The world economy is facing the risk of a global recession. The latest market turbulence has had a limited impact on the Republic, but if the crisis accelerates it could be a different story. Ironically, the problems emanating from the Far East, Japan and Russia have had some significant benefits for us. Until recently one of the main fears about the State participating in monetary union was the possibility of the economy overheating as a result of the decline in interest rates which will come by the end of the year. But this is now becoming less likely as one of the main repercussions of the global crisis so far has been the fall in world commodity prices, particularly oil. This has helped to keep inflation lower than anticipated.
As can be expected of a small open economy, most of our inflation is imported. Inflation across the rest of the world has been remarkably low and this has offset, to some extent, the effects of the slide in the value of the pound last year, which made imports more expensive. Over the past year oil prices have halved as have the costs of other commodities such as metals and gas. The results can be seen in our shops and garages, while the devaluation of the Asian crisis has made imports of electronic merchandise far cheaper. Indeed, it is expected that things can only get better for the Western consumer as the Asian nations begin to find money to fund export operations once again.
The news is also good for borrowers. Interest rates, particularly over the longer term, have fallen dramatically. This has cut the cost of the national debt and has enabled businesses to borrow to expand more cheaply.
But the same is also true of home buyers and there are still fears that the fall in mortgage rates at the end of this year could trigger large scale extra spending and a further increase in house prices. However, the good news is that this is now likely to spill over into the balance of payments only, and not lead to a big surge in inflation. Consumers will buy more imported Irish goods, but their lower prices mean inflation is not increased.
So far so good. However, the picture may not stay so rosy if the fall on Wall Street becomes more pronounced.
As the Economist spelled out earlier this week, the world economy resembles an aeroplane that has lost two of its four engines. Japan is already in recession, there are still fears that the Asian slowdown may cause China to devalue, the Russian economy is heading into the abyss and there are now fears that Latin America could be the next area to be hit.
Most of these areas matter little of themselves and even the detail of the Russian crisis is not what is important, rather it is the psychological effects on markets which many have been expecting to turn down at any minute. So far the falls have not been significant enough to halt growth in the European and US economies which are still motoring, but if Latin America were to be affected the story could be very different.
A widening of the crisis to other developing markets and above all to Latin America, could be a serious threat to US economic growth. A recession in Latin America caused by investors' loss of confidence and plunging stock markets would hit the US economy hard, since 20 per cent of US exports go to that region, against only 12 per cent to Asia.
Heavy financial losses could also dry up credit and put the brakes on consumer spending, the US economy's main engine of economic growth.
Even without that many experts fear that further sharp falls on Wall Street could hit growth. In contrast to many European countries, about half of all Americans are reliant on the stock markets for their ordinary savings and investments. In fact, many point to the growth in mutual funds as a factor behind the recent extended bull run. The recent boom has been the backbone of the consumer spending boom. With billions wiped off the value of Wall Street, many fear that the consumer may simply disappear. Analysts now believe that a further 10 per cent fall on Wall Street would halve the US growth rate.
There are now fears that such a "bust" could be on its way. One fear is that much of the boom has been driven by short-term capital flows or "irrational exuberance" as Mr Alan Greenspan, chairman of the Federal Reserve, would have it.
One possible remedy is for the Fed to cut interest rates. Lowering interest rates in co-ordination with other G7 nations should "restore investors' confidence", which was rocked by the Russian crisis and above all by a decision by the Russian authorities to cease honouring foreign debt, according to some analysts.
But one of the main reasons for such a move is that the rest of the world needs it more than the US. So far Wall Street has avoided a meltdown - although it was 19 per cent off its highs at Monday's close. As statistics showed this week, the labour market is still tight and consumer spending still buoyant.
However, the crisis is almost certain to mean the end of the prospect of an interest rate rise in the US which many had been expecting. Treasury Secretary, Mr Robert Rubin, has already been reminding investors that "the fundamentals of the United States economy are strong".
Of course, if the crash does materialise the Fed would almost certainly react as it did following Black Monday in 1987 when it lowered its short-term rate. But already the flight of capital into bond markets has pushed the US long bond to low levels never seen before. Immediately after Monday's collapse on Wall Street it was trading at 5.27 per cent.
On their own the falls of recent weeks are probably no cause for alarm here; Wall Street is still 20 per cent stronger than it was three years ago. As a result, the Republic's run of high growth looks set to continue, even at a slower pace. That is probably no bad thing. But if Wall Street really falls out of bed, we need to start worrying. After all, we cannot hope to prosper if the world economy is in recession.
