Committee on Budgetary Oversight díospóireacht -
Wednesday, 20 Mar 2024

Stability Programme Update: Discussion (Resumed)

An Leas-Chathaoirleach

I welcome the witnesses from the Central Bank, Dr. Robert Kelly and Dr. Martin O'Brien. The Committee on Budgetary Oversight is undertaking ex ante scrutiny of the SPU in order to understand the current fiscal context, to engage with stakeholders on these issues and to allow for greater parliamentary engagement and transparency to the budgetary process. Today, as I said, the committee is meeting representatives from the Central Bank and this is the committee's second engagement on this topic. Dr. Kelly and Dr. O'Brien are very welcome indeed.

Before we start, I must explain some limitations to parliamentary privilege and the practices of the Houses with regard to references witnesses may make to other persons in their evidence. The evidence of witnesses physically present or who give evidence from within the parliamentary precincts is protected pursuant to both the Constitution and statute by absolute privilege.

Witnesses are again reminded of the long-standing parliamentary practice that they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable, or otherwise engage in speech that might be regarded as damaging to the good name of the person or entity. Therefore, if their statements are potentially defamatory in respect of an identifiable person or entity, they will be directed to discontinue their remarks and it is imperative that they comply with any such direction.

I remind members of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official either by name or in such a way as to make him or her identifiable. I remind members of the constitutional requirement that they must be physically present within the confines of the place where the Parliament has chosen to sit, namely, Leinster House, in order to participate in public meetings. I will not permit a member to participate where they are not adhering to this constitutional requirement. Therefore, any member who attempts to participate from outside the precincts will be asked to leave the meeting.

I invite Dr. Kelly to give his opening statement.

Dr. Robert Kelly

I thank the Chair and members and wish them a good evening. I am joined by Dr. O'Brien, who is head of our Irish economic analysis division at the bank. In my opening remarks I will outline our latest macroeconomic assessment before turning to our outlook for the public finances and the implications we see for fiscal policy.

Turning to the economic outlook, our last quarterly bulletin forecasts the domestic economy to grow at a moderate pace, in the region of 2% annually, out to 2026. Modest growth for consumer spending underpins the outlook as household purchasing power recovers with wage growth, averaging 4.7% in the coming years, once again outpacing inflation. In contrast, the outlook for domestic investment is relatively constrained despite anticipated increases in residential construction. Our expectations for wage growth arise from the outlook for the labour market, which remains relatively tight despite some easing in recent quarters. We forecast the unemployment rate to remain in the region of 4.5% out to 2026. The disinflation process in Ireland has progressed faster than previously anticipated. In the main, this reflects the abatement of externally-driven price pressures, most notably for energy. In Ireland, the outlook for headline HICP has been revised down relative to our previous forecasts to 2% in 2024. In contrast, more domestically-driven price developments, such as services price inflation, are proving to be more sticky. They are currently running at about 5% and are expected to decline more gradually over the forecast horizon.

Risks to the Irish growth outlook are tilted to the downside. Most notably, an escalation in geopolitical tensions could see renewed inflationary pressures from rising energy prices and disruptions to world trade. Given the small, open nature of the Irish economy, such potential disruptions to the exports will weigh heavily on output. Labour costs outpacing productivity or delayed progress in addressing capacity constraints in housing and other infrastructure could generate higher and more persistent price and wage inflation and thus damage competitiveness.

Turning to monetary policy, since the summer of 2022, the ECB has increased interest rates by 4.5 percentage points in the fastest rate-hiking cycle since the start of the euro 25 years ago. The ECB’s baseline projections for euro area inflation look very similar to our own, that is, for inflation to decline gradually throughout 2024, reaching the 2% target during 2025. However, there are risks to this outlook. Similar to Ireland, domestic price pressures remain elevated, especially in services, which account for around half of the spending basket for headline inflation. For services firms in particular, wages tend to account for a large share of overall costs, which is why wage growth also matters for inflation. In addition, and as we outline in our quarterly bulletin, the mix of profit margins and labour productivity are also important factors when we think about these wage developments.

Looking ahead, the governing council continues to follow a data-dependant approach, focusing on incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission to determine the path for interest rates that will sustainably return us to the 2% target.

Turning to the public finances, the headline outlook is positive, as evidenced by the Government running a headline surplus last year while continuing to provide temporary supports to households and firms.

The significant increase in core or permanent spending measures in budget 2024, totalling €5.3 billion or 6.2%, is partially offset by a decline in non-core spending. The net effect is an expected headline surplus of 2.5% of GNI* this year. Looking further ahead, most of the remaining non-core expenditure, which includes humanitarian support for Ukrainian refugees, cost-of-living supports and legacy spending related to the Covid-19 pandemic, is due to be withdrawn in 2025. As a result, the surplus is projected to strengthen to 3.8% of GNI* in 2025 before stabilising in that region for 2026. These sizable primary budget surpluses, projected to average 4.5% of GNI*, are the most significant factor driving the reduction in the debt ratio to 66% of GNI* by 2026.

