I thank the Chair for the invitation to the ESRI to appear before the committee. I am joined by my colleague, Dr. Conor O’Toole. We are grateful for the opportunity to appear before the committee to provide our views on the present economic and fiscal situation and to discuss some key issues and risks that the medium-term fiscal strategy should consider. Obviously, events are changing day by day as far as economic issues are concerned in regard to the awful circumstances in the Ukraine, so some of our forecasts have not yet incorporated the exact implications of that. We will address that in our next quarterly economic commentary, which is out at the end of the month. We will endeavour to discuss some of the issues today in terms of how we see them impacting the medium-term outlook.
The economy has emerged from the pandemic in a robust manner. Work conducted in the ESRI suggests that the economy grew by approximately 4.5% to 5% per annum between 2013 and 2019. This meant that the economy went into the pandemic in a strong position, which provided economic space to deal with the economic shock and emerge in a resilient fashion. However, a number of challenges are set to confront the domestic economy and these have been exacerbated by the fallout from the recent invasion of Ukraine by the Russian Federation. We will discuss the potential fallout from the invasion in the risks section later.
I will turn to the fiscal and economic outlook. The improved situation with regards to the Covid-19 pandemic enabled the Government to lift almost all of the public health restrictions as of 28 February 2022. This has allowed for a re-normalisation of economic activity similar to that which operated before the onset of the global pandemic. The unwinding of public health restrictions through 2021 did result in strong recoveries in both consumption and underlying investment, while the export sector of the economy performed robustly throughout the pandemic. In 2021, we estimate that GDP grew by 13.6%, with modified domestic demand, MDD, increasing by 6.2%. For the present year, this trend is set to continue with MDD expected to grow by 7.1%. It will continue to grow strongly. This reflects strong contributions from both domestic and external sources of growth.
The labour market experienced a sustained improvement throughout 2021. Unemployment, which peaked in February 2021 at 27%, fell to 7% most recently in February of this year. This strong recovery is set to continue and by the end of the current year, we expect the unemployment rate to fall to 5%. The rapid decline in the unemployment rate, coupled with the strong domestic economic rebound, gives rise to the possibility of labour supply bottlenecks and associated risks for overheating in the economy. The strength of the economic performance is reflected in the improvement in the public finances. This year, 2022, is likely to see the first positive general government balance, GGB, since 2019; this reflects both increased Exchequer receipts and lower expenditure given the fall-off in unemployment during the pandemic.
With regard to the public finances, 2021 witnessed significant growth under almost all tax headings, with particularly large takings of income tax, VAT, and corporation tax. These three tax headings saw annual growth of 17.4%, 24.3% and 10.3%, respectively. The overall tax intake was €68.4 billion in 2021. Expenditure for the year was 2.6% higher in 2021 compared to 2020, however, it was €1.4 billion, or 1.5%, lower than had been allocated for 2021. The lower-than-allocated spending as well as the substantial tax intake produced a general government deficit of -3.1% of GNI*, or -€7.3billion, for 2021. This is significantly smaller than was expected at the onset of the year. Debt levels have increased substantially over the past two years due to the large State intervention in response to the pandemic. However, the strong performance of the economy has resulted in Ireland's debt-to-GDP and debt-to-GNI* ratios being somewhat lower in 2022 than they were in 2019, just before the pandemic. It should be noted that the suspension of the Stability and Growth Pact has also contributed to the ability of governments to intervene during the public health crisis. At the moment, reforms of the European Union fiscal rules are being debated, with some proposals suggesting that expenditure on climate-related matters should be excluded from the new rules that are proposed. The return of the public finances to a sustainable path so soon after the significant costs of the pandemic gives rise to important policy questions concerning fiscal policy going forward. Given the Government's stated plans for expenditure levels over the coming years, improvements in the public finances are likely to see a persistent fall in the debt-to-output ratio, whether output is classified as GDP or GNI*. Indeed, if the current trajectory of the public finances were to continue, the debt-to-GDP ratio could, quite soon, fall to rates not seen since the mid-2000s. However, should Government policy be aimed at achieving as low a debt-to-output ratio as possible or should a certain target be set, as suggested in a well-known contribution by economists, Jason Furman and Larry Summers in 2020?
