Ireland: Staff Report for the 1999 Article IV Consultation

This 1999 Article IV Consultation highlights that Ireland’s economic performance in recent years has been exceptionally strong. Output and employment have been growing much faster than in the rest of Europe. Real GDP growth averaged 7.5 percent per year in 1993–98, reflecting a sharp increase in capital accumulation—fueled in part by foreign direct investment—and an expansion of the skilled labor force owing to young entrants, increasing female participation, and a reversal of net emigration. Inflation has remained subdued. Public finances have improved significantly and the external current account has remained in surplus.

Abstract

This 1999 Article IV Consultation highlights that Ireland’s economic performance in recent years has been exceptionally strong. Output and employment have been growing much faster than in the rest of Europe. Real GDP growth averaged 7.5 percent per year in 1993–98, reflecting a sharp increase in capital accumulation—fueled in part by foreign direct investment—and an expansion of the skilled labor force owing to young entrants, increasing female participation, and a reversal of net emigration. Inflation has remained subdued. Public finances have improved significantly and the external current account has remained in surplus.

I. Introduction

1. The 1999 Article IV consultation discussions with Ireland were held in Dublin from May 7 to 17, 1999.1 The team met with the Minister of Finance, Governor of the Central Bank, other senior government officials, bank supervisors, and representatives of employers and labor unions as well as members of the financial and academic communities. Ireland has accepted the obligations of Article VIII, Sections 2, 3, and 4.

2. At the conclusion of the last Article IV consultation on October 14, 1998 (SUR/98/120), Executive Directors commended Ireland’s impressive economic performance and noted the important role played by sound economic management. Directors underscored the importance of adequate and timely responses to challenges posed by the advanced stage of the business cycle, the prospective downward convergence of short-term interest rates, and Ireland’s apparently competitive exchange rate at the onset of EMU. They recommended a tightening of fiscal policy to offset the stimulus from the easing of monetary conditions, and continued emphasis on structural reforms to alleviate labor and other supply constraints.

3. In reading this report, Directors may wish to reflect on two broad issues. First the extent to which wage and demand pressures are a concern, notwithstanding the apparent flexibility of Ireland’s output response in recent years and against the background of broadly sound medium-term prospects. And second, if the risks of overheating and a subsequent hard landing are a concern, what near-term policy actions, if any, would be needed in the context of EMU membership.

II. Background to the Discussions

A. Recent Economic Developments

4. Ireland’s remarkable economic performance continues into its sixth consecutive year. For most of the 1990s, strong growth had been underpinned by sound macroeconomic policies, social consensus, and rapid changes in economic structure (Table 1 and Figure 1). In 1998, real GDP is estimated to have grown by 9 percent and real GNP by some 8 percent, far in excess of growth in the rest of the euro area (Figure 2).2 Staff estimates suggest output was well above potential, although as discussed below (see paragraph 22), such estimates are subject to a high degree of uncertainty. Domestic demand was driven mainly by private consumption (Figure 3). The current account surplus narrowed sharply (by 1½ percentage points of GDP) reflecting a widening of the deficit on the balance of goods, services and income for the first time in recent years (Table 2 and Figures 4 and 5).

A01ufig01

Real Per Capita GNP Growth

(Percent change)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Table 1.

Ireland: Selected Economic Indicators

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Sources: Department of Finance; Central Bank of Ireland; IMF, International Financial Statistics; and staff calculations.

Based on National Income and Expenditure, compiled in accordance with the new European System of National Accounts (ESA 95).

Contribution of net exports and net factor incomes to GNP growth.

Year-on year in May 1999.

Estimates based on available data—first nine months of 1998.

Estimates based on available data—first six months of the 1998.

Adjusted for the effects of transactions between credit institutions and non-bank international financial companies and valuation effects arising from exchange rate movement.

End-May 1999.

Table 2.

Ireland: Summary of Balance of Payments

(In percent of GDP)

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Sources: The Central Statistics Office and staff estimates.
Figure 1.
Figure 1.

Ireland: Growth and Inflation

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: IMF, International Financial Statistics; Department of Finance; Central Bank of Ireland, Quarterly Bulletin; and OECD, Main Economic Indicators.1/ Consumer price index.
Figure 2.
Figure 2.

Ireland: Comparisons of Key Indicators with Other Euro Area Countries, 1998

(Growth rates, in percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Source: WEO and staff estimates.
Figure 3.
Figure 3.

Ireland: Contribution to GNP Growth, 1990-98

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: Central Statistics Office and staff calculations.
Figure 4.
Figure 4.

Ireland: Balance of Payments, Saving, and Investment

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: IMF, World Economic Outlook; Department of Finance; Central Bank of Ireland, Quarterly Bulletin; and OECD, Quarterly National Accounts.
Figure 5.
Figure 5.

Ireland: Development in Net Savings, 1985-97 1/

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: Central Statistics Office, staff estimates and projections.1/ Based on National Income and Expenditure compiled in accordance with ESA79.2/ The ratio of net household saving as a ratio of disposable income.

5. Indicators suggest growth may have slowed somewhat during 1998, but recent data point to a strong economy. Consumer confidence remains high, tax receipts grew strongly in the first half of 1999, and the unemployment rate declined further to a low of 6.7 percent in May.

A01ufig02

Actual and Potential Growth

(In percent)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

6. Buoyed by the strength of economic activity, employment is estimated to have increased by a remarkable 6.2 percent in 1998 with major gains in the private sector, particularly banking and construction. Employment gains were met by an increase in the labor force of 3.8 percent, bolstered in part by returning emigrants and rising female participation (Figure 6).

A01ufig03

Recent Indicators

(3-month moving average of Y/Y changes)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Figure 6.
Figure 6.

Ireland: Employment and Unemployment

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: Central Statistics Office, Census of Population, Labor Force Surveys, and Live Register Statements; and Department of Finance.

7. Consumer price inflation increased to 2.4 percent in 1998, significantly outpacing inflation in the rest of the EMU area (see Figures 1 and 7). The pick up in inflation was driven by housing costs and service price increases reflecting an upward trend in wage growth across a broad cross-section of sectors. Although annual inflation slowed to 1.5 percent in May (2.3 percent on an HICP basis), this was mainly due to a sharp fall in mortgage interest rates which lowered housing costs, rather than to an easing of underlying pressures.3 Service price inflation continued unabated in the first five months of 1999.

A01ufig04

Consumer Prices

(1995=100)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Figure 7.
Figure 7.

Ireland: Wage and Price Indicators

(Percent change from a year ago)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: CSO, Statistical Bulletin; and staff estimates.