It would be remiss, however, to focus entirely on the relatively positive outlook for the headline surplus, given the role played by the growth in corporation tax receipts. These receipts are highly concentrated, partly decoupled from the Irish economy and subject to sudden reversal. Data from the Revenue Commissioners shows that 60% of corporation tax arises from just ten multinational firms, leaving the public finances excessively sensitive to firm- or sector-specific developments, including how firms respond to international tax reforms.

At the core of this issue are the "excess" corporation tax receipts, that is, those that cannot be explained by Irish economic activity, accounting for 45% of total corporation tax receipts and just over 10% of all tax receipts. Excluding these receipts presents a much less favourable outlook for the underlying general government balance. It would remain in deficit this year at minus 1.2% of GNI* and broadly balanced in 2025 and 2026. On this basis, the underlying general government balance would have been consistently in deficit since the financial crisis.

What are the policy implications of this? Considered choices are necessary for domestic policy to support macrofinancial stability over the near to medium term. Maintaining an appropriate fiscal stance that does not unnecessarily aggravate any remaining imbalances between domestic demand and supply conditions can align with achieving near-term and longer term priorities.

The challenge for policymakers in the immediate future is creating the space and enablers for the necessary investment to address housing needs and climate change. This involves, first, considering the relative role of specific tax and expenditure measures to create the space within an economy with limited capacity while ensuring that the public finances are kept on a sustainable footing; second, prioritising investment delivery while being mindful of the most effective ways to incentivise and enable private sector investment; and, third, initiating reforms to enable more efficient investment delivery.

It is also essential to focus on other known pressures on the public finances, such as those related to an ageing population. Creating the future Ireland fund in budget 2024 is a significant and welcome step to prepare for the cost of an ageing population. The recent scenario analysis from the Department of Finance highlights the size of this challenge, with the projected withdrawals from 2035 falling short of the additional ageing demands.

As Ireland and other countries struggle to reach decarbonisation targets, the pace of investment in climate change mitigation will likely need to increase above what is currently envisaged. This is in addition to the investment required to assist the transition to net zero. It is appropriate to consider this likelihood in the design of the infrastructure, climate and nature fund.

Over the coming years, the projected health of the public finances leaves Ireland in an enviable position to address these multifaceted challenges. Still, given the critical need to sustainably fund and prioritise public capital expenditures in a way that creates economic capacity instead of absorbing it, the Government would gain from renewing its commitment to a domestic expenditure rule. Such a rule is fundamental, particularly as sustainability measures in the recently agreed-on EU economic governance framework reforms are expressed as a proportion of GDP. The mix of distortions in the GDP figures and excess corporation tax receipts means the new rules are not currently binding and are unlikely to be an effective anchor for the public finances over the medium term.

The existing rule could be strengthened in a couple of ways. For example, the distinction between "core" and "non-core" expenditures has blurred and could be re-examined. The rule should also be redefined in general terms to cover all Government expenditures.

A sustainable response to the challenges of housing, climate change and related infrastructure needs in energy, transport, water and communications requires a renewed focus. This focus should be on innovation, human capital development and productivity growth. Delivering progress in these areas can create the foundations for sustainable growth. Combined with maintaining sound public finances, this can ensure sustained growth in employment and incomes over the long term for the population as a whole.

I thank the committee members for their attention. We are happy to take their questions.

An Leas-Chathaoirleach

Thank you, Dr. Kelly. I now open the floor to members. The first contributor is Deputy Conway-Walsh.

Deputy Rose Conway-Walsh

I thank Dr. Kelly for his statement. It concurs with a lot of what we have heard on the SPU so far. I will concentrate my time on a concern I have. We are a budgetary oversight committee. I refer to Government expenditure for mica and pyrite homes and what can be done about it within the remit of the Central Bank. On a macro level, we are predicted to spend about €3.65 billion on rebuilding people's homes and people's lives, with around €230 million before 2020. While the witnesses are here, I ask them what concerns they would have about rebuilding homes that are, as the scheme sits at the moment, and as the banks are at the moment, not remortgageable and not insurable. In the Central Bank's consumer protection role, what can it do about that? We have the banking system making money from assets that are worth zero. I talk to homeowners across Mayo and Donegal, in particular, but also Clare and other areas, where the banks are actually making money out of this situation. We are predicted to spend billions and we will have housing stock that is not remortgageable or resaleable. Can the witnesses speak to that? How does the Central Bank reconcile that, and what can it do within its remit to try to resolve that?

An Leas-Chathaoirleach

I am sure the witnesses will remind Deputy Conway-Walsh that the Central Bank is not directly responsible for consumer protection and that side of the house-----

Deputy Rose Conway-Walsh

Yes. I know that.

