Central Bank sounds warning around government spending ahead of Budget

A Central Bank official has issued warnings around government spending in the upcoming Irish budget.

Robert Kelly, director of economics and statistics, described public finances as being “broadly in a healthy position”.

But he warned that increased spending risks creating inflationary pressures, and feeding overheating risks, describing Ireland’s export- oriented economy as sensitive to external factors.

Mr Kelly was speaking as he appeared alongside colleagues before the Oireachtas Committee for Budgetary Oversight on Tuesday ahead of the Budget.

He opened by referring to the Central Bank’s quarterly bulletin, published earlier on Tuesday, that forecasts inflation will average at 5.4% this year, but will decline to 3.2% and 2.3% in 2025.

However, core inflation – which excludes energy and food, is expected to remain at 2.7% in 2025.

Mr Kelly said the economy demonstrated “remarkable resilience to the overlapping shocks of the pandemic and Russia’s invasion of Ukraine”.

He described the demand for labour having surged with the reopening of society following coronavirus lockdown, and the number of workers reaching historical highs with employment falling to 20-year low, indicating an economy operating at full capacity.

But he said higher energy costs continue to have an impact, and “will largely determine the persistence of inflation”.

Mr Kelly told the committee that fiscal policy has underpinned the economic resilience since 2020, with “agile employment supports” protecting the labour market being damaged by pandemic restrictions, while temporary supports protected the most vulnerable from energy prices.

He warned: “Given the scale of these shocks, permanently offsetting the real income falls and maintaining current and capital spending in real terms, especially in light of growing demands from evolving demographics, requires significant spending increases.

“Increasing current spending in this nature, in the absence of offsetting revenue raising measures risks creating inflationary pressures and feeding overheating risks.

“This would ultimately reducing the real value of public, in particular capital, spending.

“The core consideration is not whether ‘catch-up’ is achieved – it will be – but the calibration of the appropriate pace.”

Later the committee heard from officials from the Economic and Social Research Institute (ESRI).

Research Professor Kieran McQuinn told the committee that the Irish labour market is experiencing a “degree of buoyancy unseen since the days of the Celtic tiger”.

However, he said he expects more moderate rates of growth going forward, saying the exceptional performance of the ICT and pharmaceutical sectors following the pandemic, are unlikely to be sustainable.

Mr McQuinn described inflation as “still exerting a negative impact on the Irish outlook”.

“While the pace of price increases, which had peaked at over 9% in May 2022, has been declining on a persistent basis to its present rate of 6.3%, the decline has been somewhat more gradual than what many had originally envisaged,” he told the committee.

“Energy prices are coming down, however, inflation is now being driven by other factors like food and housing costs. Higher rates of inflation act as a drag on domestic consumption levels, in particular, as real household income levels are struggling to register positive growth.”

He said the substantial improvement in the public finances in recent years gives government the opportunity to address infrastructural deficits, particularly in housing, healthcare and climate change.

“At the present time policymakers must be aware of stimulating the economy at a time of record low unemployment, therefore, restraint is needed in other areas of fiscal policy in order to create the space for the investment that is necessary,” he said.

“In particular, taxation policy must be particularly prudent if this risk is to be avoided.

“While our experience with managing and delivering large-scale investment projects has been problematic in the past, the present budgetary position is relatively unique in terms of the opportunities it presents.

“It will take a considerable degree of judgment and discipline in realising this opportunity while maintaining stable and persistent growth in the overall economy.”