Keep the moths away from that hairshirt

THE year is 2005. Ireland, after 18 years of economic growth is beginning to feel the first chill of recession. For Sale signs are staying up that bit longer, graduates are finding the interview process more arduous than did the class of 2004. Even politicians' diaries are less cluttered with ribbon cutting opportunities at sparkling new electronics factories.

In Merrion Street, hard evidence is confirming this trend with tax revenues beginning to fall off sharply. From new car sales to VAT and stamp duty receipts are way down on expectations across the board. But the good news is that at least inflation is now obliterated, running at 0.2 per cent per year.

Meanwhile despite this down on Dame Street, the Central Bank has called in the commercial banks to warn them of an impending 1-1.5 per cent hike in interest rates not a cut as the banks themselves and IBEC had been demanding. The Central Bank cannot confirm when the move will take place as the European Central Bank does not alert it. But the rumours in the European press appear to have been substantiated by a well placed mole in the Irish delegation at Frankfurt. Finally, the euro - Ireland's new currency - has just taken off against sterling. With sterling now at an old pound equivalent of £118 shoppers are flooding over the border in droves and the new hyper markets around Newry have never seen better business.

To older heads, the tell tale signs of recession are unmistakable. But for the younger ones - the children of the 1990s boom - all talk of slowdowns, hard times and belt tightening are simply dismissed as a failed generation whingeing as always.

Could this be a vision of the Irish economy in the first few years of the next century? Possibly, it is not as far fetched as it now seems. The central reservation about the next leap into the EMU dark is not that sterling may not be involved although that is a significant worry, but that the Irish economy is European in name only. The implication of this is that it is very possible that the EU economy will be growing at a time when the Irish economy is shrinking - the mirror image of what is going on at the moment.

The economy parted company with the rest of the EU sometime in the late 1980s. Since then, the Irish economy has grown by an average of 5.5 per cent per year while the EU economy has barely notched up 1.4 per cent. The economy is now completely out of killer with the main bloc of the EU. For the next few years, on going labour growth, strong foreign investment and low interest rates, it would be fair to assume that Irish ascendancy over the rest of the EU will continue.

The arrival of EMU will give an extra boost to the Irish miracle because short term interest rates will initially fall further. This last shot in the arm may well prove fatal as it will propel the economy just as it is at the peak of the economic cycle. This could cause the domestic economy to accelerate at a ridiculous pace, with consumers taking on more debt and asset, particularly housing, prices rocketing. Meanwhile, if present trends in the structural budget deficit are anything to go by, the underlying fiscal situation will not be very encouraging either. The baseline fiscal situation has been in a state of deterioration since 1993. During this period the rest of the EU has recorded a slowly improving situation. If we consider the situation without the present buoyant tax revenue an accurate background situation can be assessed.

The underlying deficit (adjusted for the economic cycle) is approaching 3 per cent of GDP.

What happens if, under its own steam, the economy begins to slow down around 2005? House prices begin to fall, bringing negative equity; employment growth dries up; our 10 per cent corporation tax derogation runs out, while the CAP is finally scaled down and the EU funds disappear as the economy has overtaken the EU average income by that stage.

In such an eventuality, we would need falling interest rates and an expanding budget deficit to cushion the blow. Now consider the case that, unlike today, the EU economy was growing at a time when the Irish economy was contracting. Our interest rates would be rising not falling, as would our currency.

What about the budget deficit? Well, if the structural deficit remains close to 3 per cent of GDP, the stability pact, which has now been put to bed by EU ministers, will prevent any member states' deficit from rising above 3 per cent of GDP. Therefore, the recession which is likely some time in the next decade (economies move in cycles after all), could be very deep indeed. With interest rates and the exchange rate rising and the budget deficit tightening, the economy could go into a short lived tail spin. EMU may not necessarily be a saviour as most are contending. Indeed, EMU could easily be the mechanism which gives us enough rope to hang ourselves.