An Leas-Chathaoirleach

-----but I have no doubt that they will respond as efficaciously as they can.

Dr. Robert Kelly

I was literally about to say-----

Deputy Rose Conway-Walsh

I absolutely and completely understand that, but I would be negligent in my duty, while we have any member of the Central Bank before us, not to raise the issue that is most pressing across the whole of the western seaboard, including in terms of our overall public expenditure. I would therefore really appreciate it if the witnesses would speak to that.

Dr. Robert Kelly

I was about to start by saying - and thank you, Chair - that consumer protection is not necessarily within the remit of the Central Bank. I think my colleagues would be much better placed to answer the Deputy's questions. However, when we think about this in terms of the public financing and the link, I can understand the concerns. If the Deputy would like me to comment on this, I could take it away, talk to my colleagues and come back to her, but I fully appreciate that it is a big concern for her constituents.

Deputy Rose Conway-Walsh

I really appreciate that and I thank Dr. Kelly. I ask him to do that because there are mixed messages in a sense coming out from the Central Bank. I think the Central Bank has a central role to play for us in trying to get this right not only to protect taxpayers' money but also to enable people to get on with their lives. Banks should never be capitalising from people's misery on assets that are worth zero. All people are asking for is for those assets to be restored. They are not buying new assets; they are asking for them to be restored. I would really appreciate it, therefore, if Dr. Kelly would take that back on this occasion.

In the quarterly bulletin, the Central Bank is now projecting inflation below 2% in both 2025 and 2026. Should that be a factor now as the ECB considers interest rates? What role does the Central Bank of Ireland have in feeding into the issue of interest rates?

Dr. Robert Kelly

I will break that in two. What is happening in the Irish economy feeds into the euro area economy, so the ECB's decision-making is governed by what happens in terms of the European economy.

The Irish economy is about 2% to 3% of that overall, if we think of the size, so our inflation contributes with that weight. To be brutally honest, our inflation path would not necessarily be the majority of what we would see in terms of the euro area aggregate, although it does contribute.

In terms of our role within the monetary policy path, that is slightly different. Our Governor sits on the governing council, which is the deciding body, but it takes a euro area perspective. Something that is worth reflecting on when we think about the path for interest rates is that there is a lot of similarity between what we see as the path for inflation here and what we are seeing in Europe. There are nuanced differences and maybe we will return to the 2% target a little earlier than the aggregate, which is 2025, but broadly, there is a lot of similarity. In terms of decision-making, it is definitely for the governing council and we would have a weighted input according to the size of our economy.

Deputy Rose Conway-Walsh

The ESRI said that Ireland was among the countries with the lowest investment in housing in the EU in 2022, only exceeding Greece, Poland and Bosnia and Herzegovina. That is shocking, given what we hear constantly from the Government. In the quarterly bulletin, the Central Bank talks about how labour constraints are easing. Will Dr. Kelly expand on that and outline if increased public spending can shore up the labour transfer to address that problem?

Dr. Robert Kelly

There are two elements when we think about the labour market. One is that we have what would be seen as a more general easing. I would point to two things in this regard but we need to set the context. We had an extremely high level of demand for labour coming out of the pandemic and there is also supply, whereby we have seen people returning from inactivity into the labour force and quite a lot of migration. However, there are signs in the past six months that there is easing within the system. For example, if we look at the number of people working part time who say they are available and willing to work extra hours, we see quite a large increase in that. It has been up about the mid-30,000s in the past year, so there are now more people in that category than there are unemployed. That is for the general labour market.

When we think about housing in particular, what we would point to is that we have seen a slowdown in commercial real estate development. A crucial point here is skills matching. For example, tradesmen who work in construction on commercial real estate can potentially be redeployed to the delivery of housing. While we would have seen labour shortages in the construction sector, they are alleviated to some degree and are potentially transferable to the delivery of housing. That is one area that potentially creates labour supply for the delivery of housing when, previously, there was a much higher level of demand across commercial and housing.

Deputy Rose Conway-Walsh

How should we use the employment data as a sign of economic strength? Dr. Kelly says there is an increased labour force and the low unemployment rates we see across the board. I do not know any state that does not have low unemployment rates at the moment. Are we overreliant on the low unemployment rates to give us a narrative that everything is okay? Looking at that, what are the bigger risks that the Central Bank would see at the moment? There is an acknowledgement of our overdependence on a small number of FDI companies. What are the other risks?

Dr. Robert Kelly

Ultimately, most countries would think about economic health in terms of GDP. I am sure we have discussed previously, even within this committee, that there are challenges in using GDP for various reasons, such as the activities of globalised firms and things like that. We can potentially use a measure like MDD, which much better reflects the Irish demand. Even there, however, we have seen some very large investments, in particular in some of the multinational sectors. In pharmaceuticals, for example, the level of vaccines produced in Ireland meant there were large levels of investment and there were also some one-off ICT investments. Therefore, even those numbers do not necessarily point to a situation where we would say there is a slowdown in MDD. Some of these factors are moving through the system almost like a wave as we are normalising.