8. Asset prices have surged suggesting excess demand pressures and mounting infrastructure constraints. House prices, which increased by 30 percent during 1998, rose by a further 15 percent (at an annual rate) during the first four months of this year (Figure 8). The slower rate of house price inflation may partly reflect government measures to lower tax incentives on residential investment and to increase the supply of land available for residential construction. Equity prices, which increased by 21 percent during 1998, rose by another 37 percent (at an annual rate) during the first five months of this year reflecting both buoyancy of the domestic economy and a surge in the share prices of Irish banks. Rapid increases in housing and equity market wealth are likely to have contributed to strong private spending.

Figure 8.
Figure 8.

Ireland: Asset Prices

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: IMF, International Finance Statistics; and Central Statistics Office.1/ House prices for Ireland refer to new house prices.

9. Monetary conditions have eased significantly, with the ECB’s April interest rate cut exacerbating the sharp stimulus received in 1998 from the convergence of short-term interest rates to EMU levels in anticipation of the launching of the euro. The base rate declined by some 3½ percentage points during 1998 and the first four months of 1999 (Figure 9). With the Irish pound widely regarded as having locked into the euro at a somewhat undervalued exchange rate, the depreciation of the euro has also contributed to a further easing of monetary conditions (Figure 10).

A01ufig05

Retail Lending Rates

(In percent)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Figure 9.
Figure 9.

Ireland: Interest Rate Developments, 1990-99 Interest Rates

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: Central Bank of Ireland, Quarterly Bulletin; and IMF, Surveillance Database.
Figure 10.
Figure 10.

Ireland: Exchange Rate Developments 1/

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Source: IMF, International Financial Statistics.1/ Data are expressed in foreign currency units per Irish pound. As of January 1, 1999 the euro is the currency of Ireland, the irrevocably fixed conversion rate between the euro and the Irish pound is 0.787564.

10. Private sector credit growth picked up sharply during the six months ending March 1999 following a slowdown in the middle of 1998. The increase coincided with the reduction in short-term interest rates starting in October, suggesting that borrowing may have been postponed given widespread expectations that interest rates would decline with Ireland’s membership in EMU. Credit has been expanding rapidly (at year-on-year rates in excess of 20 percent in real terms) since 1997 (Figure 11).

A01ufig06

Semi-Annual Growth of Credit to the Private Sector

(In percent at annual rates)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Figure 11.
Figure 11.

Ireland: Money and Credit Indicators

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: IMF, International Finance Statistics; Central Bank, Quarterly Bulletin; and staff calculations.

B. Policy Developments

11. The fiscal surplus rose in 1998 and the first half of 1999 mainly reflecting the cyclical strength of the economy and lower interest payments (Table 3 and Figure 12). The cyclically-adjusted primary surplus remained broadly unchanged in 1998, indicating that the increase in the overall balance is likely to have had little, if any, contractionary impact on demand since almost all of the adjustment came from a reduction in interest payments (see Supplementary Note).4 Noninterest expenditures increased markedly by 9½ percent in 1998 mainly due to spending on goods and services and wages (the public sector wage bill rose by 11½ percent).

Figure 12.
Figure 12.

Ireland: General Government Finances, 1980-98

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Sources: Department of Finance, Economic Statistics.
Table 3.

Ireland: Government Finances

(In percent of GDP)

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Source: Department of Finance and staff estimates.

Revised staff projections based on End-June 1999 Exchequer Returns. The original 1999 budget target for the general governmenbt surplus was 1.7 percent of GDP (see Table 4). The authorities raised the projected general government surplus to 2.3 percent of GDP in February 1999, which corresponded to the primary balance of 4.9 percent of GDP.

Table 4.

Ireland: Stability Program (1999-2001)

(As a percent of GDP)

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Source: Department of Finance.

Fiscal projections are based on ESA95 basis.

Annual change in percent.

As a percent of GNP.

12. In 1999, the general government surplus is projected to reach 2.7 percent of GDP (1 percent of GDP in cyclically-adjusted terms), about the same as the 1998 outcome. Key elements of the 1999 budget were continued reform of the tax system and greater infrastructure spending. Substantial net tax reductions were aimed primarily at improving work incentives by reducing tax distortions and lowering the tax burden of low income earners. Corporate income taxes were reduced as part of a move to unify corporate tax rates.5 The decline in revenues is projected to be more than offset by a reduction in current spending—stemming mainly from lower interest and transfer payments—allowing a substantial increase in capital spending.

13. Ireland’s Stability Program envisages a broadly stable overall fiscal balance and a 1 percent of GDP fall in the primary balance in 2000-2001 (Table 4). The government announced its intention to continue reducing corporate and personal taxes, with the impact on the overall balance being offset by further contraction in current spending, mainly transfers and debt service payments (Table 4).6 ECOFIN concluded that the program complies with the Stability and Growth Pact (SGP), but cautioned that the economic situation contained risks, particularly of an overheating economy with rising wages and prices. The Council noted that while there had been some tightening of policy, a greater tightening would be more prudent and a budget surplus should be maintained throughout the program. It supported increasing public investment to meet infrastructural needs.

A01ufig07

Cumulative Changes in Average Earnings

(In percent)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

14. Incomes policy came under increasing strain as wage growth in a broad cross section of sectors exceeded the norms stipulated in the multiyear centralized wage agreement (Partnership 2000).7 Driven by sectoral labor shortages, wage growth in services exceeded that in the tradable sectors, with the largest increases recorded in the public sector and in construction.

15. Notwithstanding the impressive decline in the overall unemployment rate, the government has been taking active measures to reduce the incidence of long-term unemployment which has remained relatively high. Following the introduction of interviews for benefit claimants late last year, the number of claimants has dropped sharply.8 The government has also sponsored job creation schemes and enhanced training opportunities.

16. A minimum wage is expected to be introduced early next year. In 1997, the Minimum Wage Commission had recommended that the rate be set at two-thirds of median earnings (IRE4.40 at the time) with a lower wage (70-90 percent of the full rate, applicable for a maximum of 3 years) for job entrants, trainees, and workers under 18 years of age.

17. A number of steps have been taken in the area of deregulation and privatization. The telecommunication market has been opened up to private companies and the government’s majority share of Telecom Éireann was put up as a public share offering in July, with proceeds expected to reach at least IR£3 billion. The government has approved the sale and merger of the two state-owned banks, and the sale of the state-owned fertilizer company is under way.

18. Given the increasing complexity of financial transactions, the government has decided, in principle, to establish a Single Regulatory Authority (SRA) for banks and financial institutions. The recommendations made by an Advisory Group on the issue included the following: (i) all financial services should be supervised by the SRA which should also be given statutory responsibility for consumer issues related to these entities; (ii) the SRA should be an entirely new, independent organization, funded by industry, although a minority opinion preferred to locate it within a restructured central bank; (iii) in order to ensure cooperation and information disclosure, a statutory high-level Standing Committee should be established composed of representatives from the Department of Finance, central bank and the SRA. The proposals are being discussed by the government, but no final decisions on the specific recommendations have been made as yet.

