Can an economy growling at almost 7 per cent a year contain inflation at around 2 per cent? Meeting the Maastricht criteria means Ireland must maintain this record and keep inflation no higher than about 2.5 per cent this year and next.
The Central Bank warned last week that inflation could become the hurdle Ireland fails to clear to join monetary union. This may look alarmist and is possibly a ploy to influence any new round of wage negotiations but clearly the Bank is keeping a very close eye on price pressures and will not hesitate to manipulate the exchange rate and even raise interest rates to control any real or imagined inflationary bogeyman.
The co-existence of Ireland's low inflation and high growth can be explained by the strong exchange rate of the pound against sterling and by low international inflation, as well as continuing low wage settlements. High unemployment may also have helped to hold inflation back by ensuring wage growth remains subdued.
The booming multi national sector has had little inflationary impact on the Irish economy because those companies source relatively few supplies here.
The appreciation of the sterling exchange rate is crucial. We import 35 percent of all goods from Britain, so cheaper imports certainly help curb inflation. The flip side of this is that a 5 per cent devaluation against sterling could lead to as much as a half point on inflation enough to put the Maastricht criteria under serious pressure.
The slowdown in growth across most of Europe and the increased competition from low cost producers in the Far East and elsewhere implies there is likely to be little imported inflation from that direction. As two thirds of Irish inflation is imported, this is good news for us.
Money supply growth is the only indicator in Europe of potential problems. In the late 1980s, a massive growth in money supply preceded the surge in inflation. As this wall of credit money slipped into consumers' pockets in the 1980s, it translated almost directly into higher prices as more cash chased consumer durables.
This time around, money supply growth across Europe is being driven mainly by the corporate sector, particularly through borrowing for mergers and acquisitions.
Despite this, there are a few warning signs in the Irish economy. Although unemployment remains high, at around 13 per cent, certain industry sectors are beginning to show signs of skill shortages. In the first nine months of 1995, skilled wages in the construction sector rose by 7.5 per cent on average. If these pay rises were translated across the economy, the lights in the Central Bank would be flashing red.
Capacity utilisation in manufacturing rose to 83.3 per cent in the first quarter of this year, compared with a previous cyclical high of 78.7 per cent and order books are very strong.
House prices are also rising rapidly. In the first nine months of 1995, new house prices in Dublin grew by 6 per cent and by more than 9 per cent outside the capital.
Many householders are borrowing as much as they can afford. This reduces the amount of money they have to spend generally and so higher housing prices do not necessarily feed through to higher prices.
On the plus side, general wage growth is still remarkably subdued. Wages in manufacturing grew by under 3 per cent last year as did earnings in financial services. From 1990 to 1994 earnings in manufacturing moved in a 4 to 6 per cent band. The sudden dip in 1995 is helping to subdue inflation. But there's the rub.
The Programme for Competitiveness and Work expires at the end of the year. The trade unions have already been making noises that the Government has reneged on its side of the bargain to cut tax rates. They want a bigger slice of the cake.
This is what the Central Bank is trying to avoid. If inflation is to be kept under control, it says, the unions must accept the argument that the post EMU world will be more competitive with less job security.