A key metric, and probably the best indication for households with regard to the potential distress they might experience, is whether there is availability of jobs and whether people can work. I did not want it to come across in any way that I was being definitive about the labour market and it is a much more relative statement. In absolute terms, the labour market is tight at below 4% and we do not necessarily expect it to rise from there, or the unemployment rate. There are still shortages, but given the intense imbalance between demand and supply a year ago, we are seeing some more gradual normalisation of that. Perhaps Dr. O'Brien would like to come in with a view. I would point to the labour market as maybe being the key area we would look at in terms of the overall health of the economy.

When we think about the risks to the outlook, for me, there is one crucial component we would talk about. When we look at the global level, what I would say surprised us last year is that while the growth outlook is roughly in line with what we expected, what is way down is the level of trade. Ireland has a small economy and we have seen a contraction in trade. Some of that might be said to be sector-specific but there is also a general downturn. We are expecting a recovery in exports. We expect them to be below the historical level but there will certainly be a recovery. If there was to be an event, whether geopolitical in nature or a disruption to shipping, supply lines or anything like that, it would directly impact an export-oriented economy like ours. I think that is probably the biggest risk facing us currently.

Dr. Martin O'Brien

I would come back to the Deputy’s reflection that every country's unemployment rate is relatively low right now. That is certainly the case. However, it is important, instead of just looking at the unemployment rate, to look at employment growth itself, that is, how many new jobs are being created in net terms and the intensity of that employment. Dr. Kelly mentioned the fact that while there are certainly a lot more people at work, on average, people are not working as much in terms of, for example, the number of hours per week. It is important for us to understand the relative role of the number of hours people are working and whether that is a choice on the employees’ part or driven by the demand from the employer. As we see the easing of the tightness in the labour market, that relative balance between whether it is a person's choice not to work so many hours or something they are arranging with their employer is going to be the key change point as to when we could see a less beneficial appetite for employment. Obviously, that impacts people's incomes and their ability to spend. If some of these global risks were to materialise, that is the cohort of people who would start to feel it because, instead of not working so many hours, they could be more likely to transition out of the labour force entirely. That is certainly something we will keep monitoring over time, in particular the overall growth in employment and the intensity of that employment.

Deputy Rose Conway-Walsh

I would like to see the outworkings of the decline in commercial property activity. How do the witnesses see that continuing and what do they think needs to be addressed? What is the impact on the overall economy as that declines?

Dr. Robert Kelly

That is a very interesting question. A heightened focus in terms of our risks and financial stability would be to think about the channels and potential linkages through to the financial system. It is worth saying a couple of things. First, in terms of commercial property, the investment base within commercial property is very different than it would have been 15 or 20 years ago. Fifteen or 20 years ago, the banking sector was heavily involved in the development of real estate and the ownership would have mainly been domestic. What we have seen happen since then is that this has shifted to an international investor base. When we think about the linkages through to the financial system, it is important to understand that change and what it might mean in terms of the Irish banking system and the potential ramifications of a downturn in commercial real estate.

We also need to think about the structural change that has happened. The pandemic, to some degree, has impacted how we utilise workspace, for example, and the potential for more hybrid working means demand is down. We are in a position where the vacancy rate in Dublin has risen and we expect that to continue.

The high interest rate environment has also had an impact on the delivery of investment, which we would expect in this area. In terms of the bulletin, one thing we would forecast is that, similar to housing delivery, and while it is hard to take apart, say, public infrastructure investment from commercial real estate, we would expect other building to fall into next year and then slowly recover. That is where we see it. We would see a normalisation in that market.

Deputy Rose Conway-Walsh

It would appear there are currently a lot of vacancies, but rather than rents coming down, they are being held at a level. Do the witnesses foresee rents on commercial property coming down rapidly over the next months?

Dr. Robert Kelly

Commercial real estate is a little different from residential real estate in that there would be a lot of lease agreements. Another thing that is quite a big factor is the type of commercial real estate. There is a difference between buildings with a very high climate rating, ESG and all of these things that we would look at, so those buildings will attract higher rent and higher levels of demand.

We need to think carefully about what that means for a stock of buildings, especially in a market where the demand is lower and whether they need a retrofit scheme. The market might segment even a little bit more and we may see some buildings being reused for something different. There is very different demand across office space, for example, and logistical space. We have seen that divergence where previously there was an uplift in demand for all types of commercial real estate. There are unique stories underneath what is going on at the aggregate.

An Leas-Chathaoirleach

I am going to make some observations now, if I may. I am required, unfortunately, to be in the Chamber in a few minutes to participate in a Second Stage debate on a Bill.

