from an increase in the standard rate band. These households are not in the top tax rate so they do not benefit from a change to the standard rate band. Sometimes they receive the working family payment, which was increased by less than inflation in the budget so that is a real income loss for those families. Child benefit was also frozen in cash terms. Many of those middle income families have children so that amounts to a real income loss for them as well. The last major contributor is the fact that USC and PRSI payments were mostly frozen in nominal terms. That means there was a real increase in the USC and PRSI burden for most households. If they were located in the middle four deciles, those households were not benefiting from tax cuts that would have counteracted that burden. That is what is behind that pattern.

I have two follow-up questions on that issue. Is it fair to say that addressing that issue would require something like an increase in child benefit or the working family payment to target those particular households? While I accept that the losses might be relatively low, is it correct that this is having a more significant impact on particular groups like lone parents than on other families?

Dr. Karina Doorley

An increase in the working family payment or child benefit will benefit households with children, primarily those located in the middle of the income distribution because that is where working family payment households tend to be located but it will not benefit households without children. To target those households as well would require USC and PRSI rates to be indexed in the same way the tax bands were indexed. After the budget, we made the point that the budget was framed around maintaining the standard of living for households in the face of rising prices. One way to do that is to index tax bands and credits but PRSI and USC also fall into that category. If they are not indexed, it amounts to a real increase in USC and PRSI payments for many households. If we want to specifically target households with children, then child benefit and working family payments are good instruments to do so. If we want to target families without children, PRSI and USC bands also need to be indexed.

Dr. Doorley kindly answered my other question, which was on lone parents, so I will move to base effects. I must admit to not being fully aware of this aspect. Is it possible for somebody to unpack that a little? What are the base effects as we are reading through the latter half of 2020 and to what extent is current inflation a result of those base effects?

Dr. Kieran McQuinn

That is why we included a graph with our opening statement. We wanted to show that there was disinflation or price falls last year for a number of goods and services. The base effects idea concerns price levels versus growth rates. We always focus on the growth rate when we talk about inflation but if looking at the price levels we see that even if we have a strong increase in prices this year, the level may not be much different from where the long-term price level would be for those goods and services. The fact that there was a fall in prices last year means that even if there is a small increase in prices in those goods and services this year, it can show up a big increase in inflation and the price change. In the analysis that has been done, more internationally than domestically, to break down the current components of inflation, a certain element of it is the base effect and then the supply chains are another element. That is the work I referred to and the Bank for International Settlements has done a lot of work trying to break out the impact of the supply chain disruptions on inflation. The energy cost increases then come in on top of that. Those are the three major components in an international context but we have them in Ireland as well. The housing element mainly comes through in higher rents on the cost side.

Is the impact of the base effect relatively stable throughout various sectors or is it oversized in some sectors and undersized in others?

Dr. Kieran McQuinn

It depends. It is a bit like the impact of the pandemic generally. Certain sectors of the economy were completely unaffected by the pandemic and some sectors did better during the pandemic than they normally would have, for example, medicinal exports and the like. Those areas would not have experienced any deflation or disinflation and prices in them would have continued to do whatever they normally would have done. It is in other areas such as the hospitality sector, tourism and certain elements of the retail sector that price falls would have been experienced in past year and as a result, those are the areas that will be most prone to the base effects this year when the demand picks up. When the demand surges and people come back into shops and normal economic activity resumes, it will cause the prices of those goods to surge as well.

We have talked a little about how we hope or expect, or how the models suggest, that this level of inflation will be relatively transitory. Is it likely that the ECB will increase rates in the coming months or year? What mechanisms does our Central Bank have to control or mitigate the rate of inflation?

Dr. Kieran McQuinn

Our Central Bank is limited as inflation and monetary policy are conducted at the level of the euro area. The base rates or key policy rates are determined at the level of the euro area and, for good or ill, they are determined on the basis of what is happening across the euro area economy. I made the point earlier that since we joined the euro area, we sometimes have a disconnect between how our economy is performing and how the euro area as a whole is performing. That issue can have implications for the impacts of monetary policy because it is set at a euro area level and is not always specific to the problems of individual countries like Ireland.

If we look at the commentary of the European Central Bank, from its president to its chief economist who gave a significant speech recently, it is evident that the ECB will not raise rates over the next six to nine months. It is cognisant that the recovery across the euro area is still at a nascent or early stage. The ECB is afraid that if it were to raise rates, it would choke off the recovery and have a negative impact on it generally. It is also probably cognisant that if it does anything on policy rates, there is a danger that it could have a knock-on effect on the rates that the sovereigns face when it comes to borrowing.

Obviously, a lot of sovereigns and individual countries have been increasing their borrowing quite significantly over the past year. We do not want any tremors as far as sovereign rates are concerned because that could have quite an adverse impact on sentiment and the perceived sustainability of the increase in borrowing that many countries have engaged in. I do not think the ECB is going to engage in any policy increases or make changes to its policy rates over the next six to nine months. Of course, there is the issue of the other policy which it has at present, namely, the asset-purchasing schemes. There may be some pressure brought to bear on the ECB to taper or start to reduce those asset purchases. However, I do not envisage any immediate effect on policy rates until the summer of next year at the very earliest.

I do not see any hands raised among the members on the call so I will finish with a question that the witnesses might possibly hate because it is rather open-ended. What policies do they, as experts in the field, think the Government should consider due to the increased level of inflation we are seeing?

Dr. Kieran McQuinn

The inflationary areas that we talked about include energy, supply chain issues, base effects and housing. On the housing side, there is always pressure in terms of dealing with the issues there. To go back to the point I made in response to an earlier question, the only thing the Government can do that will have a sustainable and long-lasting impact in that area is to try to achieve as great an increase in supply as possible. That is the ultimate solution to the housing difficulties, particularly in the provision of cheaper social and affordable housing. That is the key policy conclusion in that area. Those are the kinds of changes that can help to reduce housing costs in the economy which are long-term costs. A lot of the increasing costs we are talking about at present are relatively short term and are related to the pandemic. The real long-term high costs in the Irish economy when we benchmark ourselves against other countries are in housing. House prices and rents are very high compared to other countries. This has been identified by the National Competitiveness Council and international agencies as something that we really need to tackle.

Dr. Karina Doorley

Budget 2022 was framed around trying to compensate households for expected increases in prices. When it comes to budget 2023, it might be wise to take a retrospective look at how well the changes announced in budget 2022 worked in compensating households for rising prices. Government should keep that in mind when formulating policy for budget 2023 and ask if indexation of the entire system is an appropriate response. The answer may be "Yes" or "No". It should ask whether there are certain groups who need to see increases in their welfare payments or whether there should be increases in the PRSI bands or the USC bands. Government must be conscious of what happens in terms of inflation over the course of 2022 and look ahead to 2023 to make sure that purchasing power is maintained as far as possible while still allowing policy makers scope to target particular groups that they feel need additional policy instruments, for whatever reason.

Dr. Niall Farrell

Just to add to that, in terms of energy, European exposure to fluctuations in gas prices is being discussed at an international level. From an Irish perspective, in terms of shielding ourselves from fluctuations in international gas prices, accelerating decarbonisation is the best long-term solution.

Thank you. I am glad I asked that annoying question now. On behalf of the committee, I thank Dr. Doorley, Dr. Farrell and Dr. McQuinn for their attendance and for their contributions. It was a very interesting session and I thank them for their time today. Next week the committee will hold its third public meeting to discuss inflation and will engage with officials from the Central Bank.

The select committee adjourned at 7.15 p.m. until 5.30 p.m. on Wednesday, 24 November 2021.
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