The signs of summer drawing to an end are all around us. Children are preparing to go back to school. The evenings are drawing in. Football is on the telly. And central bankers, refreshed from their traditional August break, are starting to lecture us again.
Ireland will be a prime target of central bank advice this autumn, but even those giving the advice will surely realise that they are merely going through the motions. Ireland is set to be the euro zone's first test case of an economy way out of kilter with all the rest, with little policy-makers can now do about it.
Earlier this week the new president of the European central bank, Mr Wim Duisenberg, had his first outing of the new season. It was just the kind of stuff that central bankers love, a little oration on the benefits of price stability, followed up by a dig at EU governments that they needed to tighten their budgetary policies. Be in no doubt that we will hear a lot more of this in the weeks ahead from Mr Duisenberg, from Bundesbank president Mr Hans Tietmeyer and, no doubt, from our own Central Bank. They will not be slow to advise the Government here to plan a tight Budget to keep inflation in check.
The thesis they will put forward goes along the following lines. Irish policy-makers are no longer able to raise interest rates as a weapon to control inflation, while the level of our exchange rate is going to be fixed against our euro partners. Hence, we will no longer be able to pull the levers of what economists call monetary policy. This means that the only tool at the disposal of the Government to influence the overall level of economic activity will be fiscal or budgetary policy. So with the economy racing ahead, Europe's central bankers want us to introduce a tight Budget which keeps a lid on Government spending and refrains from cutting taxes. This, they will argue, is the only way that the Government here can act to put a brake on inflation.
QED? Absolutely not. Even those who will peddle this line in the months ahead will realise that, in fact, there is little that Irish policy-makers can now do to manage the economy's overall performance. In a small open economy like ours, the impact of budgetary policy on the overall level of economic activity is limited. True, Charlie McCreevy would be unwise to add fuel to the economy's fire by dishing out tax cuts right, left and centre. But to suggest that a tight Budget can somehow slow the economy's gallop is nonsense. Only savage cuts in spending and big tax increases could begin to achieve this and such a strategy would be economically foolhardy, not to mention politically impossible.
But this will not stop our euro partners telling us that we must pursue a "tight" Budget policy. Charitably, we might think that they haven't really studied the Irish situation and are merely applying a textbook remedy. Or perhaps they are merely trying to underline to the Government here that, given the strength of our economic performance, an overly generous Budget would not be wise.
But in most cases they are probably preaching fiscal rectitude to Ireland because they haven't a clue what else to do. Clearly an economy growing at an annual rate of 8 per cent plus and where the price of assets such as houses has shot up sharply is well out of step with most of the rest of the euro zone. The Danes, after all, introduced a tight Budget for 1999 this week as they feared their economy was overheating at the heady growth rate of 2.5 per cent. In the pre-EMU days our euro partners would have expected us to slow our economy through a sharp increase in our interest rates. Higher interest rates could certainly have taken the heat out of the housing market and would have acted to at least moderate the rate of economic growth. However, budgetary policy is a much less efficient tool in controlling the economy's rate of expansion. It would take a sharp hike in taxes to slow consumer spending and even then much of the impact would be felt through lower imports while sizeable cuts in Government spending would be a very blunt and inefficient instrument to slow economic growth. In any case, there is a strong argument for targeted tax reductions to lower the burden on work and maintain pay moderation and for improving the level of Government services in areas such as health and welfare. Meanwhile few would argue that Government investment spending needs to remain high to build the infrastructure needed to support economic growth.
Europe's central bankers, of course, realise all this. In the months ahead our euro partners will be looking on as the Central Bank here is forced to reduce interest rates sharply. Due to the Asian crisis and low inflation in Germany, it now appears that German interest rates will not increase much from current levels, meaning that Irish wholesale market rates will have to fall by more than 2.5 percentage points before the end of the year. In turn, retail interest rates charged to borrowers will fall by up to 1.5 points. Irish Permanent chief executive Roy Douglas said this week that the cost of an average variable rate mortgage could fall below 6 per cent. This interest rate fall will give another powerful boost to the economy.
Ireland, representing not much more than 1 per cent of Europe's GDP, will be an interesting test case of a euro-zone economy where a touch on the brakes is clearly needed, but cannot be applied. From the point of view of the European central bank, it is our problem and, as they must set interest rates with the needs of all of Europe in mind, there is nothing they can do about it. Apart, of course, from lecturing us about the need to introduce a tough Budget and watching with interest to see what happens here in the months ahead. After all, it could provide some interesting pointers if some of Europe's bigger economies face a similar situation in the years ahead.