C. Economic Outlook

19. The outlook is for output growth to slow in 1999 and over the medium term, albeit to rates significantly above growth rates elsewhere in the euro area. The staffs 1999 growth projection, in line with private forecasts, is somewhat higher than that of the authorities mainly reflecting different judgements on the contribution from net exports as a result of the slowdown in Europe and increased global competition (see Table 1). Private consumption growth is also somewhat stronger reflecting continued increases in asset prices, lower interest rates, and falling unemployment. Over the medium term, output growth is expected to slow further as capacity constraints become increasingly binding and labor force expansion tapers off. Consumer price inflation would remain above the euro area average due to stronger wage growth reflecting higher productivity growth in Ireland.

20. There are risks in both directions to the near-term forecast. The response of domestic demand to monetary easing may turn out to be stronger than anticipated. A stronger recovery in Europe, particularly the U.K., may also boost exports and output further. On the downside, the global slowdown may exert a greater-than-expected drag on exports, particularly if Ireland is unable to sustain the increases in market share it has experienced in the past. Also, a weakening of sterling from its present high level may dampen Irish export growth further. At the same time, a decline in U.S. stock prices and slower U.S. growth could have negative spillovers on local asset prices and spending as well as on foreign direct investment.

III. POLICY DISCUSSIONS

21. Discussions focused on the risks of a hard landing from the present high rates of growth and appropriate policy actions, particularly given the asynchronized cycles of the Irish and other EMU economies. Policy recommendations were based on an assessment of potential output growth in Ireland; excess demand pressures and sustainable inflation rates; and short-term monetary conditions. There are three main sources of risk of a hard landing: (i) an overshooting of sustainable wage levels due to excess demand pressures and realization of long-suppressed wage demands reflecting the expectations of an increasingly prosperous population; (ii) monetary conditions that are not fully consistent with Ireland’s business cycle; and (iii) increased vulnerability of the financial system and indebted households to an increase in interest rates or an economic downturn due to inflated real estate prices and high credit growth. Although the authorities were mindful of these risks, they were, on the whole, more sanguine than the staff about the prospects of a smooth transition to a lower growth path.

A. Current Policy Setting

Potential output growth

22. The authorities and the staff agreed that the extent to which wage and demand pressures are excessive needs to be established since rapid output growth per se need not signal a concern given Ireland’s low inflation rate and a current account surplus. Although assessments of overheating are usually based on a view that the economy is operating above potential, the particular structural features of the Irish economy render the usual estimates of potential output highly unreliable and difficult to interpret. Not only has Ireland undergone rapid growth and far-reaching structural change, but it also has a highly flexible labor supply due to migration and rising female participation. Standard techniques for estimating potential output based on extrapolating past experience may be unreliable because the factors which have driven past growth are unlikely to continue long into the future.

23. The authorities agreed that it would be more useful to formulate a view of potential growth from a forward-looking perspective. The Irish economy is growing temporarily at an unusually rapid pace as it catches up with income levels in the rest of Europe. However, as the demographic effects taper off and income levels converge, growth would be expected to slow to a more sustainable rate based on more normal rates of productivity growth, although the timing of the transition would be difficult to predict. The authorities estimated this potential growth rate at 4-5 percent per annum, still significantly above potential growth in the rest of Europe. Staff studies, based partly on a sectoral analysis of total factor productivity growth, suggest a somewhat higher range of6-6Vz percent. 9 The implication is that demand and wage growth consistent with these ranges would help lower the risk of a hard landing as growth eventually slows.

Excess demand and sustainable inflation

24. The staff noted that demand pressures were intensifying as indicated by surging house prices, the upward trend in wages, and pressures on public infrastructure. Although some indicators appear to contradict this view, a closer look suggests otherwise.

  • While price inflation appears subdued, the CPI does not in an economy as open as Ireland’s accurately reflect domestic demand pressures given the high weight of imports in the consumption basket. Inflation of nontradables (both wage and asset prices) which provides a better gauge of risks, has been picking up strongly. The GDP deflator, for instance, rose by 5.6 percent in 1998.

  • Although the external current account is in surplus, there was a marked narrowing of the balance in 1998 mainly due to a weakening of the goods and services balance and a further decline in net EU transfers.

  • While the rapid output growth in recent years would appear to support a pick up in wage growth, in fact, most of the rise in trend growth since 1993 is accounted for by an expansion in labor supply rather than rising productivity. Total factor productivity growth has been high, but stable suggesting that wage growth should be strong, but stable as well.

A01ufig08

Contributions to Potential GDP Growth

(In percent)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

25. Authorities and staff agreed that it would be useful to quantify, as a rough benchmark, sustainable wage and price inflation in light of productivity growth in Ireland in relation to that of its trading partners. Rapid growth in Ireland relative to the rest of the euro area suggests the need for real appreciation which, in a currency union, implies higher real wage growth and price inflation than elsewhere (the Balassa-Samuelson effect). Given possible initial undervaluation in converting to the euro and strong productivity growth in traded goods, wage growth and price inflation may well continue to be higher than elsewhere in the union without any loss of competitiveness or overheating. Rough estimates by staff based on examination of sectoral data suggest sustainable average wage increases in the order of about 5 percent in nominal terms corresponding to a price inflation differential over the euro area of about 1 percentage point (Box 1).10 Average earnings growth in 1998 (before much of the recent short-term interest rate decline took place) was within this range, but officials noted it was on an upward trend and likely to pick up further given current wage demands (see Table 1 and see Figure 7).

Monetary conditions

26. Staff noted that while Ireland’s participation in EMU is likely to yield substantial long-term benefits, the sharp decline in interest rates at a time of intensifying demand and wage pressures, poses considerable short-run risks. Given the asynchronized cyclical conditions with the rest of the euro area, there is a further risk that the ECB would eventually raise interest rates at a time when growth in Ireland was slowing down. Staff argued that the full effects of the rate reduction are not yet likely to have been felt, particularly since short-term interest rates did not decline until October last year and credit growth has been especially rapid since then. Moreover, the existence of fixed rate contracts and the time it takes for consumers to adjust spending patterns to a new lower level of interest rates would suggest some lags in the monetary policy transmission mechanism.11

Inflation, Wages, and Productivity Growth in Ireland

1. Ireland’s manufacturing sector has experienced growth well above euro area rates through much of the 1990’s. This growth, were it to continue, could be expected to lead to a real appreciation of the exchange rate which, in a currency union, would imply wage and price inflation differentials over the rest of the union (the Balassa-Samuelson effect). However, for reasons outlined below, the measured productivity growth of Irish manufacturing is likely to overstate the actual productivity gains embodied in Irish factors of production, and therefore, the apparent scope for higher wage and price inflation over the rest of the euro area.

