At the start of the year, most forecasters were expecting 2022 to be a period of economic rebound. With the pandemic waning, businesses reopening and consumers ready to unleash their vast accumulated savings, growth was expected to surge. Some thought we might have a repeat of the “roaring twenties”, a reference to the decade of consumerism that followed the 1918-21 influenza pandemic.
Now the comparator decade is the 1970s, a period characterised by high inflation, low growth and record-high interest rates.
Russia’s invasion of Ukraine, and the ensuing energy and food price surge, has changed the direction of travel, turning the optimism of just a few months ago on its head. Developing countries are now facing a large contraction in living standards with consumers squeezed on one side by higher prices and on the other by rising interest rates while developing economies are looking down the barrel of food shortages, a possible breakdown in civil order and even famine.
“The war in Ukraine, lockdowns in China, supply-chain disruptions, and the risk of stagflation are hammering growth. For many countries recession will be hard to avoid,” was how World Bank group president David Malpass put it this week in its latest Global Economic Prospects report. It said war in Ukraine had compounded the damage from the pandemic and “magnified” a global slowdown while warning that the global economy could be entering “a protracted period of feeble growth and elevated inflation”. In other words, stagflation.
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The good news is that Ireland — technically speaking — can’t or at least is unlikely to fall into recession
The Washington DC-based institution said the current juncture resembles the 1970s in three key aspects: “persistent supply-side disturbances fuelling inflation, preceded by a protracted period of highly accommodative monetary policy in large advanced economies, prospects for weakening growth, and vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.”
A key takeaway was that many countries will fall into recession in the coming months.
The World Bank’s assessment was followed up by an even bleaker one from the Organisation for Economic Co-operation and Development (OECD), that warned the economic fallout from Russia’s invasion could be more damaging than initially thought and harder to set right through fiscal and monetary policies.
In its latest outlook report, it detailed a long list of risks ranging from an abrupt Europe-wide energy interruption if Russia cuts gas flows in response to sanctions to further increases in commodity prices and stronger disruptions to global supply chains.
The good news is that Ireland — technically speaking — can’t or at least is unlikely to fall into recession. By definition, a recession requires back to back quarters of negative GDP growth and GDP, in the Irish context, is supercharged by the activity of multinationals.
The bad news is that GDP is increasingly removed from the real feel of the Irish economy and the upcoming period will probably see household budgets fray even if the headline indicators stay positive. Consumer prices soared by 7.8 per cent in the year to May 2022, the largest increase in almost 38 years, the Central Statistics Office said on Thursday.
[ Europe at risk of winter energy rationing, global watchdog warnsOpens in new window ]
“I don’t think we will experience a recession this year, however the growth rate of the economy is will probably see to be more subdued than last year,” Kieran McQuinn of the Economic and Social Research Institute (ESRI) says. “That, in some way, is to be expected as last year saw a swift bounce back from the health restrictions in 2020 that had particularly affected the domestic economy,” he says.
“However, there are significant downside risks facing the domestic and global economy in the present year with more persistent inflation and greater levels of uncertainty due to the war in Ukraine being the most significant challenges,” he says. “This is will probably see to impact significant channels of growth including consumption, investment and the external demand for Irish goods and services,” McQuinn says.
In its report, the OECD said Ireland would grow in GDP terms by 4.8 per cent this year and by 2.7 per cent next year. While positive it is a fraction of the 13.5 per cent growth seen last year. The projections tally with McQuinn’s notion of a more subdued economy.
“Surging inflationary pressures, caused by disruptions in global supply chains and geopolitical concerns, will cut households’ real income and dampen consumption growth,” the OECD said of Ireland. It also warned the Government needed to be more targeted in its approach to financial supports, in other words targeting solely low-income households.
The Republic’s unemployment rate fell to 4.7 per cent in May, a level not seen since before the pandemic, as the labour market continues to tighten. Despite the hike in living and business costs, staff wanted signs are a ubiquitous feature of the post-pandemic economy.
