Economy to overheat from 2019, Department of Finance says

Research prepared for the Department of Finance has found that the Irish economy is likely to overheat in the medium term, with strains likely to start as early as next year.

While the country’s economy will ultimately fail to reach its full potential this year, the so-called output gap will turn positive in 2019 and widen thereafter, “pointing to signs of overheating in the medium term”.

The paper, Estimating Ireland's Output Gap, prepared by department economists, took a number of measures into account to assess the State's medium-term growth prospects by looking at the output gap.

This is the difference between actual economic growth, measured by gross domestic product (GDP), and its potential level. When the economy produces above its potential level, the positive output gap suggests it is producing above levels that are sustainable.

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Anything below the output gap means the economy’s resources are being underutilised.

"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," Minister for Finance Paschal Donohoe said in a statement.

“We must focus on maintaining competitiveness-oriented policies, whilst avoiding pro-cyclical policy measures,” he said. “To this end the Government is actively building capacity within the economy through increased public capital investment. This targeted investment is designed to address the bottlenecks to growth which emerged during the economic recovery, such as the need for residential development and public infrastructure investment.”

Competitiveness challenges

The findings of the report are consistent with the department’s view that the economy is likely to reach full employment soon.

A report last Tuesday said Ireland’s booming economy faces a number of competitiveness challenges that could seriously derail future growth, however.

The strong performance by a small number of indigenous companies is masking the fact that the majority of Irish companies are underperforming, with productivity growth either stagnant or falling, National Competitiveness Council chairman Peter Clinch said.

In a strongly worded commentary, the council warned of “severe vulnerabilities in the fabric of the economy” that threaten future prosperity.

Other commentators have warned that with Brexit on the horizon, the economy could take a hit of up to 7 per cent in output.

Department economists accepted that measuring potential output is more complex for a small, open economy such as Ireland’s. Nevertheless, it has incorporated Brexit into its model, adding that there will be some closure of the gap from 2021 onwards, driven partly by the forecasted drop in migration attributed to the UK’s decision to leave the EU.

In his response to the paper, Mr Donohoe said the Government would continue to implement budgetary measures designed to ensure economic stability. He added that the State would eliminate the deficit this year.

“We have made exceptional progress in recent years in stabilising our economy, getting people back to work and keeping the train on the tracks,” he concluded.