Dr. Kelly notes that HICP inflation has been revised down relative to previous forecasts and the forecast for 2024 is 2%. However, I note the Central Bank's own review suggests that service prices inflation is sticky, as Dr. Kelly describes it, and is currently running at about 5%. Does a proportion of that relate to profit-taking?

Dr. Robert Kelly

This is a very interesting piece. Certainly, services inflation is much more driven by domestic imbalances. It is much more driven by what is happening here. There would be a larger wage component to a lot of that sector, for example. We would have done a piece, and may have even spoken to it at a previous hearing of the committee, where, in 2022, we looked at the composition of what is called domestically generated inflation. We would have seen then that unit profit margins were quite a large component of that. It is important to point out that this is a kind of return of capital, so it would be before taxation or repayment of interest on debt and things like that. It is very important to understand exactly what that is. Then we would have spoken to a point that said that, in our expectation for inflation to be on the downward path we referred to then, we would expect that wage demands and compensation for employees would be absorbed to some degree by these unit profits. We repeated that exercise in the most recent quarterly bulletin and we see in 2023 that while unit profits are contributing to inflation, it is below its historical norm and they are clearly doing a job of absorbing some of what we are seeing, along with increases in labour productivity.

An Leas-Chathaoirleach

I understand that a memorandum on the revised EU fiscal rules was brought to Cabinet today. What kind of impact will these rules have on our own ability in terms of expenditure on public service and infrastructure? Certainly, monitoring the work of the European Parliament earlier on this year and the work our own social democrats group did, it seems that some of the lessons from the austerity period have been learned and that there is more latitude now for member states to invest, at the appropriate time, their own resources in areas of the economy and in infrastructural delivery and so on that require support, mainly climate mitigation and, arguably, housing. Would that be Dr. Kelly's assessment?

Dr. Robert Kelly

In essence, when we think about those rules, the concern we may have, as a better way of putting it, is that they are anchored in GDP, which provides that they are not a good way of thinking about the resilience-----

An Leas-Chathaoirleach

Certainly in an Irish content, it is not.

Dr. Robert Kelly

Exactly, and it is very different for other countries. The spending framework which was established a couple of years ago is part of it and will be a guiding light. That is the right thing and we should definitely think about how that is a good way of thinking about the mix of expenditure. However, I would agree with the Leas-Chathaoirleach. What the economy needs most right now is to think about the investment mix within that and ultimately taking actions that will increase the capacity of the economy over a couple of years. Whether that is public infrastructure or to his point about climate transitions so that it does not necessarily accrue a large cost in a couple of years, we need to think about front-loading some of that and trying to unlock private capital. What do we mean there? Maybe the State can spend on the infrastructure rather than the delivery of housing to ensure it can be delivered in certain areas by private capital. The State will always have a role in the delivery of housing but it is understanding what investments get us the most capacity back.

An Leas-Chathaoirleach

The view of the Central Bank prior to budget 2024 and the post-budget assessment was that the measures announced in the budget, reflected in the Finance Bill and in the expenditure programme, were at least mildly inflationary. Would Dr. Kelly still stick to that position?

Dr. Robert Kelly

Regardless, our view is we have created domestic spending room. The credibility we can even build within that is invaluable to the State. The previous budget went above that. To the fact that relative to sticking within that rule, the measures did create inflation. We did a counterfactual exercise to understand the extent of it but we would still feel that relative to sticking within the spending framework, it was somewhat inflationary.

An Leas-Chathaoirleach

Dr. Kelly makes the point in his presentation, and I think he was being optimistic, that most of the remaining non-core expenditure items will be wound down by 2025. Obviously, there are political decisions that will have to be taken but is the advice of the witnesses as economists that what at least is described as non-core expenditure would be wound down by 2025? They are the political implications. It is unlikely, frankly. Our own assessment would be that this is probably unlikely but that is a question for Ministers and not economists in the Central Bank. I fully appreciate and understand that. Is it a bad idea to present areas of expenditure as non-core expenditure when they have been repeated so many times and some are likely to remain as expenditure items on the books for the next few years?

Dr. Robert Kelly

This is necessarily our view the Leas-Chathaoirleach is articulating. It is not necessarily what we see that is potentially in non-core spending now. We would have to think about a pandemic support at this stage a number of years later. If we, and the members as Government, understand there are certain areas, households or firms that need support for a given reason, it is about moving it back into core expenditure and back in under the rule and being honest about it. Essentially, it is treating it as exceptional.

An Leas-Chathaoirleach

I will have to leave the meeting now for a few moments and I ask Deputy Conway-Walsh to take the Chair. I invite Deputy Patricia Ryan to make a contribution now if she is available.

Deputy Rose Conway-Walsh took the Chair.

Deputy Patricia Ryan

I thank our guests. I will ask two brief questions. With regard to the ECB interest rates and any reductions, what measures will the Central Bank consider to force vulture funds to pass on the reductions to those who have mortgages?

