The Irish Economy - Essay Example

School The Irish Economy Introduction The Republic of Ireland is a located in the north-west of the European continent (Nolan). After suffering from invasions in its early years, the country managed to survive politically and economically. The Irish economy is worthy of a glance, particularly how it managed to achieve the sudden economic growth and more importantly how it continuously survive the threats from recession and economic crisis. In this paper, we will investigate on how successful has the Irish Government and the European Central Bank been in running the Irish economy over the last two years (2008 and 2009) when there was an international financial crisis and the corresponding macro economic policies used by the Irish Government and the European Central. Our paper is divided into five sections. The first one is the discussion of the current economic state of Ireland particularly using the 2008 and 2009 data plus the recent 2010 figures for an update, then we discuss the contributing factors to such a state in the next section. To get into the details, we examine and analyze the fiscal and monetary policies done recently. This will compose of the third and the fourth sections respectively, wherein analyses using economic theories will be in-depth. The last section discusses the question of how successful has the Irish government and the Central Bank been in managing the economy. Here we will be able to directly answer the question. Main Body Where the Irish Economy Stands (2008-2009) Ireland has been a success story, until the recent global economic recession. From an agricultural country at the start of 1900, Ireland experienced an unprecedented economic growth with its GDP doubling in size in a little more than a decade (ESRI). It entered the European Union in 1973, as one of the pioneering countries. Fuelled by its EU membership and several investment promotion policies, the Irish economy became the fastest growing economy among the EU members (iExplore). "In recent decades the Irish economy has been transformed from being agrarian and traditional manufacturing based to one increasingly based on the hi-tech and internationally traded services sectors. In 2007, the services sector accounted for 64 per cent of Irish GDP, while industry accounted for 33 per cent and agriculture just 3 per cent" (ESRI). Ireland's economic transformation was achieved through the promotion of export-led and advanced technology business thorough an open economy. It has attractive packages to investors with its banking and finance growing significantly, together with tourism (iExplore). Mr. John Hurley, Governor of the Central Bank and Financial Services Authority of Ireland noted that the current Irish economy is not comparable to what it has been 20 to 25 years ago, particularly in the area of standard of living, transforming from a relatively low standard of living to one with an average per capital income being above the entire EU Average (Hurley). Over-all, it is the EU membership that can be safely assumed to have brought forth the change in Irish economy, transforming it from a mainly agricultural society into the "modern, technologically advanced Celtic Tiger economy" (European Union). The remarkable economic growth that the country has achieved face an uphill at the start of 2007. "The pace of economic growth decelerated in the second half of 2007, largely due to a contraction in housing construction. In 2008 it is estimated that output fell for the first time since 1983, and the recession deepened in 2009" (ESRI). The graph below shows the GDP growth from 1997 to 2009. After 11 years of positive growth, with the highest posted in 1999 at near 12%, Ireland suffered a recession in 2008 and 2009. It posted a real GDP growth of around -2.5% in 2008 and around -7.1% in 2009. Source: (ESRI) The decline in GDP has been manifested in various economic aspects such as prices, production and employment. Volatile Money Supply: Irish Inflation Inflationary pressures has been one of the dominant result of recession in the last 2 years. "Ireland's competitiveness position has weakened in recent years because wage and broader cost inflation has been higher than (its) main trading partners" which results to weakened competitiveness especially in terms of export (Hurley). The significant inflationary pressures that it faces comes from the "very elevated levels of energy and other commodity prices" (Hurley). Inflation has some social costs, whether expected or unexpected. Some of the social cost of expected inflation are menu cost ( the need to print new menus and catalogs), the shoeleather cost (the need for moer frequent trips to the banks to withdraw smaller amounts of money), and the inflationary tax (Mankiw). On the other hand, unexpected inflation has cost in terms of income redistribution (Mankiw) and makes businesses afraid to venture into investments (Biz/ed / Institute for Fiscal Studies). Accoridng to Hurley, inflation in general "creates uncertainty for savers and investors and undermines confidence in an economy in a way that ultimately damages the welfare of its citizens" (2008). The increased inflation was however short-lived for Ireland as there was a sudden shift to deflation which continued in the following year (Slattery). Oil