2. Ireland’s recent manufacturing growth has been highly concentrated in a few sectors characterized by large foreign (typically U. S.)-owned export-oriented firms. For example, over 80 percent of the measured real growth in value added per worker in manufacturing during 1991-96 is accounted for by five sectors which together employ less than 10 percent of manufacturing workers. The chart below illustrates the extent to which a few sectors dominate aggregate productivity growth in manufacturing. In these sectors, unusually high earnings are attributed not to Irish labor or capital, but to other factors such as activities carried out in the home country (R&D, advertising), returns to patents and licenses etc. which arise from the integrated production relationships between multinationals and their Irish subsidiaries. These earnings are reflected as outflows in the form of repatriated profits and royalties in Ireland’s balance of payments, thus creating the significant difference between GDP and GNP. Measured productivity growth arising from multinational activity need not place direct pressure on Irish wages and, indeed, have greatly exceeded real wage growth. For instance, in 1991-96 measured value added per worker grew by an average of over 8 percent in these industries (compared with 4 percent in other industries) although average real wages grew by less than the 3½ percent in other industries.

3. A staff background paper attempts to broadly quantify the range of wage and price inflation that could be sustainable in Ireland by isolating that portion of productivity growth attributable to Irish factors of production from productivity attributable to intangible assets of multinationals.1/ On this basis, annual total factor productivity growth for the tradables sector between 1991-96 is estimated at about 3½ percent, compared with 1½-2 percent for euro area countries. Using the Balassa-Samuelson framework, such differentials in total factor productivity growth, if sustained, are estimated to be consistent with Irish inflation exceeding euro area inflation by about 1 percent. Assuming an euro area inflation rate of about 1 percent, this suggests that Ireland could sustain price inflation rates of about 2 percent and wage growth rates in the order of about 5 percent over the long run.

1/ See Selected Issues paper on “Ireland and the Euro: Productivity Growth, Inflation, and the Real Exchange Rate.”

27. Views were divided among the authorities regarding the economic impact of the decline in interest rates. Some were very concerned that it would exacerbate demand pressures, stimulate the housing market, and encourage credit expansion with potential ramifications for the vulnerability of the financial system down the road. Others argued that since Ireland’s participation in the final stages of EMU had been widely anticipated, most of the convergence in interest rates during 1998 was already incorporated into private sector decisions. They noted that long-term rates had already converged early last year and thus expected the remaining effect on domestic spending to be minimal, although they acknowledged that some effects still remain, as evidenced by the high rates of growth of car and retail sales.

B. Fiscal Policy

Short-term issues

28. Given monetary union, fiscal policy must become the principal tool of macroeconomic stabilization. Staff and the authorities agreed that fiscal policy in 1998 may not have been as contractionary as the cyclically-adjusted overall balance suggests (see Supplementary Note), and that tax cuts this year may be having an expansionary impact on private consumption. Staff advised that in view of the recent sharp decline in interest rates on the back of rising demand and wage pressures, fiscal policy needed to be more unambiguously countercyclical with a tightening of the stance—in terms of an increase in the cyclically-adjusted primary surplus—this year and, most likely, next year as well. Officials noted that fiscal tightening may not have a significant domestic demand impact in a small open economy such as Ireland and also that private savings could offset increases in public savings as in past years (see Figure 5).12 While acknowledging these factors, staff suggested that the effectiveness of fiscal policy is likely to be greater in a monetary union than in the past when offsetting movements in the interest rate and exchange rate were possible.

29. The authorities noted the political difficulties in justifying fiscal restraint given the sizeable surpluses generated by the strong economy and indicated that political realities would not permit a tightening this year. They recognized nonetheless that Ireland’s fiscal strength may be somewhat overstated. Pension liabilities, which are substantial, are not adequately reflected in the budget numbers and funding them would essentially wipe out the reported surplus (see paragraph 34 below). In addition, the methodology used to calculate the cyclical adjustment is likely, for technical reasons, to overstate potential output growth in recent years, and hence, the cyclically-adjusted fiscal surplus as well.13

30. The falling public interest burden, strong fiscal surplus, and the tax-based incomes policy provide a strong political impetus to reduce taxes. In view of the relatively high rates of marginal taxation of personal income, the authorities reiterated their commitment to further tax reduction, especially the objective of lowering the standard and maximum personal income tax rates to 20 and 40 percent, respectively (from 24 percent and 46 percent currently). In addition, the process of replacing personal tax allowances with tax credits (introduced in the 1999 budget) needed to be completed in the next budget. They noted that personal income tax reductions so far had mainly offset the upward drift in the revenue ratio due to bracket creep and that the sharp reduction in the standard corporate tax rate by 2003 would not have an overly negative revenue impact in view of the rising corporate tax ratio. Given the need for demand restraint in the present macroeconomic environment, staff cautioned against tax reductions in next year’s budget.

A01ufig10

Tax Revenue as a share of GDP

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

31. The clear need to increase investment in public infrastructure in order to ease supply constraints poses a dilemma for budget policy. Reflecting past budget cuts and notwithstanding prudent investment of EU funds, public infrastructure in Ireland has failed to keep up with rapid income growth. Hence, on the one hand, greater capital spending is urgently needed to upgrade public infrastructure, particularly roads and transportation. On the other hand, higher public expenditures add to wage and demand pressures in the short-run, particularly given labor shortages in construction. The authorities are developing a new National Development Plan to set public investment priorities over the medium-term.

32. Staff expressed concern regarding the sharp increase in the public wage bill in 1997-98 and the emergence of a potentially problematic dynamic in public sector wage settlements. Excessive wage increases granted to certain public sector employees through a reopening of past wage agreements were creating risks of further wage pressures as other groups attempted to restore wage relativities. A wide range of private sector representatives echoed these views, pointing to the influence of public sector settlements on private sector wage outcomes. The authorities shared concerns on wage pressures, but felt that while public sector wage increases were more visible, the real impetus was coming from the private sector, with public sector wages attempting mainly to catch up. Public wage growth in the year ending September 1998 (the data latest available) was 5 percent, similar to industrial sector wage growth, although this excludes the very large increases granted to nurses and police late last year.

A01ufig11

Structural Revenues in 1998

(In percent of potential GDP)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

Medium-term issues

33. Staff supported the need for tax reform over the medium term, but stressed that this should focus mostly on changes to the tax structure rather than overall tax reduction. The government has made substantial improvements to the tax structure, but further efforts are warranted particularly in personal income taxes where, for instance, the top tax rate applies at a relatively low level of income (about 87 percent of average industrial earnings). It is worth noting that the structural revenue ratio has declined sharply by some percentage points of GDP since 1996 (see Supplementary Note) and may decline further when corporate tax rates are reduced over the next few years. Moreover, the public debt ratio at end-1998 was still high (53 percent of GDP), net EU transfers are projected to decline sharply, and there are substantial future expenditure needs related to public infrastructure investment and unfunded pension liabilities. Ireland’s structural revenue ratio is lower, and its structural primary balance not particularly high, relative to other European countries. These considerations suggest that further reductions in the structural revenue ratio need to be considered in a medium-term context that factors in competing demands on public resources.

