Economy is in danger of overheating next year, admits Donohoe

The economy is in danger of overheating as early as 2019 and “will reach and exceed its sustainable level” in the coming years, according to research prepared for the Department of Finance.

The findings bear out warnings this month from expert bodies including the Irish Fiscal Advisory Council (IFAC) and the Economic and Social Research Institute (ESRI).

IFAC’s chairman Seamus Coffey told the Oireachtas Budget Oversight Committee that the economy was close to its peak and facing a number of risks that could cause it to crash.

Overheating happens when the so-called output gap turns positive.

In simple terms, it means the total of what the economy is producing exceeds what the economy can produce sustainably.

Typically the immediate result is to force wages and other costs – such as accommodation – to climb to uncompetitive levels, which can trigger a downturn.

Finance Minister Paschal Donohoe said he was aware of the danger.

“The estimated output gap is forecast to turn slightly positive in 2019 and increases thereafter, pointing to signs of overheating over the medium term, which is something the Government is acutely aware of and remains cognisant of at all times,” he said.

Ireland is expected to have full employment in 2019, but there’s a lot of debate about what that means when employers can draw on workers from elsewhere in the European Union and returning immigrants.

IFAC heavily criticised Mr Donohoe for failing to use the Budget to shore up the public finances, describing spending plans as having a “lack of credibility”.

Research this month from ESRI also found the Budget had increased the risk of the economy overheating.

Two technical research papers published by the department yesterday attempt to find the best way to measure the “output gap” as a guide for policy makers.

The Irish economy is notoriously one of the most volatile in Europe and also one of the least predictable.

Up to now, forecasts by the Department of Finance have used the EU’s harmonised methodology for estimating output growth, a one-size-fits-all approach that is ill-suited to Ireland’s unusually open economy.

The department said its new methodologies, announced in Budget 2019, provide a more plausible estimate of the economy’s position in the economic cycle.

Using them, researchers found the economy appears to be operating marginally below its potential in 2018; but is likely to reach and exceed a sustainable level of production in the coming years.

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