Vol. 486 No. 1
52 Mr. McDowell asked the Minister for Finance the Government's estimate of the projected annual rate of inflation for 1999 having regard to the fall of the value of the Irish pound vis-à-vis other currencies and in particular that of sterling; and if he will make a statement on the matter. [1949/98]
53 Mr. Noonan asked the Minister for Finance his Department's estimate of annual inflation for 1998; the items in the consumer price index which are expected to increase in price; and if he will make a statement on the matter. [1721/98]
I propose to take Questions Nos. 52 and 53 together.
My budget day forecast for inflation was 2 per cent for l998 and l999. This forecast was based on the standard assumptions of unchanged exchange and interest rates. In projecting inflation for l998 and l999, account was taken of macro-economic factors such as current low international inflation and increased competition in the economy. There are no forecasts in respect of individual projects. The next forecast, which will take account of all relevant circumstances, will, as usual, be published by my Department at mid-year in the Economic Review and Outlook publication.
In his Budget Statement the Minister predicted an inflation rate of 2 per cent for each of the next three years. However, he will be aware that independent commentators have predicted much higher rates of up to 4.5 or 5 per cent for l998 and l999. Will he agree there would be a distinct danger to Partnership 2000 if the inflationary predictions on which it was predicated were exceeded?
Partnership 2000 was predicated on an average inflation rate of 2.1 per cent over the period of the agreement. The out-turn for inflation for l997 is 1.5 per cent, the lowest in the European Union. Using the harmonised index, which is known as the HICP and which will be used in the future after we have fully joined EMU, the rate is 1.2 per cent, which again is the lowest in the European Union. The out-turn for l997, the first year of the agreement, is 0.6 per cent, which is lower than the average for the period.
The outlandish predictions by some business people of increases in inflation this year do not accord with the facts. It is obvious that some business people want to use the excuse of volatility in the exchange rate markets to jack up prices. This matter has been elucidated in recent reasoned comment. Many people do not take into account the effect of the problems in Asia on inflation in this part of the world. I see no reason at this stage to change the forecasts for inflation announced in the budget. At that stage the Central Bank estimated that the inflation rate for the year would be 2.25 per cent, while the Economic and Social Research Institute gave an estimate of 2.3 per cent and the European Union gave an estimate for Europe as a whole of 2.2 per cent.
I was interested to hear the Minister's points about the harmonised rate but he knows well that this specifically excludes mortgage repayments and house prices, which are increasing at a rate of approximately 20 per cent. No doubt they will increase further as a result of some of the actions taken by the Minister in the budget, specifically the reduction in the rate of CGT.
Is the Minister saying that, notwithstanding our extraordinary growth rates, the level of consumer spending and emerging labour shortages in some sections of the economy, he does not expect an increase in the inflation rate over and above the 2 per cent predicted in his Budget Statement?
The forecast may have to be revised mid-year but I see no reason at this stage to revise any of the forecasts in my Budget Statement. Some economists think I do not pay much attention to them — and maybe I do not in some of my utterances — but I wish to refer to interesting comments on inflation and the components of the CPI made by Mr. McLoughlin of ABN AMRO which did not receive wide coverage. These comments may be of interest to Members and those who are trying to hype up the level of inflation. In his market document of 16 January he said:
Looking at the inflation side, one point to remember is that over 40 per cent of the consumer price index is composed of items whose price is determined by Irish wages and not the exchange rate. This includes housing, insurance, repairs etc. , services, for example, hairdressing, postage, telephones, transport, shoes and light. Food and drink account for another 35 per cent and well over half of this will be home grown. So the direct component of the consumer price index most exposed to the weak punt-sterling rate is durables, clothing and footwear and other goods with a total weight of 16 per cent.
That is the make up of the consumer price index. While the value of the Irish pound vis-à-vis sterling has a weighting in the composition of the CPI, it is not as great as some commentators might lead us to believe. I have never met Dr. McLoughlin nor has he ever communicated with me. Neither am I given to quoting economists very often; some of them believe I do not listen to them. However, it is important he elaborated on the composition of the CPI. It was of interest to me, but I did not see much coverage of it in the national press at the time.
The Minister should give Dr. McLoughlin a call. He is an interesting fellow with whom to have a chat.
I believe so.
I am grateful for what the Minister said about the consumer price index, but it is still true that exchange rates have a significant impact on inflation. The Minister informed the House that his Department estimated at budget time that the rate of inflation for 1998 would be 2 per cent. When that was compiled, what exchange rate between the Irish pound and sterling was factored in for the second half of the year?
The methodology used by the Department of Finance or other institutions of the State in making economic forecasts is more or less the same. It is based on the exchange rate at the time of compiling the forecast and the best estimate of what it will be for the rest of the year. The methodology used by the Department of Finance would be based on the rate at the time.
I accept what Deputy Noonan said. I am not so naive as to think exchange rates do not have an effect on prices, because they do. However, there are a number of complexities in this argument. For example, although the Irish pound-sterling exchange rate is weaker than previously, 16 per cent of imports come from Asia. Due to the weak Asian currencies, it is certain that the lower price of their imports will have a deflationary effect on prices. A number of balancing factors exist. Some of the comments made a few weeks ago focused totally on the exchange rate between the Irish pound and sterling. It is not correct to do that.
