The ESRI publishes a new medium-term outlook for the Irish economy

December 05, 2016

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Macroeconomics
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The ESRI published Ireland’s Economic Outlook: Perspectives and Policy Challenges today (5 December 2016). The research uses a new macroeconomic model, COSMO (COre Structural MOdel of the Irish Economy), developed by the ESRI to determine the potential path of the Irish economy in the medium to long term future.

The report is divided into three parts:

  • Part one presents a baseline projection for the economy.
  • Part two uses COSMO to examine the potential impact of Brexit and the Common Consolidated Corporate Tax Base (CCCTB) on foreign direct investment in Ireland.
  • Part three examines future levels of housing demands and the associated challenges for the banking sector.

Baseline Projection for the Irish Economy

The research used COSMO to create a baseline projection for the Irish economy, which acts as a benchmark against which a number of scenarios can be examined. The projection relies on a set of assumptions relating to demographic trends, the world economy and the public finances.

The baseline projection, which extends to 2025, identified a number of key points:

  • The sustainable long-term real growth rate of the Irish economy is approximately 3 per cent, driven mainly by growth in the traded sector.
  • A key factor underpinning this growth is the continued expansion of the labour force, which is expected to increase by close to 2 per cent per annum. This growth is supported by the natural increase in the working age population together with increases in female participation and a return to net immigration.
  • Strong labour demand is expected to reduce the unemployment rate to just over 6 per cent over the medium term.
  • Inflation is expected to remain relatively low at under 2 per cent per annum.
  • Results are produced for a number of possible Brexit scenarios, depending on whether the UK remains within the EEA or is subject to WTO rules.

Foreign Direct Investment

Researchers examined the potential macroeconomic implications of opportunities and threats to FDI flows and the associated impact on revenues based on the following two scenarios:

Diversion of investment from the UK to Ireland following a UK departure from the EU

The research finds that Ireland might benefit from a substantial relocation of FDI from the UK; however, the size of this positive effect is dependent on the level of global demand. Under these conditions, a simulation based on COSMO finds that real GDP will increase by 3 per cent and employment will increase by 1.8 per cent. However, where investment is not accompanied by a shift in demand to Ireland, the effect on output and employment would be negligible.

Major alteration of tax rules across Europe

A second scenario examines the impact of the proposed Common Consolidated Corporate Tax Base.The proposal, which could affect both revenue and the attractiveness of Ireland’s low corporation tax rate as it would apply to a smaller proportion of a multinational company’s income, is estimated to result in Irish potential output being 1.5 per cent lower than the baseline.

Housing Demand and the Banking Sector

The research assessed likely future demand for housing based on projected demographic change and related financing requirements within the Irish banking system.

The results indicate that based on trends in household formation, there is likely to be an increase in demand for housing from the current level of 23,000 units per annum to just over 30,000 per annum in 2024.

The increased credit levels associated with providing 30,000 units is likely to pose challenges for the domestic banking sector. It is likely to result in a significant increase in the difference between credit levels and domestic deposits, which is commonly referred to as the “funding gap”.