A01ufig13

Structural primary balances in 1998

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 087; 10.5089/9781451818710.002.A001

34. Pension liabilities are substantial, and the government is working on pension reform to begin at least partially funding public service and social welfare pensions. It is considering recognizing pension liabilities in the budget and is exploring various funding options including making payments into a notional fund within the budget or creating an independently managed fund outside the treasury.14 Staff estimates based on current contribution and replacement rates suggest that the net present value of existing and future pension liabilities is substantial. (Estimates of the addition to the public debt ratio range upward from 130 percent of GDP, depending on assumptions).15 Moreover, fully funding these pension liabilities is estimated to lower the general government balance by around 2½-3½ percent of GDP, essentially wiping out the present surplus.

35. The authorities are taking steps to place budget policy on a medium-term footing. A comprehensive spending review is envisaged to assess departmental spending practices. They acknowledged that the nominal current spending limit of 4 percent per annum was not binding as currently specified because it included interest payments and was defined net of social security contributions, but said there was limited scope to change this definition since it was an election commitment. Staff suggested that medium-term budgeting be further strengthened by an articulation of the government’s intentions on tax policy in the form of a multi-year tax reform package with implications for the structural revenue ratio clearly laid out; multi-year departmental spending limits—consistent with a medium-term public investment program–Hinder which expenditure overruns would be offset by cuts elsewhere; and a transparent accounting of accrued pension liabilities. The authorities noted that the government’s intentions with regard to tax reform had already been laid out clearly in the election manifesto. Staff also encouraged the authorities to undertake a self-assessment with respect to the Fund’s Code of Good Practices on Fiscal Transparency.

C. Incomes Policy

36. Staff agreed that centralized agreements have been useful in moderating wage pressures, but pointed out that the practice of trading off tax cuts for wage concessions imparts a procyclical bias to fiscal policy in that tax concessions are likely to be largest when wage pressures are strongest.16 Hence, revenue-neutral changes to the tax structure rather than net tax reductions should be considered in future wage agreements. Authorities acknowledged that the wage agreement in its current form imposed a constraint on fiscal policy, but noted that since tax reductions were essential for restraining wage demands and maintaining social consensus, the benefit in terms of wage moderation was worthwhile.

37. The authorities thought it likely that another centralized wage agreement would be reached when Partnership 2000 expired next March, but negotiations were not scheduled to start until later this year. They stressed the need for a coherent strategy with regard to the next such agreement. In particular, greater flexibility would be required in determining acceptable wage increases given tight labor market conditions and the need to minimize the tendency for such agreements to thwart relative wage changes. More extensive use of performance-related wage increases, including profit-sharing options, is thus likely.

D. Labor Market and Other Structural Policies

38. Unions are pressing for a realignment of the proposed minimum wage rate of IR£ 4.40 per hour to two-thirds of current median earnings (approximately IR£5 per hour as of December 1998.). Authorities were concerned that the proposed rate is high compared with minimum wages in other industrialized countries. They support a youth rate in order to limit the negative impact on youth employment. Private sector views were mixed regarding the impact of the minimum wage on employment. A government-sponsored study suggests that the effects on employment would be relatively minor (the impact effect would raise the unemployment rate by 0.5 percentage points) in part because wage increases would vitiate the employment impact by the time the wage is introduced (assuming the minimum wage is, in fact, set at IR£4.40 an hour and that it is not indexed).17

Minimum Wages in 1998

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39. The authorities expect active labor market policies to have a significant impact on long-term unemployment, particularly among younger workers. The focus of recent budget policies has been to reduce poverty traps and encourage work incentives by attempting to alleviate the tax burden on lower paid workers, rather than by lowering benefits. However, staff estimates suggest that replacement ratios may not have changed significantly when the total impact of all measures in the 1999 budget are considered, suggesting scope for more efforts to lower replacement ratios. (Box 2).18

40. On trade policy, the authorities felt that the draft copyright bill adequately addresses concerns relating to the U.S. complaint to the WTO on Ireland’s intellectual property laws. They acknowledged that the existing copyright law was out of date and said that the new bill, published in April, brought Irish legislation in line with that in other OECD countries. The bill is currently before Parliament and is expected to be passed by end- year.

E. Financial Sector Issues

41. Staff expressed concern about the effects of rapid credit growth and sharp increases in asset prices on the health of the financial system and the quality of banks’ portfolios, particularly those exposed to the housing and property markets. Currently, the banking system is well-capitalized and highly profitable reflecting the strong economy, but vulnerability to an adverse shock such as an economic downturn, an increase in interest rates, or a decline in real estate prices remains difficult to gauge.19 Supervision would need to consider the risks to the financial system from a generalized macroeconomic shock, particularly since many standard indicators of financial health are not sufficiently anticipatory in this regard. The authorities shared these concerns and noted their recent request for credit institutions to carry out sensitivity analyses of portfolios to a specified deterioration in macroeconomic conditions. In addition, banks were being monitored carefully, particularly with respect to lending standards. Following a series of inspections, the Governor of the central bank wrote a letter to mortgage lending institutions in April expressing concerns about cases where lending standards had been relaxed. The authorities were of the view that while there have been specific instances of questionable standards, there were no generalized problems with regard to deteriorating credit approval criteria or asset quality. They welcomed the staffs suggestion to undertake a peer review as a means of further strengthening supervision.

Recent Changes in Incentives to Work

1. In the budgets for 1998 and 1999, the government made significant efforts to improve incentives to work for low wage earners and the unemployed. Measures included (i) reducing income tax rates; (ii) extending eligibility for certain social welfare benefits to former unemployed for the first 3 years of their employment; and (iii) raising the level of personal tax allowances above the tax exemption limit, thus significantly reducing poverty traps created by high marginal tax rates (reaching as much as 40 percent).

2. Notwithstanding these efforts, replacement ratios have remained quite high, particularly for workers with families, implying low incentives to work.1/ In 1999, for instance, replacement ratios for a single person ranged between 34-56 percent, depending on the income level, while for a married earner with 2 children, they ranged about 64 -78 percent Although tax measures in the 1999 budget were aimed at improving incentives to work, the combined effect of all 1999 budget measures on replacement ratios appears to have been rather modest. This is in part because, as in past years, social welfare benefits were increased in line with average earnings. As shown in the charts below, for most income ranges and for different types of workers, the net reduction in replacement ratios due to 1999 budget measures ranged between 0 and 1 percent.