The budget was announced on 3 December 1997. At that time the Irish pound was trading at DM 2.62 to DM 2.63 and 93p to 94p sterling. It is now down to 82.5p sterling.
Today it was trading at 84.5p sterling.
Did the Department of Finance use the exchange rate of 3 December and project it through 1998? If so, the Minister's 2 per cent inflation estimate has no solid basis.
Exactly.
If the Department did not use that rate and decided to use the average for the year in a fluctuating exchange rate market, it must have taken a view when it formed its 2 per cent estimate of what rate the pound would enter EMU in the second weekend in May. The Minister has two choices. He can tell us the Department of Finance officials have an entry rate in their heads of which the Irish public is not being informed or, alternatively, he can tell us the Department's 2 per cent inflation estimate does not have great credibility, because it is based on a currency prediction already wildly out of line with what is happening in the markets.
The Deputy referred to 3 December when the budget was announced and before which the forecast was compiled. On that date, the volatility in exchange rates in the Asian markets was not contemplated by either the Department of Finance or anyone else. Those factors must be taken into account. The methodology used by the Department and other institutions takes into account the exchange rate fluctuations up to the date of the compilation of the forecast and also assumes an exchange rate from that date.
The composition of the consumer price index is more heavily influenced by the trade weighted index, which is a basket of currencies. A study of that over the years will give a better insight into inflation than the exchange rate between the Irish pound and sterling because we also trade with many other countries. However, even the trade weighted index as a measure of what was forecast for Irish inflation in the past four years was incorrect. The index increased one year and fell the next, yet inflation did not follow. The recent performance of the Irish economy with regard to inflation has confounded all analysts outside Government institutions and within the Department of Finance, the ESRI and other bodies. The inflation rates the Central Bank predicted for 1996 and 1997 were way above the mark. We were all wrong. Something has been happening recently in the Irish economy which does not lend itself to the normal historical and traditional analysis which has been applied. I wish to point that out because no one has been able to explain some aspects of the Irish economy in recent years, and inflation is definitely one of them. It has not lent itself to normal analysis. In conclusion, the effective exchange rate is possibly the better way of examining this matter because it takes into account more than just the exchange rate between the Irish pound and sterling.
I recommend the Minister to have a quick read of his speech on the budget in January of last year where he spoke of people hyping up inflation. He made some salient and interesting points in that speech.
I agree with much of what the Minister said. There is no doubt commentators expected inflation to increase earlier than it has. However, none of us believe there is a limitless capacity for growth in the economy, and it certainly does not exist for inflation-free growth. What is the Minister's estimate of the capacity of the economy for growth? This year it is expected to be 7 per cent gross.
The Deputy poses an interesting economic question which could be put another way. Is the Irish economy being utilised to its full capacity? I do not know, because with the growth rates we have experienced over recent years, traditional economic models would say it should have reached full capacity. That has not occurred; the Irish economy has grown at an enormous rate. Using the traditional methodology I was taught when I was at UCD and that Deputy Noonan was also taught at third level, this should have led to some inflation. It has not, but I suggest that is as a result of much spare capacity which was not thought about or predicted at the time. The honest answer to Deputy McDowell's question is that I do not know, because some factors in the Irish economy in recent years have confounded all the experts. The traditional method of measuring the economy was being used. I accept the points he made about my reply as Opposition spokesperson to the budget speech in early 1997 and previous to that as I also would have been using the traditional economic models. The Irish economy has not lent itself to the traditional analysis.
Do we just stoke it up?
No, as I said before the budget of 1997 in trying to dampen down expectations, there is not a limitless capacity to keep stoking up the fire. It is better to be cautious, but other factors must also be taken into account. Much of the success of the Irish economy has been as a result of the trade off between low wage increases and taxation reductions. Those balances must also be taken into account.
I take it from the Minister's reply that things have changed dramatically since budget day and that he will not go to the wall on the 2 per cent prediction issued then because the rate of inflation could be significantly higher due to circumstances having changed dramatically according to him.
Stoking up, as the Minister describes it, has already begun in terms of asset inflation. Has he any figures for asset inflation?
I spoke on this issue as Opposition spokesperson on Finance. The consumer price index does not measure actual inflation. One must wait until higher mortgages feed into the index. The expectation is that falling interest rates will have a downward effect on inflation. One country tried and failed to introduce an index in this regard.
The escalation in house prices has been a worrying feature of recent years. The danger is that people take out large mortgages and any blip in interest rates places them in difficulty. This might feed into wage inflation. Moderate, nominal wage increases have been behind the recent success of the economy. I cannot say how this can be solved overnight. The Minister for the Environment and Local Government has commissioned a study into house prices. If they continue to rise, inevitably they will lead to wage inflation and we will be back on the merry-go-round which we had managed to get off. We are continuing to review the situation.
The time allotted for Priority Questions is concluded. Questions Nos. 54 and 55 may be taken in ordinary time.