Dr. Robert Kelly

Just so I understand the Deputy's question, is she asking, in the event we see policy rate changes, how they will transfer through to mortgage holders?

Deputy Patricia Ryan

That is correct.

Dr. Robert Kelly

There are three categories here. First would be what people locally call the trackers. They are a set of mortgages which essentially are tied within their contracts to the policy rate. If there is a change in the policy rate, those will feed directly in within a matter of weeks, the same as when we saw rate increases. There is another cohort of mortgages which are fixed. They will not reflect the changes at all until the fixed rate period ends. Then the final category is what is called the standard variable rate, SVR, cohort of mortgages and there it would be at the discretion of banks as how changes would be passed on. What we saw on the way up was, when we think about the level of change in the policy rate, the same magnitude was in no way reflected in the SVR rate. We saw some of the change pass through but it was not a direct one for one. It is hard so say what we would see necessarily on the way down. That is a commercial decision for a bank.

Deputy Patricia Ryan

Okay. It is just we have so many people who are put to the pin of their collar currently with vulture funds and many of those people are getting older and their mortgages are quite lengthy. I am concerned for their needs because a lot of people, as they age, are going to have to sell their homes and perhaps not be able to stay in them.

Dr. Robert Kelly

Yes. Dr. Martin O’Brien may want to come in on that in a moment. I fully appreciate in individual cases this could definitely be the case. This is piece on which we have been doing more and more work, to understand not necessarily what we focus on in the aggregate but, underneath that, the distribution of what is happening in individual households is really important. However, and my consumer colleagues will be able to speak much better to this, we have a robust consumer protection framework and mortgage supports. There are potential avenues there for individuals who are experiencing mortgage distress. I do not want in anyway to come across as saying that, with policy rates coming across, there are not individual cases where mortgage holders would need to engage with their lenders to understand the level of distress. Taking it even a level back and going back to what we talked about regarding the labour market, one thing which would be quite significant that we expect to happen over the coming years is that the level of wage growth will once again exceed inflation, and this may happen for the first time in a generation of many of the workers we currently have in the workforce. They experienced a period whereby inflation was much greater than their wage growth.

They were looking at their purchasing power. To the Deputy's point, they were still trying to buy the weekly shop and pay debts. They felt quite a lot of pressure. I can only imagine how a number of households felt. What we expect to happen is to see a resumption in households' purchasing power growing again with the expectation, as the Deputy said, in the market where we might see policy rates coming down. Therefore, the outlook is quite a bit different from what we have seen over the last two years.

Deputy Patricia Ryan

I thank Dr. Kelly. Does the other gentleman want to come in on that?

Dr. Martin O'Brien

No, that is fine. Dr. Kelly covered it well.

Deputy Patricia Ryan

Okay. I want to ask Dr. Kelly about Ireland's ageing population and how things are becoming increasingly more age-related. We are looking at directly increased State pension costs and further pressure on age-related services, including health. What measures could the Central Bank of Ireland envision to mitigate the increased costs? Would a higher taxation of so-called vulture funds be a consideration?

Dr. Robert Kelly

How governments think about the trade-off between spending, even when they think about future spending and tax and revenue-raising measures now, that balance is something they need to think about where they want the incidences of tax to fall. That is one for them to consider when it comes. I very much agree with the Deputy's point that we have this ageing population. We have looked at this. There are definitely signs that as we progress through the next decade, we are going to have higher and higher levels of dependency on the State.

The future Ireland fund and the way in which that was created actually finds a nice balance between two things, one of which is the excess corporation tax receipts we talked quite a bit about. We need to build a resilience and not allow them become part of core spending because if, for any given reason, they were to stop, we would have an instant problem. At the same time, we should build up a fund, such as the future Ireland fund, building resilience, which speaks to the Deputy's point. We will have an amount of funding so that when we see this demographic shift happen, it can help support it. As I said, when we look at the Department of Finance's scenarios, it does not necessarily cover all of them, but it certainly makes inroads in terms of what will need to be provided for in the future.

Deputy Patricia Ryan

I thank Dr. Kelly.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

Do any other members wish to contribute? I will ask Dr. Kelly a couple of final questions. How important are interest rates on the investment levels? How important is it that the European Central Bank, ECB, is not too slow to bring interest rates back down in order to protect the investment levels?

Dr. Robert Kelly

In essence, of course, policy rates and lender rates are very important for investments because, essentially, in finance speak, it changes to what is called a hurdle rate, so the amount of investment has to realise to cover the cost of it. It is, therefore, quite important. We did a piece of analysis within the bulletin and looked at SME firms and how they have responded to this higher interest rate environment. What we saw there, and one would expect this as a transmission effect, is that they decrease the loans that may be more long-term lending, which are for investment basis. What we have seen is maybe a uptick almost perfectly offsetting in terms of their short-term liquidity needs. Therefore, in some ways, this is monetary policy in action. It is about deferring investments. It is about slowing demand and allowing the economy to slow. This is exactly why, as we return to that medium-term stability in terms of a 2% target, the ECB rates will move slowly out of restrictive territory as it sees that horizon coming and it will then undo some of the features of a more restrictive interest rate environment, such as less investment spending.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

Do we know how many fixed-rate mortgages are due to end this year?