I will now turn to risks in the medium term. Despite the significant upturn, a number of factors pose challenges to the economy and living standards in the near future. In the short-term, rising inflation and the cost of living are particularly pressing. The most recent data indicates that the annual inflation rate was 5% for both the CPI and the HICP in January 2022. This inflation is largely a result of international factors, with energy and transport costs being the main driver of the rising cost of living. This is due to supply chain disruptions during the pandemic and a faster-than-expected economic revival globally. The rising energy costs are putting pressure on households and on lower-income households in particular. It is believed, however, that these inflationary effects are temporary, with many expecting the supply chain issues and other pressures to ease through 2022. We have forecast an average inflation rate of 4% in 2022, with a peak in spring followed by decreases as base effects subside and supply chain issues are resolved. However, we will revisit that forecast soon. The forecasts were published before the recent crisis in Ukraine and the price of oil and gas has already risen since the actions taken by the Russian Federation. Sanctions have been placed on the Russian economy and although no sanctions have yet been placed on the energy sector of the country by the European Union, this has been discussed as a possibility. It seems likely that energy prices are set to increase further. Indeed, recent research by the National Institute of Economic and Social Research, NIESR, in the UK suggests the global inflation rate could rise by 3% this year alone. This could have significant implications for the recalibration of monetary policy by the European Central Bank, ECB. To date, the general assumption has been that the recent increase in inflation was temporary and, hence, policy rates have been left unchanged in the short term. This policy may change if higher inflation rates are expected to persist, although the ECB will also factor in the impact of the crisis on the growth performance of the euro area. Over the medium term, western authorities may decide to reduce European consumption of Russian gas and oil. This would almost inevitably lead to higher energy bills over the short to medium future. There has been significant research, even in recent days, on this matter. More generally, the radical shift in the geopolitical landscape will inevitably result in a sharp rise in international business uncertainty. This uncertainty is likely to drive growth lower in the general precautionary savings channels. The Irish economy, owing to its small and open nature, is particularly sensitive to significant changes in global economic activity. Preliminary estimates from the ECB indicate that the conflict could reduce economic output in the euro area by up to 0.4% this year. Previous modelling work done using the COre Structural MOdel, COSMO, the large-scale macro-econometric model of the economy, indicates a 1:1 relationship between global and domestic economic activity. The aforementioned study by NIESR in the UK indicates that the potential impact on global growth of the Russian invasion could be in the region of 1%. Most of the key drivers of the recent surge in inflation, such as the increase in energy costs, have been external to the domestic economy. However, one key element of recent increases in the cost of living, which reflects domestic challenges, is the cost of housing. Recent estimates from the Central Statistics Office, CSO, indicate that house prices are now growing by 14% per annum, while rents are growing by 8%, according to indicators from the ESRI and the Residential Tenancies Board, RTB. These increases are on top of sustained increases in both categories over the past six to seven years. The pandemic, which had a negative impact on the supply side of the housing market, has exacerbated the pre-existing imbalance between supply and demand in the economy. While a number of affordability-related issues are associated with these increases, one area where it may have a direct impact on domestic economic performance is through a loss of competitiveness. The lack of adequate housing supply has been identified by a number of domestic and external agencies as being one of the biggest challenges to our competitiveness as an economy. The recent Housing for All initiative by the Government is welcome in terms of its multi-annual targets and expenditure commitments, and the State must continue to focus on the delivery of social and affordable housing to tackle this issue.
Another significant challenge facing the economy over the medium term is that of climate change and the green transition. Through the recent Climate Action and Low Carbon Development (Amendment) Act 2021, the State has committed to an emissions reduction path of 51% by 2030 and net-zero emissions by 2050. The importance of such a commitment is widely recognised, but it is also acknowledged that meeting such targets, along with tackling the housing issue, will require significant investment by the State going forward.
The economy has recovered strongly from the pandemic and both it and the public finances are on a firm footing at present but international factors could have a large effect on the domestic economy. Inflation has prompted a policy response from the Government in the form of energy credit payments and it is not inconceivable that other policy responses will be required if these international circumstances worsen further, with particular attention being paid to the conflict ensuing in Ukraine.