price was at its peak in July 1008, which sold at $140 per barrel, but it fell substantially after that together with interest rates, with the average inflation posting at 4.1% in 2008 declining further by 4.5% in 2009 (ESRI) Unemployment "The current economic downturn has already manifested itself in the labour market. The number of people on the Live Register increased by 70% in 2008. The average rate of unemployment for 2009 is estimated to have reached almost 12per cent, and is expected to risefurther in 2010" (ESRI). Recession as characterized by slow down in production results to less labor demand. This results to surplus of labor or unemployment. Figure 1 depicts this story. This happens to the labor market during recession. The labor demand shifts to the left resulting to lower quantity of people employed: from Q1 to Q2. Labor market Source: (Campbell R. McConnell) Contributing Factors to the State of the Irish Economy There are various reasons to the advancement of Irish economy. This includes "EU membership and access to the Single Market; Ireland's low corporation tax rate and a large multinational presence; a high proportion of the population of working age; increased participation in the labour market especially by females; a reversal of the trend of emigration toward immigration; sustained investment in education and training; co-ordinated social partnership agreements and a more stable public finance position" (ESRI). From an agriculture dependent country, Ireland has become strong in manufacturing, business, financial services and foreign relations (Hurley). On the other hand, the current Irish recession is brought by different factors. In addition to the inflationary pressure that the country has experienced, there were outside factors that brought the recession. It believed that "the difficulties in the international financial markets that emerged in 2007, and worsened throughout 2008, have compounded Ireland's economic and financial challenges" (ESRI). The Central Bank Governor noted that "there were many downside risks and vulnerabilities that could push growth lower. These risks related to the potential for interaction between global financial market turbulence, rising global energy and food prices and the slowing of activity within the economy, which was already underway" (Hurley). All these downside risks have materialized in the recent years that's why the recession was worse than what the government has expected (Hurley). In Particular, it is the export sector of Ireland that has been badly hurt (ESRI). Irish is particularly linked to the United States with U.S exports to Ireland amounting to $8.65 billion and Ireland's export to U.S amounting to $31.35 billion (U.S Bureau of Public Affairs). ". The range of U.S. exports includes electrical components and equipment, computers and peripherals, drugs and pharmaceuticals, and livestock feed" (U.S Bureau of Public Affairs). With the recession starting from and worst in the United States, Irish export has been badly hurt. Aside from export, one sector that has been badly hurt is the housing investment. Housing investment was forecasted to be reduced by 7.5% in 2008 "which represents a very substantial scaling back of activity" (Hurley). The Fiscal Policies of the Government Fiscal policy basically refers to the way the government adjusts is spending and taxes to suit the current economic climate (Stiglitz). Ireland has benefited from "prudent, stability-focused policy approach" (Hurley). "This has helped to deliver domestic economic stability, has contributed significantly to attracting foreign investment and has greatly facilitated growth. To ensure a sustainable recovery, it is very important that we maintain this approach and focus on key policy areas under our control. These include the public finances, the efficiency and effectiveness of public spending, particularly in relation to increasing the productive capacity of the economy, and overall competitiveness" (Hurley). The country has experiences of budget surplus such as in 2006 where the figure was recorded at 3% of GDP (ESRI). The recession has changed this face as budget deficit reached 12% of GDP in 2009, with the national debt scaling up to 41% of GDP from 12% in 2007 (ESRI). The decline in tax collection was attributed to the slowdown in the residential sector and other sectors of the economy affecting both consumption and employment (ESRI). This has of course lowered down the taxes on consumption as consumption lessened due to recession. Over-all, the government revenue declined leading to deficit declined so that the government resorted to borrowing. The figure is shown in the graph below: Source: (ESRI) Inevitably, the recession is affecting the fiscal polition of the country. Aside from the decline in ropoerty and consumption taxes, the weakening of the labor market is also increasing social expenditure (Hurley). "Within these constraints, it will be necessary to carefully manage the allocation of scarce public funds and to focus on measures to increase the efficiency and effectiveness of government spending, both current and capital. A particular priority within the capital programmed should be the maintenance of expenditure on key infrastructural projects, which can enhance productivity and improve the potential for the economy to grow in the future. 