The Irish economy is at risk of being dragged into a “wage-price spiral” if workers begin demanding higher wages to match the current cost-of-living increases, the Economic and Social Research Institute (ESRI) has warned.
In its spring economic bulletin the think tank also cautioned that more “untargeted” Government measures to combat inflation could add to existing price pressures and compound the problem.
It said the Irish economy is more at risk from a cycle of price and wage increases as it is growing at a stronger rate than most other economies, meaning there is already considerable upward pressure on prices and wages.
Regulators and central banks fear that if companies and workers try to chase the current surge in inflation by raising prices and demanding higher wages this will trigger a wage-price spiral.
In its report the ESRI said it expected inflation to increase to 8.5 per cent in the coming months as the Ukraine crisis adds to existing energy price pressures.
While wage growth in Ireland has outpaced that of the euro zone in recent years it is has remained in line with historical trends, the ESRI said. Wages grew by an average of 4 per cent last year.
However, “if inflation expectations begin to be bid into wages demands”, and with the current tightness of the labour market, this could lead to a wage-price spiral, it said.
The ESRI also warned that Government measures aimed at combatting inflation could ironically exacerbate the problem.
As part of a cost-of-living package announced earlier this month the Government introduced a €200 energy credit, a reduction in excise duty on fuel and an increase in the regular fuel allowance.
As part of its report the ESRI modelled the impact of these measures finding they resulted in nominal income gains of 0.5 per cent for Irish households, with larger effects for households in low-income deciles.
“We’re in a situation right now that anything the Government does that increases income levels in the economy is by definition inflationary at a time when there are already significant inflationary pressures...so it’s a difficult balance to strike,” the ESRI’s Kieran McQuinn said.
“Certainly going forward the emphasis will have to be on more targeted measures to ensure the inflationary pressures aren’t compounded by Government measures.”
Tax cuts
Mr McQuinn also cautioned that it would unwise to cut taxes at the current juncture as it could add to existing inflationary pressures. The Government has earmarked €500 million for tax cuts in the upcoming budget.
In its report the ESRI forecast that improvements in the labour market would see unemployment falling to 5 per cent by the end of 2022, while on the housing front it forecast that new home completions would rise to 26,000 this year and 30,000 next year.
However, it cautioned that the current economic and geopolitical fallout from the Ukraine crisis could present considerable downside risks to the realisation of these forecasts.
“If the current commodity price inflation continues and feeds through into direct building materials or labour costs, this is likely to dampen supply,” it said.
Annual housing demand in the Irish market is estimated at 35,000 units. On prices and rents, it said the adverse impact of the pandemic-related health measures on the supply side means that housing costs – both in terms of prices and rents – are set to continue to increase for the rest of 2022 and into 2023.
