Dame Street's last stand heralds an era of doubt

IT is ironic that all the recent muscle flexing by the Central Bank comes at a time when a key report, which signals the demise of the said institution, is being widely lauded by the political classes. Given that the ESRI's report on the benefits to Ireland of EMU presumes the end of Dame Street as a policy making hub, are we now witnessing she last hurrah of the Bank Ceannais na hEireann? If we are, how will our replacement Euro wide monetary policy deal with future mini booms in Ireland?

The answer to the first question is relatively simple. Yes, we are seeing the beginnings of Dame Street's last stand. In a couple of years, if EMU goes according to the politicians' plans, there will be no unique Irish interest rate at all.

Several related factors, which have become part of the Irish political landscape, will also disappear. There will be no one from whom IBEC can demand lower rates, nor will there be anyone for the Government to blame if rates rise. In general, there won't be a soul for the individual lobbyists to call on to ado this or that" with the mortgage rate. This will probably come as a relief to most of us, but what will we have in its absence?

Replacing the Irish interest rate will obviously be a Euro wide interest rate. Simply because we are too small to affect the stance of the new European central bank there will be no unique way of dealing with local booms and troughs. Therefore the likely set of reasons Bank Ceannais na hEireann give for an imminent tweak upward in rates such as rising Dublin house prices, rising Irish credit growth and expanding Irish money supply will have no role in determining our interest rates in the future.

Thus, if we were already in a monetary union, with Ireland booming and the rest of Europe in the doldrums, our interest rates would never rise in response to domestic conditions.

Germany, due to its size, would dominate the rate environment and, given that only two days ago senior Bundesbank officials were hinting at lower rates in Germany, it seems fair to conclude that if we were in EMU now, our rates would be falling rather then rising!

This has huge implications for the economy because it implies that, in the future, the only domestic mechanism to control domestic activity will be changing the level of taxes. It is impossible to imagine a government raising taxes to take the steam out of a property price boom, in a way the present Central Bank raises mortgage rates to cap housing prices.

So, during monetary union, as long as the Irish economy grows at a faster pace than its neighbours, domestic activity will be given an extra kick by very low interest rates. The central question, therefore, is whether a deviation in growth rates could occur over a long period of time.

The simple answer is yes, of course. If we look at the history and, crucially, the geography of economic growth throughout the world, we see long periods of time during which neighbouring regions experienced strong deviations in growth the north and south of both the EU and US eastern Europe versus western Europe in 199/96 the west of Poland versus the east at the moment. The list is long, varied and, significantly, Ireland is set to remain part of this catalogue for a few years yet.

The reasons for this are pretty straightforward. Between now and the early part of the next century, Ireland will continue to receive significant inflows of cash from the EU, which will serve both to underpin the growth rates and, via increases in infrastructure, enhance future performance. Meanwhile the Government will be in a position to cut taxes in the years ahead.

In addition, the recent announcements of a surge in foreign investment projects will begin to come on stream and this has significant implications for domestic investment and employment. Furthermore, our traditional trading partner, Britain, appears to be on the cusp of an upswing in domestic consumer activity.

Finally, the leading indicators of domestic activity, particularly in terms of business and construction investment, point to continuing expansion. All this implies that the first few years of EMU, if it were to begin in 1999, would see continued strong growth in Ireland.

By contrast, Germany Italy and France appear to be stuck in a state of near recession and, looking forward, their rising unemployment, their need for ongoing fiscal contractions and the consistent haemorrhaging of domestic investment funds to eastern Europe and beyond, indicate that things may not improve for some time to come in the continental powerhouses.

Thus, without Banc Ceannais na hEireann to cool things down, we may see the economy hurtling along far too quickly, with prices rising in both the domestic services and property sectors. If this were the case, there could be some inevitable pressure on domestic wages which would impact negatively on the competitiveness of certain parts of industry where productivity levels are not that strong.

In that scenario, a slowdown when it eventually comes, may be caused not by higher domestic interest rates but by domestic job losses in exposed industries. Unfortunately, this alternative is a significantly more painful process.

Although the passing of Bane Ceannais na hEireann into the annals of Irish policymaking history may prompt a period of lower than usual Irish interest rates, when the inevitable slowdown comes there could be a nasty sting in the tail.