2 per cent of GDP. Our own internal estimates are broadly in line with this assessment" (Hurley). What the Irish government did was to cut in public spending through a slash in the public sector wages and welfare benefits (Barber). This is recorded to "form part of what is most stringent budget in Ireland since the declaration on independence in 1919" (Barber). What is good about the move of the government is that it faced mild public reaction enabling the government to push through with the only viable measure to combat the budget deficit (Barber). The Monetary Policies of the European Central Bank The monetary policy is one the government strategies in managing the economy, through the control of the supply and availability of money (Financial Pipeline). It is the Central Bank, usually through a Monetary Board that determines decision on money supply. Monetarists like Milton Friedman believes that money supply affects the over-all economy particularly inflation. He was quoted saying," inflation is always and everywhere an economic phenomenon" (Mishkin). Money supply is assumed by theory to affect the prices through the working of the quantity theory of money. As shown below movements in the money supply results to corresponding movements in prices and value of money. In the graph above, we show the money demand and money supply curves. The money supply curve is vertical since it is dictated by the Central Bank. The x axis is the quantity of money and on the y axis (left side) we have the value of money and on the y axis (right side) we have the price. The movement of money supply from Ms1 to Ms2 shows an increase in the quantity of money supplied in the economy. The graph shows that the result of this is an increase in price from 1 to 2 and a decline in the value of money from 2 to 1. Therefore, increasing the money supply results to inflation, but in a way enlivens the economy through increased spending, and on the other hand, decreasing the supply of money results in deflation but limits economic activity. The Irish government faced the problem of inflation in the early months of 2008. This however suddenly shifted to deflation after oil prices have declined. The Central Bank injected more money in the economy so as to increase the money in circulation which then encouraged consumption (Barber). Increased consumption increases economic activity which then increases GDP and even tax revenue. This is the importance of monetary policy. It is good to note that "that Irish financial institutions have negligible exposures to impaired US sub-prime and related structured credit products, and loan arrears remain historically low" (Hurley). Observers have noted that the "Irish banking sector fell into such distress as a result of the global financial crisis that the government was forced to inject 11bn, or 7 per cent of GDP, into its banks last year. It has also been forced to establish a "bad bank" - the National Asset Management Agency - to detoxify the system. If it had not been for the unorthodox support measures provided by the European Central Bank, it is entirely likely that the Irish financial sector would have gone into meltdown" (Barber). How Successful has the Irish Government and European Central Bank been in running the Irish economy over the last two years An article in "The Economist" written at the start of 2010 remarks that Irish recession may now have come to an end (The Economist). Thanks to the abrupt and courageous fiscal and monetary measures pursued by the irish government and the European Central Bank. As to the question of how successful were these two in running the Irish economy, let me say that they are very successful. They have managed to cope with the devastating effects of economic recession in a way that in the most logical and focused way. Being focused has always been the strength of the Irish economy and it continuous to be so. Ireland has achieved mush growth, endured much difficulty and now beginning to rise again. Indeed, the success of the economy is not in its immunity to outside attacks such as economic crisis but on its resilience to combat the challenge and build on a coherent and wise economic decision to start with. References AFP. http://www.google.com. 25 March 2010. 29 April 2010 . Barber, Tony. http://blogs.ft.com. 28 January 2010. 29 April 2010 . Biz/ed / Institute for Fiscal Studies. http://www.bized.co.uk. 29 April 2010 . Campbell R. McConnell, Stanley L. Brue, David Macpherson. Contemporary Labor Economics. McGraw-Hill, 1998. ESRI. http://www.esri.ie. 2010. 28 April 2010 . European Union. http://europa.eu. 29 April 2010 . Financial Pipeline. 29 April 2010 . Hurley, John. http://www.bis.org. 15 July 2008. 28 April 2010 . iExplore. http://www.iexplore.com. 29 April 2010 . Mankiw, N. Gregory. Principles of Macroeconomics. 3rd. South-Western College Publishing, 2004. Mishkin, Frederic. The Economics of Money, Banking and Financial Markets. Pearson, n.d. Nolan, William. http://www.gov.ie. 29 April 2010 . Slattery, Laura. http://www.irishtimes.com. 10 April 2009. 29 April 2010 . Stiglitz, Joseph. Economics of the Public sector. 3rd. 2002. The Economist. http://www.economist.com. 21 January 2010. 29 April 2010 . U.S Bureau of Public Affairs. http://www.state.gov. 29 April 2010 . Read More