Dr. Tom McDonnell:

Let me start by thanking the Chair and the members and staff of the committee for the invitation to appear before the committee today. I am accompanied by my NERI colleague and economist, Mr. Paul Goldrick-Kelly.

NERI is very grateful for this opportunity to present our views on the economic and fiscal position. I will begin by discussing the economic context and labour market developments before discussing the appropriate role of fiscal policy and various options.

Western economies generally recovered quickly from the pandemic. However, the bounce back in demand came up against significant supply constraints and disruptions arising from the lockdowns. The resultant inflationary pressures were then exacerbated by the war in Ukraine and the further rise in global commodity prices. Rising prices have prompted central banks to raise interest rates and otherwise tighten policy. Rising prices have also precipitated a decline in real incomes and a worsening cost of living crisis in many countries.

Global growth is now weakening. The UK economy is projected to be in recession by the end of this year, with price inflation continuing to eat into real incomes and the volume of demand. Similarly, the emerging combination of tightening monetary policy, declining real incomes and weakening consumer confidence means that there is now a meaningful risk of the United States, and especially the euro area, falling into recession.

Ireland’s own recovery held up well in the second quarter with strong growth in investment in machinery and equipment, new dwelling construction and service consumption, although retail sales have softened in recent months. We do not project a technical recession in the short term but we anticipate a weakening of growth in demand.

The labour market is now close to full employment and hours worked in the economy is at a record level. The unemployment rate was 4.3% in August with the job vacancy rate elevated over pre-pandemic levels. The composition of employment has generally shifted towards more high value sectors – a very positive development. However, the Central Statistics Office, CSO, employee index suggests that net employment has stalled in recent months.

Real incomes and living standards will actually fall for most households this year, notwithstanding the tight labour market. Inflation projections are especially tentative at the moment, but our baseline view is that economy-wide price inflation is likely to average over 8% this year, but reach 10% for lower income households. This is because such households generally spend a higher portion of their incomes on the type of necessities such as energy, food and rent that are experiencing the sharpest price increases.

We will see a significant rise in deprivation rates for those on fixed incomes in the absence of meaningful fiscal or regulatory interventions from government. NERI's view is that all social assistance increases in budget 2023 should at least match inflation in order to protect real incomes and to ensure that no one is left behind by the cost of living crisis.

Budget 2023 can help dampen inflationary pressures by focusing on targeted measures to reduce the cost of using public services such as education, public transport and healthcare.

Once-off measures related to current spending generally make poor policy, particularly given that prices are unlikely to fall in the short to medium term. However, the ongoing energy crisis is placing considerable pressure on household budgets. The Government’s response must support households in need, while remaining consistent with longer term objectives of reduced energy use and decarbonisation of supply. The Government could explore direct payments and-or adjusted energy rates to soften the impact of these price shocks. We are happy to discuss this further during the questions and answers.

Fortunately, the public finances are in a reasonably strong position. Tax receipts have been buoyant this year, with a modest projected surplus in 2022 and 2023, although the position is flattered by the surge in corporation tax receipts. Most of our debt is fixed at low interest rates. Our view is that the expected €6.7 billion budgetary package for non-once-off measures is broadly appropriate in terms of the fiscal stance and strikes a good balance in supporting the economy while not being overly inflationary.

Budgetary supports should be targeted at those households likely to experience distress and the Government should not attempt to chase inflation for all households. Higher income households have generally built up significant savings during the pandemic with aggregate household deposits rising sharply. Many of these households can absorb the hit to their real incomes by reducing their rate of savings. Such households do not need fiscal support from the Government to manage the cost-of-living crisis and are unlikely to experience any qualitative decline in their living standards. In particular, the stated plan to cut taxes for higher earners seems unwise to us. Income tax cuts are very badly targeted in respect of helping households experiencing income adequacy issues, and such cuts would push against the need to temper inflation.

The Government should also remain conscious of the very significant medium- to long-run fiscal pressures from age-related demographic change, pressures from the investment and other costs of climate transition, and pressures from the gradual loss of receipts from fuel excises as Ireland, it is to be hoped, achieves its climate targets. This is before we even consider the existing spending deficits in areas like childcare, education, research and development, and public housing. The reliance on corporation tax receipts is a further concern as it means the health of the public finances depends on the performance of a small subset of firms. Our view, therefore, is that any tax cuts should be fully offset by tax increases in other areas, for example, by eliminating certain tax breaks and increasing taxes on capital.

The fundamental position remains relatively strong but falling incomes presage weaker demand, while high inflation is causing income adequacy issues for some households. We have the fiscal resources to fully protect vulnerable households provided the Government takes a targeted approach in the budget. Mr. Goldrick-Kelly and I are happy to take any questions or elaborate upon any of our points.