Inflation is climate change for politics. It leaves nothing untouched. Current rates at more than 8 per cent are startling. More sobering is a prospect, all going well, of lower rates of 4-6 per cent for the foreseeable future. The good news, if it arrives, is that when energy prices spike and then fall, so will inflation. But there will be no return to the low interest rates and low inflation of the recent past. Those good old days are over and not all of them were halcyon. Irish inflation since 1960 averaged 5.3 per cent per year.
Politically, this changes everything. The Government faces the challenge of muddling through in circumstances it had not anticipated and for which it did not prepare. A recurring motif of Irish official thinking is that in every crisis it remained in antiquated and overly optimistic orthodoxy long after the world had moved on. It may be desirable to regain inflation levels of about 2 per cent. That is certainly what the European Central Bank and central banks generally are aiming at. Opposed to this monetary policy is a fiscal policy of unfettered spending. It has never been known for any economy to spend its way out of inflation. The same people manning the fire engine are pouring petrol on the flames.
The jamboree of finance ministers at the International Monetary Fund meeting in Washington, DC, last week was uninspiring. The United States epitomises the dilemma. At 8.2 per cent in September and slightly down from 8.3 per cent in August the US rate of inflation remains stubbornly higher than forecast. Predictions are that the US Federal Reserve will further increase rates. That’s the fire brigade.
The petrol is the $1.9 trillion economic rescue package, culminating in the Inflation Reduction Act, which last year became the centrepiece of Joe Biden’s presidency. Curiously it is being abandoned as a talking point by endangered Democrats in tight midterm election races. Seemingly political nectar at the time, now it is studiously avoided by Democrats running from accusations that profligate spending has fuelled inflation. Republicans are spending heavily on inflation-themed television ads.
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[ City councils to warn of housing delivery challenges posed by inflationOpens in new window ]
The toxicity of inflation has been highlighted by the fact that the real cost of rent is being eroded by high inflation. It is true that rent increases are not keeping pace with inflation. But the person who is getting some slack on the real cost of their rent is doing so off a very high base. Out of the same modest budget to house, feed and heat themselves and maybe have a life, they are paying more across the board. When the big picture is bad, picking out the positive pixels is a mugs’ game politically.
The Biden administration, like our Government, sought to break the negative cycle of delivering tax cuts and spending increases but getting no political gain. Their strategy was to deliver cheques directly to voters. Payments of up to $1,400 for the less wealthy and an increased child tax credit, worth up to $300 per child per month, were delivered. The stimulus plan was cheered at the time but the relentless march of inflation has meant it is not just eaten bread, it is almost forgotten. And whatever its potency proves to be on election day, in three weeks’ time, it has handed Republicans an economic stick with which to beat the administration.
Higher interest rates are both a symptom of and a partial remedy for inflation. An immediate effect is felt by everyone applying for a mortgage. You are stress tested by lenders at about 2 per cent above the interest you will be initially charged. The cycle of interest rate increases is set to continue upwards. In a functioning housing market, that would choke off demand. But not here. Pent-up demand after a decade of inactivity and rents that match or outstrip mortgages mean demand is insatiable. Affordability, however, is being further eroded by inflation, and so is supply.
Housing is the imperative Irish political issue. Remarkably, the Government is now set to step into the build-to-rent sector, which is cooling rapidly. The higher interest rates fuelled by inflation mean yields in the Irish market are declining. The cost of building is increasing and there are better returns to be had elsewhere for mobile international money. The blindingly obvious criticism is why should the Government prop up projects that in some instances are built to lower specifications brought in as part of a sweetheart deal for mobile international sector in the first place? Well, the unprepossessing truth is that such is the lack of finance in the Irish market, if the Government doesn’t step in to bring these planning permissions over the line, nobody will. It’s the Hobson’s choice left over after bad policy.
[ Irish inflation moderates to 8.2%, marking second consecutive monthly declineOpens in new window ]
Inflation has eroded the value of public investment in social and cost-rental housing schemes. As money from the Housing Finance Agency becomes more expensive because of higher interest rates, driven by inflation, the scale of direct State investment has had to be increased to support existing schemes, including to approved housing bodies. From the start the help-to-buy scheme, which provides up to €30,000 to first-time buyers, was arguably inflationary anyway in a market where supply was already too tight. You can’t choke and feed inflation simultaneously.
Governments are not prepared to carry the political cost of seriously tackling inflation. It would be unbearable for many governments including our own. Instead a see-saw of contradictory policies is set to prolong and exaggerate the consequences.