3. The introduction of the national minimum wage (NMW) is expected to result in a significant reduction in replacement ratios because of the increase in starting pay (about 30 percent of unemployed are estimated to benefit from the NMW if they start work).3/ The chart below shows how the distribution of replacement ratios shifts when the NMW is introduced. In particular, those currently experiencing a replacement ratio above 50-60 percent (i.e., most unemployed, low-wage earners) would find their- ratio pushed down below 50 percent (peaking at 40-50 percent). While work incentives are, not surprisingly, improved by the NMW, the important question is whether the demand for these workers will be correspondingly improved.4/

1/ The replacement ratio is defined as the benefit level when unemployed over the after-tax income when employed. A fall in the replacement ratio signifies an increase in the incentives to work.2/ A negative number denotes a decline in the replacement ratio (for a specific type of worker at given income level) due to measures in the 1999 budget. Median annual earnings in 1999 are estimated at IR£15,000.3/ T. Callan and J. Walsh, Microsimulation Analysis of the Impact of the Minimum Wage on Work Incentives.4/ See Selected Issues paper on “Work Incentives and Recent Labor Market Policies.”

42. Staff inquired into the adequacy of the institutional setup in Ireland for handling a possible financial crisis and the changes necessitated by EMU, in particular with regard to the functioning of the lender of last resort (LOLR) role. The authorities assured the staff that they were well-prepared to deal with a crisis should one emerge and that current understandings between the ECB and national central banks were clear with regard to the modalities for emergency LOLR actions, including the sharing of necessary supervisory information. The issue of LOLR had been actively discussed at the EU Council level and the ECB had set up a system of communication for crisis situations, with every national central bank aware of its responsibilities. The authorities expected that, following EMU, competition in the financial services sector would increase over time with possible banking system consolidation. Such pressures, however, were not evident as yet.

IV. Other Issues

43. In 1998, Ireland’s spending on official development assistance was broadly unchanged at 0.2 percent of GDP. This falls short of U.N. target of 0.7 percent of GDP.

44. The government has made good progress in Y2K compliance and Ireland has been rated at level 1 - the best state of readiness—by an independent industry study (the Gartner Group). The government is confident of meeting its deadline of July 31, 1999 to achieve compliance. According to the Central Bank, most credit institutions are now in the testing and contingency planning stages. The Bank requires all institutions to have adequate business continuity and disaster recovery plans in place.

45. Ireland has subscribed to the Fund’s Special Data Dissemination Standards and is also subject to the statistical requirements and timeliness and reporting standards of the Eurostat and the ECB. The authorities have made significant progress in improving data reporting, but scope for improvement remains in some areas (Appendix II).

V. Staff Appraisal

46. The performance of the Irish economy remains impressive. Over the past few years, sound macroeconomic policies backed by social consensus, a strategic approach to foreign direct investment, and an unusual confluence of favorable supply factors have left Ireland well placed to take advantage of integration into the euro area as well as global markets. The external current account appears to have weathered the turbulence in world markets relatively well and the outlook for growth remains favorable in the near term. Prudent management has substantially strengthened the fundamental fiscal position while structural policies have enhanced incentives toward gainful employment and further deregulated markets.

47. Excess demand pressures, however, are mounting. Clearly, some degree of wage and price inflation higher than in the rest of the euro area is justified by the possible initial undervaluation in converting to the euro and stronger productivity growth in traded goods in Ireland. Nonetheless, surging house prices, sectoral labor shortages, and pressures on public infrastructure are raising the risk that wages may overreach rates of growth justified by productivity gains. Staff estimates, admittedly rough, suggest that wage growth in 1998 was at the upper end of a range consistent with underlying productivity growth differentials between Ireland and the rest of the euro area. A sustained pick up in wage growth beyond this range would be a cause for concern. Notwithstanding the clear long-term benefits of joining EMU, the associated sharp fall in interest rates has taken place at a time when wage pressures are intensifying and demand pressures are straining capacity. With domestic credit growth picking up from already high rates, the vulnerability of bank portfolios to an adverse shock is naturally a concern.

48. While it is possible, indeed likely, that the Irish economy will continue to rack up very high growth rates in the near-term, the risks of a hard landing also rise as the expansion continues and demand pressures mount. If wages overshoot sustainable levels, output and employment growth may have to decline unnecessarily sharply to restrain real wages. If a shock, such as an increase in euro interest rates, exposes weaknesses in asset portfolios, banks may be forced to contract credit, thus exacerbating a downturn. Similarly, overextended households may be forced to cutback spending more sharply than otherwise. Membership of the larger euro area will not necessarily shield Ireland from a localized downturn, particularly given limited factor mobility.

49. While the Irish economy’s strong performance and sound fundamentals hold much promise, the challenge is to ensure that timely action is taken to forestall the risks that threaten its impressive record. Given monetary union and cyclical asynchronization with rest of the euro area, fiscal policy must take on a greater role as a stabilizing force. A tightening of the fiscal stance in 1999, and probably next year as well, would reduce the risk of a hard landing as Ireland transitions to its medium-term growth path. Given that wage and price inflation in 1998 were already around benchmark levels suggested by productivity differentials, the tightening should at least offset the expansionary effect of the 3½ percentage point fall in base rates since late last year. Even in a small open economy such as Ireland, the short-term demand effects of a fiscal tightening can be sizeable, particularly since monetary union rules out offsetting movements in interest rates and exchange rates.

50. It is important, in this context, to restrain public sector wage increases which have picked up significantly in the last two years. The increase in public sector wages in excess of norms agreed under Partnership 2000 is a cause for concern, even if the adverse impact on the fiscal balance has been offset so far by the cyclical strength of tax revenues and the decline in interest payments. Further wage pressures—particularly from attempts to restore wage relativities—should be firmly resisted. It is essential that the public sector play its part in delivering wage moderation, particularly in the run up to negotiations on the next centralized wage agreement. Moreover, given the political constraints to raising taxes and the clear need to expand public infrastructure spending, the wage bill offers the greatest scope for action in tightening fiscal policy.

51. In view of current cyclical pressures, further net tax reductions should be avoided in the 2000 budget, all the more so since this would go beyond the commitment in Partnership 2000. The government’s efforts at tax reform are commendable, particularly the measures in the 1999 budget to reduce poverty traps and disincentives to work. Further efforts are needed to change the tax structure, but these changes should not lead to unsustainable structural revenue losses over the medium-term, nor be vulnerable to reversal during an economic downturn.

52. Given monetary union, it is critical that future wage agreements not constrain the use of fiscal policy, or worse, force it to act procyclically. While these agreements have been effective in moderating wage demands in the past, their reduced effectiveness in tight labor market conditions changes the strategic calculus in trading tax reductions for wage moderation. The next wage agreement, if one emerges, should focus on changing the tax structure rather than reducing net taxes at a time of intensifying demand pressures and a declining structural revenue ratio. More extensive use of performance-related pay provisions would be welcome to foster greater relative wage flexibility and to reduce the risk of excessively high across-the-board wage increases.