Dr. Robert Kelly

Yes, my understanding is that is roughly 10% of mortgages. There are approximately 750,000 mortgages, so approximately 70,000 will come off the fixed rates this year.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

It is 750,000.

Dr. Robert Kelly

That is the total number of mortgages, so about 70,000 mortgages would be coming off.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

It is 70,000, okay. Do we know what they had been fixed at or-----

Dr. Robert Kelly

We can certainly use the likes of the credit register to understand that. There have been piece of work to understand what rates they are at relative to others. This is an important point. When we look out a year or two from now when some of these fixed rates will be falling off, it will be the prevalent rate available within the market versus if they had fixed rates at various points in the past. Therefore, some people will experience an increase. Of course, all increases are difficult for households to absorb. Some will see significant increases and some will see less significant increases. We can look at the rates there, but it would be very much as we go out six months from now looking at what the market rates are that they will transfer to or that will potentially be open to them.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

In terms of our over-reliance on foreign direct investment, FDI, and the small number of companies, were there to be changes in taxation policy in the US following an election or whatever in increasing the amount of tax on earnings abroad, what impact will that have?

Dr. Robert Kelly

Certainly, any factor that may potentially change the tax dynamic for firms operating here is potentially important. Let that be political. However, the reality is also that there are potentially a small number of firms, it is less than ten. They could take a business operating decision to change how they organise their tax and it could easily happen. Is there political risk? Yes. People talk about that. They will talk about the base erosion and profit shifting, BEPS, process, if we were to have the first pillar of that, and what that would mean in terms of tax and where tax would potentially be paid. Ultimately, it is even more narrow than that. We could see certain companies change how they approach paying their taxation and where they pay their taxation could have a big implication. That is how we keep citing this. Are these excess corporation taxes bad? No. They are a great asset to the State if one thinks about building and in some ways it reflect a very successful model. We just need to be very careful we do not become dependent on them day-to-day and create a risk for ourselves. If that were to stop, we would have to do very sharp cuts in spending to match it.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

Are we doing an assessment on the impact of BEPS? The previous one was done in 2017 in terms of the €2 billion it may cost. We obviously need an up-to-date assessment on it. Do we have an up-to-date assessment or is that in the pipeline of being done?

Dr. Martin O'Brien

My understanding is the Department of Finance will be undertaking such an assessment again. I do not have any further details with respect to that. There has been no update since that exercise, which I think quantified about €2 billion of a hit with respect to pillar 1 and another range of hits with respect to the other pillars. However, the Department of Finance would ideally carry out an assessment in that regard.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

The Central Bank must have an opinion on how important it is to have that done so that we know how much it is likely to cost.

Dr. Martin O'Brien

Undoubtedly. It speak specifically to the key risks that lead to the appropriate creation of things like the future Ireland fund, ICLF and things like this and more generally to this point around not just the hits in terms of the potential hits from BEPS or other issues, but appropriately categorising what these excess taxes are and linking that appropriate evaluation through to the kind of quantum of funds we would need to maybe put into the funds to support future spending, whether that be on ageing or other issues. That is certainly something that does need to be reflected on in a little bit more detail, in addition to the updated assessment on what the potential costs with respect to the BEPS process may be.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

I will mention two things on the constraints of FDI and growth and production in infrastructure. How important is it that we account for inflation in the spending on the national development plan? We had mention of €2.5 billion per year that is behind €19 billion after 2030. How concerned would the Central Bank be about that in terms of the impact of not being competitive in investment in infrastructure?

Dr. Robert Kelly

In terms of inflation, the Deputy's point is very well made. It is about the real level of investment that can be put in. We often talk about these in nominal terms. When we look forward, if we look at our inflation forecast, we do very much see it returning to that trend of 2%, which people might think is quite normal and planned. The real challenge is that we have seen a level shift in pricing that we do not expect to dissipate fully. We expect more modest growth rather than a downward curve. Therefore, some of what we are seeing is maybe some of the more acute price increases we saw due to supply constraints. We might look at energy or even some of the construction materials, for example. Some of those were real supply chain bottlenecks and when they are unwound, we might see faults, but we do not generally expect it across the economy. Therefore, it is very important to account for how much less real investment we get in terms of volume for that effect that came. That is part of some of the analysis we have seen done by the Department of Finance as we look out at what that cap will be.