One of the more unexpected trends to emerge during the Covid era has been the increased incidence of woman participation in the Irish labour force — the participation rate for women is now close to 60 per cent, higher than at any other time — but it hasn’t deflected the staff shortages narrative.
Job postings on recruitment website Indeed are 50 per cent above pre-pandemic levels. “Candidate supply” has not kept pace with the rapid increase in demand for workers, Indeed’s chief economist Jack Kennedy says. Many people have not returned to the workplace in the wake of Covid and “are continuing to sit on the sidelines of the labour force,” he adds.
A central problem for policymakers — if we enter a concentrated period of stagflation — is how to combat it.
“Any softening of demand for staff amid an economic slowdown should help rebalance the labour market, easing hiring challenges for employers across a range of sectors. Moreover, intensifying cost of living pressures may be a pull factor for some of those opting not to join the labour force,” Kennedy says.
“The hope for policymakers would be a soft landing scenario whereby that adjustment occurs primarily through a slowdown in hiring of new staff, with vacancies gradually declining from current elevated levels, rather than an alternative scenario of widespread cuts to firms’ existing workforces.”
A central problem for policymakers — if we enter a concentrated period of stagflation — is how to combat it. There’s no agreed antidote. Raising interest rates will in theory limit price growth but increased borrowing costs will hinder growth. Equally, keeping monetary policy loose comes with a risk of higher inflation.
Because the euro area is a net importer of energy, the current surge in inflation is effectively imported inflation — in other words, inflation over which monetary policy has little control.
[ War in Ukraine exacerbates Irish economic problems lurking in the backgroundOpens in new window ]
While comparisons with the 1970s now abound, most economists don’t believe it will turn out as bad, primarily because inflation won’t climb as high, central banks have more firepower this time around; and governments can shield poorer households better.
“Real incomes are already falling at their fastest pace since Ireland’s banking and sovereign crisis over a decade ago and this has further to play out over the coming quarters,” Goodbody’s chief economist Dermot O’Leary says. “However, this comes at a time when Irish household balance sheets are in their best shape ever, with record-high wealth levels and debt at an all-time low.”
“The build-up of savings will also help the cushion the blow and the labour market remains very strong. There are some more tests to come over the winter period given the ongoing rise in the price of fuel and also looking into 2023 given the threat of a combined US and UK recession and the knock-on impact on the Irish economy,” he says.
The decline in real income will soon interface with higher interest rates, placing an additional burden on indebted households. The European Central Bank has ended more than a decade of accommodative monetary policy and is set to begin a sequence of interest rate rises this year.
While most regulators are predicting the inflationary shock will ease over the next 12 months and there is — as yet — little sign of the dreaded wage-price spiral
“Interest rate rises are a new phenomenon for almost a generation of the Irish population, but this generation, in general has low debt levels amid low owner-occupancy,” O’Leary says. “The end of the era of zero interest rates will have important implications for asset prices generally, but we believe that the housing market is well insulated due to the macroprudential rules in place since 2015.”
Exports have continued to drive the Irish economy. They lifted the country out of recession in the aftermath of the 2008 crisis, withstood Brexit, and proved practically immune to the pandemic. How they will fare in a normal downturn remains to be seen.
“Fortunately, Ireland has been able to position itself in industries that are in structural growth, but the heady growth of the ICT sector is unlikely to be repeated in the coming years. Indeed, the fall in the stock market valuations of many ICT companies may halt some of their growth ambitions and force some retrenchment,” O’Leary says.
While most regulators are predicting the inflationary shock will ease over the next 12 months and there is — as yet — little sign of the dreaded wage-price spiral that can be triggered by excessive price growth, these predictions contain huge downside risks because of Russia’s war in Ukraine. It’s not obvious that way this is going and therefore the economic fallout can’t be forecast with any degree of accuracy.