53. The government should seize the opportunity created by the present fiscal surpluses to begin funding public service and social welfare pensions. Pension liabilities are large, notwithstanding Ireland’s relatively young population, and substantive moves must be made without delay to address the problem. In order to protect pension resources from future budget pressures, independently managed pension funds could be created with appropriate safeguards in terms of public accountability. Annual charges based on a preset formula should be made to the budget to properly reflect the true level of expenditure commitments. Proceeds from the privatization of public enterprises could be used to strengthen the pension funds and help move towards full funding over the medium-term.

54. The recent moves towards a multi-year budgeting framework are commendable; this approach needs to be further strengthened, particularly through a tightening of expenditure control mechanisms. The staff supports the development and implementation of a sustainable medium-term investment plan with a view to upgrading public infrastructure over time. A clearer articulation of the government’s intentions on tax policy and associated structural revenue implications as well as a transparent accounting of all pension liabilities would also be important for clarifying the true underlying fiscal situation. A self assessment with reference to the Fund’s Code of Good Practices on Fiscal Transparency may be useful in this regard.

55. The government’s active labor market policies are highly commendable. The economy’s strong demand for labor has been met in part by an impressive shift of workers from unemployment into employment. The recent tax changes and efforts to intervene actively through interviews and training of benefit claimants promises further progress in this direction. Challenges remain, however, in tackling the incidence of core, long-term unemployment.

56. Given its high level, the introduction of a minimum wage at IR£ 4.40 per hour could jeopardize efforts to reduce unemployment, particularly among youth and the long-term unemployed. A realignment of the rate to two-thirds of current median earnings or indexation to earnings should be avoided in order to limit potential adverse effects both on the unemployment rate and—in current tight labor market conditions—on overall wage levels. The proposed lower rate for youth, job entrants and trainees is welcome, but the age limit for the youth rate should be set at 21 years so as to limit the negative impact on youth unemployment.

57. Although the banking system appears well-capitalized, rapid credit growth and strong house price increases raise the vulnerability to an economic downturn or an increase in interest rates from their current low levels. With competitive pressures driving financial institutions to deviate from traditional lending norms, there is increasing risk of an asset price bubble, particularly if easy credit availability allows house prices to be bid up on the expectation of further price increases. The supervisory authorities have a solid professional reputation and their efforts to strengthen prudential supervision are welcome. In order to enhance the forward-looking aspects of regulatory policy, it would be useful to build on the recent initiative to assess financial system vulnerability to macroeconomic shocks. The authorities may also find a peer review helpful, especially by supervisors in a country that has undergone a real estate expansion. Whatever decisions are finally made with regard to the location and functions of the SRA, it would be important to ensure that the process is not disruptive to the maintenance of supervisory vigilance and that the arrangements function effectively within the context of the ESCB in both anticipating potential problems and facilitating a rapid response should problems emerge.

58. Ireland’s macroeconomic data permit effective surveillance on the whole, although there is scope for improvement in some areas. While the authorities have made significant efforts to improve data reporting, further progress in shortening lags in publishing key economic indicators would enhance the monitoring of short-term economic developments.

59. The staff encourages the government to make further progress towards achieving the U.N. target of 0.7 percent of GDP for official development assistance, particularly in view of Ireland’s relatively strong fiscal position.

60. It is proposed that the next Article IV consultation with Ireland be held on the standard 12-month cycle.

Supplementary Note

Composition of Fiscal Adjustment

1. Ireland’s fiscal position has strengthened significantly in recent years with the general government balance shifting from a deficit of 2.1 percent in 1995 to a surplus of 2.4 percent in 1998. As indicated by the table below, this improvement reflected strong GDP growth, a decline in debt service payments, and some fiscal adjustment.

2. In 1998, the cyclically-adjusted primary balance remained almost unchanged with most of the increase in the (cyclically-adjusted) overall balance coming from a substantial decline in interest payments. In addition, the cyclically-adjusted overall balance did not strengthen by as much as the actual overall balance due to the importance of cyclical factors in the fiscal performance. The structural revenue ratio fell by almost 2 percentage points of GDP compared with 1995.

Composition of Fiscal Adjustment 1/

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Sources: Department of Finance, and staff estimates.

Cyclically adjusted, unless otherwise indicated, based on revised National Income and Expenditure data compiled in accordance with ESA95. Cyclical adjustments are sensitive to the revisions to GDP.

1999 budget adjusted for revised revenue projections based on Exchequer outturn for the first half of the year.

First difference of the corresponding levels.

3. Nominal expenditure increased sharply in 1997-98, although it fell as a ratio to potential GDP because of the strong growth of the denominator (see chart below). Wages, expenditure on goods and services, and public investment contributed most to this increase with the impact on total expenditure in 1998 being mitigated by the decline in interest payments. In 1998, spending on wages, transfers and public investment exceeded the budget limits, but these overruns were partly offset, at the level of the primary balance, by lower expenditures on goods and services. Noninterest expenditures grew more strongly than anticipated in the budget.

4. This decomposition of fiscal adjustment suggests a shift in the sources of adjustment in 1998. Although the overall balance increased in cyclically-adjusted terms, the impact of fiscal measures on domestic demand may not have been contractionary. Most of the apparent contraction arose from reductions in interest payments which are likely to have weak multiplier effects, particularly since about a third of the public debt is held abroad. The cyclically-adjusted primary balance in fact deteriorated slightly. The substantial decline in the structural revenue ratio— mainly reflecting reductions in personal income taxation—and increases in the public wage bill, direct government spending on current goods and services as well as capital investment are likely to have had stronger multiplier effects by comparison.

5. The cyclically-adjusted primary balance is projected to remain unchanged in 1999, notwithstanding the increase in the actual overall balance due to cyclical factors. Despite a substantial upward revision to revenues to reflect strong Exchequer returns in the first half of the year (with the overall balance correspondingly increasing from 1.7 percent of GDP in the original budget to 2.7 percent of GDP), the cyclically-adjusted (structural) revenue ratio is projected to decline sharply again. Although the cyclically-adjusted overall balance is projected to increase slightly (0.3 percent of GDP), this mostly arises from lower projected interest payments. Hence, as in 1998, the (projected) strong fiscal outturn is likely to reflect mainly cyclical factors and reductions in interest payments.

APPENDIX I: Ireland: Basic Data

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Sources: National Income and Expenditure; Balance of International Payments; and staff estimates.

APPENDIX II: Ireland: Fund Relations

As of May 31, 1999

I Membership Status: Joined: 08/08/57; Article VIII

II General Resources Account:

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III. SDR Department:

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IV Outstanding Purchases and Loans: None

V Financial Arrangements: None

VI Projected Obligations to Fund: None

VII Exchange Arrangement

As of January 1, 1999, the euro became the currency of Ireland; the irrevocably fixed conversion rate between the euro and the Irish pound is 0.787564. Previously, the Irish authorities had maintained a maximum margin of ±15 percent between the Irish pound and the currencies of other countries participating in the exchange rate mechanism of the European Monetary System. Prior to August 2, 1993, this maximum margin had been ±2.25 percent. The Irish pound’s central parity was revalued by 3 percent in March 1998.