Dr. Martin O'Brien

In the context of prioritisation, it is possible to prioritise the delivery of certain investment projects that would sort of overcome - not necessarily fully overcome but alleviate - some of the issues and challenge around the constraints. If we are particularly constrained in a particular area, whether it be labour or whatever the case may be, the ordering and prioritisation of public investment that could be done does not necessarily need as much of that particular input or resource. That can help alleviate the issues with respect to the higher prices. There is also the fundamental higher level of the price level.

Equally, when we think about the overall balance of capital expenditure versus current expenditure within the overall boundaries we should have around the expenditure rule and things like that to make it sustainable in the longer term, it behoves us to consider if some perspective should be given to the relative balance between capital expenditure and current expenditure in how that evolves over time. I refer to ensuring sufficient and necessary levels of investment in public infrastructure, in housing and things like that, are achieved.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

One of the biggest constraints pointed out to us by business is the lack of housing and the housing crisis. Looking at the target of 30,000 units, we know, and have known for a long time, that this is kind of meaningless in terms of what we need to do to address the legacy that exists in this area. How concerned would the witnesses be about this aspect? How important would they think it is that these housing targets would be more realistic in terms of meeting demand and ensuring stability?

Dr. Robert Kelly

That point is very well made. In essence, what we are talking about here is the capacity of the labour market to grow. When we bring this aspect right down to the essentials, this is what someone having somewhere to live comes down to. We undertook an exercise some years ago that came up with a number in the mid-30,000s as the demand. Within that, though, we would have had scenario analyses that would have examined factors such as migration patterns and household formation numbers, for example, as well as headship rates within households. We have seen that the estimates we would have had are on the upper regions of those figures. If we were to look at how we would think it has played out, we would be talking about the mid-40,000s to mid-50,000s as being the range of what we would see as being needed in terms of housing delivery now.

When we bring this aspect back to the public finances, we do see a continued increase in the delivery of housing. This will be up towards 37,000 units by the end of the forecast horizon. The real challenge, though, is how we can make this figure jump up another 10,000 units. I really do think this aspect speaks to what Dr. Kelly said concerning the need to think about prioritising developments. One problematic aspect we are constantly seeing, and I am not necessarily an expert in this area, is with the provision of water in our cities. We cannot build houses if this infrastructure is not in place. There are also other elements that may be seen as frictions within the system. I refer to the time and length of the planning process, for example, and delays in the planning system. All these elements, essentially, add to the cost and slow down the delivery of housing. I think, therefore, that there is a financial element involved and this will also be a part of this context. Equally, however, these enablers I spoke of and removing frictions in the system are what is really required to allow us to start thinking about how we can make this jump up to providing an additional 10,000 units annually.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

Of course, it is not just about having places for people to live, as greatly important as this need is. It is also a matter of the escalating rents, which leave less money in people's pockets to spend in local economies and the knock-on impact of this reality.

Turning to human capital and the labour force, looking at an all-island approach to human capital and investment in education and mobility and having a more aligned approach to the development of human capital across the island and thus increasing our base there, what would the witnesses have to say on this point?

Dr. Robert Kelly

I do not think we necessarily looked at an all-island approach to this matter. In a general sense, though, what is needed in terms of increasing the capacity of the State, and what Ireland has been quite good at, is having a very well-educated workforce and one that is deployable. I refer to what economists call "high-value-add" items, within the multinationals, for example. This is what has been exceptionally successful for Ireland. Regarding some of what the Deputy has said around housing and rents, etc, yes, there are capacity constraints there, but the key to addressing this context is having a labour market that is dynamic and well-educated. I refer as well to our legal system. All these things are very attractive when it comes to foreign direct investment.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

Obviously, though, increasing our labour force makes sense across the island as does removing the barriers and restrictions in this regard to offer mobility to workers and opportunities for students to study across the island. Investment in education is not going to impact inflation, so investment in our human capital is, therefore, very important. Moving to the point on the number of workers working part-time hours, this situation would point to many workers not being able to do extra hours because they cannot afford to lose a medical card or other essential supports they might need to be able to live. I refer as well to women and families in terms of childcare and going back to participate in the workforce. Investment in childcare there is important.

Dr. Robert Kelly

Enablers to increase the level of participation in the workforce are definitely a net positive for the economy. When we look at that cohort, though, I see this context slightly differently. These are people who are declaring they are available and want more hours, so they do not, necessarily, see a blockage to wanting more hours. Potentially, some of the points mentioned are playing out there, and I am not for a moment denying that. These are aggregate statistics. They do, however, suggest to me that there is a cohort of people who would be willing to work more hours if these were available.

An Cathaoirleach Gníomhach (Deputy Rose Conway-Walsh)

There certainly are, but there are certainly people who cannot because of the way the welfare and taxation system is designed. We need better congruence in this regard. We will leave it at that for today, unless anyone else online would like to contribute. No one wishes to. I thank everyone for their contributions.

The select committee adjourned at 6.46 p.m. until 5.30 p.m. on Wednesday, 10 April 2024.