VIII Article IV consultations:

The discussions for the most recent Article IV consultation were conducted in Dublin during June 12-22, 1998. The staff report (SM/98/234) for that consultation was considered by the Executive Board on October 14, 1998 (SUR/98/120). Article IV consultations with Ireland are currently on the standard 12-month cycle.

IX Technical Assistance: None

X. Resident Representative: None

APPENDIX III Ireland: Statistical Annex

Ireland is subject to the statistical requirements and timeliness and reporting standards of the Eurostat and the European Central Bank (ECB). Ireland has cooperated fully with the Fund in providing monetary, international reserves, and selected other financial statistics related to its membership in the European Economic and Monetary Union (EMU). These data are considered comprehensive, reliable, timely, and well documented.

1. Ireland has subscribed to the Fund’s Special Data Dissemination Standards (SDDS). The Irish authorities began publication of the current account of the balance of payments within three months of the reference quarter. However, the authorities are lagging behind on the adoption of the 1993 System of National Accounts (SNA), and the introduction of quarterly national accounts, both of which had been originally scheduled for early 1999.

2. Information on flows of direct investment, equity, and other capital is provided on a net basis and does not permit monitoring of gross capital inflows and outflows. Moreover, capital and financial account data prior to 1990 were not revised in line with the 1995 Balance of Payments Compilation Guide.

3. While the authorities publish Exchequer returns on a quarterly basis, information on the general government balance is available only annually.

4. Real sector data are sometimes published with a lag of 3-6 months, and in some cases even a year later. Lags are particularly long for unemployment benefits and assistance, employment, earnings, and productivity indicators. Information on unemployment benefits and assistance becomes available 12 months after the reference month, while earnings (including public sector earnings), employment, and the index of unit wage costs, are available with a six-month lag.

Ireland: Core Statistical Indicators

(As of June 1999)

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1

The staff team comprised of Ms. Coorey (head), Mr. Aitken, Ms. Koliadina, and Mr. Kontolemis (all EU1). Messrs. Bernes and Charleton, Executive and Alternate Executive Director for Ireland, respectively, also participated in the meetings.

2

According to the European Commission, Ireland’s per capita GDP reached 105 percent of the EU average in 1998, while the corresponding GNP-based measure reached 87 percent.

3

The CPI includes the cost of housing services which is influenced by changes in mortgage costs. It does not reflect house price increases—which are asset price changes—except insofar as rents are affected. The HICP excludes housing servicing and hence has shown a higher rate of inflation than the CPI in recent months. Two-thirds of the consumption basket in Ireland comprises tradable goods.

4

Estimates of the cyclically-adjusted fiscal position are subject to a significant margin of error mainly because of uncertainties regarding the output gap.

5

The standard (non-manufacturing) corporate tax rate was reduced from 32 to 28 percent. Under the July 1998 agreement with the European Commission, the current 10 percent tax rate applying to manufacturing and certain internationally traded services will be unified at a standard rate of 12.5 percent by 2003.

6

The program is based on unchanged policies—for instance, it includes only a modest allowance for public capital expenditure. Staff estimates, based on various output gap estimates, suggest that the structural balance required to comply with the provisions of the SGP is in the range of -1½ to ¼ percent of GDP (SM/98/238). The recently-announced EU budget envisages a sharp cut in overall EU transfers to Ireland from IRE6.5 billion (1.8 percent of GDP) in the current six-year program ending in 1999 to less than IR£3 billion over the next program.

7

Partnership 2000 for Inclusion, Employment and Competitiveness covers a three- year period through March 2000 and specifies a cumulative pre-tax wage increase of 91 A percent in exchange for personal tax reductions worth of IR£900 over the three years.

8

The incidence of long-term unemployment was about 45 percent in 1998. In the first 6 months of interviews, 61 percent of those contacted left the benefit roll (“Live Register”), with a substantial portion of the leavers never turning up for the interview.

9

These issues are discussed in greater depth in the Selected Issues paper “Potential Output Growth in Ireland.”

10

These estimations are discussed in greater detail in the Selected Issues paper on “Ireland and the Euro: Productivity Growth, Inflation and the Real Exchange Rate.”

11

Preliminary estimates suggest a two-year lag, albeit with about half of the full effect felt in the first two quarters. In the United Kingdom, which has a similar interest rate structure, monetary policy shocks are also estimated to take two years to show full effect. About 60 percent of mortgages in Ireland are at rates that are fixed for one-year.

12

No reliable estimates of the fiscal multiplier are available for Ireland in part because of estimation difficulties associated with controlling for offsetting interest rate and exchange rate effects as well as for the level of the public debt. Tentative estimates (based on pre-EMU relationships) suggest a multiplier of about 1 (i.e., a one to one impact) in the first five years, but this appears to be on the high side.

13

See Selected Issues paper “Potential Output Growth in Ireland.” Staff estimates suggest, for instance, that if the potential growth rate were lowered by 1 percentage point in 1998, the cyclically-adjusted fiscal balance would decline by 0.4 percent of GDP.

14

Under ESA 95, notional funds within the control of the government do not affect the fiscal balance. However, payments made to an independently-managed pension fund outside government could be considered current expenditures, thereby reducing the fiscal balance.

15

For a more detailed discussion see the Selected Issues paper on “The Impact of Future Pension Liabilities on the Fiscal Position.” Estimates are based on the pension projections and economic assumptions in two government-sponsored reports: The Actuarial Review of Social Welfare Pensions (1997) and The Interim Report of the Commission on Public Service Pensions to the Minister for Finance (1997). Results are highly sensitive to the assumed real discount rate and to the estimated initial (1999) pension balance.

16

There is, for instance, an understanding among social partners that if growth turned out less than expected, tax cuts would be lower than agreed. With growth higher than expected, tax cuts have gone beyond Partnership 2000. During 1997-99, personal tax reductions amounted to some 2.5 percent of GDP compared with tax cuts of 1 percent of GDP in the original agreement.

17

The Impact of the Minimum Wage in Ireland, Report for the Inter-Departmental Group on the Implementation of a National Minimum Wage, March 1999.

18

For a more detailed discussion of recent labor market policies, see Selected Issues paper on “Work Incentives and Recent Labor Market Policies”

19

See Selected Issues paper on “Structure and Performance of the Financial System” which provides a description of supervisory arrangements and discusses indicators of financial system vulnerability based on the Guidance Note for Monitoring Financial Systems under Article IV Surveillance (SM/98/151).

Ireland: Staff Report for the 1999 Article IV Consultation
Author: International Monetary Fund