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Varadkar and Martin accept Central Bank warning on budget spending

Varadkar and Martin accept Central Bank warning on budget spending

The Taoiseach and Tánaiste have accepted advice from the Central Bank that the Government needs to be cautious that budgetary policy does not fuel further inflation.

Across the euro area, inflation is now at 6.1 per cent, down from a peak of 10.6 per cent in October 2022.

In Ireland it is now down to 5.4 per cent, according to the flash estimate released by the CSO on Wednesday, down from 9.6 per cent last summer.

Central Bank governor Gabriel Makhlouf said that if fiscal policy adds to aggregate demand in the economy, then monetary policy interest rates “will have to work harder” to bring inflation back to target.

He said when inflation is already “far too high”, expansive fiscal policy risks undermining monetary policy, primarily by increasing aggregate demand but also by signalling that the Government is counteracting the effects of policies aimed at reducing inflation, potentially increasing inflation expectations.

“With the underlying strength of demand conditions in the economy as a whole, now is not the time for the overall fiscal position to be adding more money into the economy through government spending than it is taking out through government revenues.

“If fiscal policy adds to aggregate demand in the economy, then monetary policy will have to work harder to bring inflation back to target.

“High inflation imposes enormous costs on our society. History has shown that the costs of bringing down inflation are likely to increase if monetary policy action is weak or delayed.

“A period of restrictive monetary policy is now needed to stem inflation and return it to its 2% target in the medium term.

“Fiscal policy can and should help by avoiding boosting aggregate demand, holding back supply, or raising prices and, of course, by supporting structural reform to meet the challenges of the economic transitions – climate change, ageing society, in particular – that our communities are facing.”

Mr Makhlouf also said more interest rate increases from the European Central Bank are likely.

Taoiseach Leo Varadkar said the advice on Government spending is “correct”.

“Inflation is now coming down. It was not far off 10 per cent last year, its now in around 5 per cent so I think we’re successful in bringing inflation under control.

“Although, it needs to come down further and despite the fact that we had a very generous budget last year, or at least a budget that put a lot of money back in people’s pockets, inflation did come down so it’s still possible to have a good budget and bring inflation under control.

“We do have to be wise to the fact that anything we do in terms of increased spending, increase pensions, increase pay, increase welfare, lower taxes that could potentially fuel inflation, but it’s about getting the balance and the mix right.”

Speaking to reporters at the Bord Bia Bloom gardening festival in Dublin, Mr Varadkar said there was a danger that putting more money into the economy would further drive inflation.

“But what’s the counterfactual? If you don’t do those things, people’s living standards fall, we don’t have the public infrastructure that we need and public services suffer.”

Speaking to reporters at the same event later in the day, Tánaiste Micheál Martin said Government was “absolutely” aware of the risks of fuelling inflation.

He said controlling inflation at a European and Irish level is “vital”.

“We’ve got to get a handle on it. It’s coming down, projections are for 2.5-3 per cent by the end of next year, that’s good.

“Because we don’t want to continue to be chasing our tail in respect of inflation. We have to be sensible about our policies, notwithstanding that we have surpluses.

“I think we can be strategic in terms of the investment in infrastructure that will be required into the future in terms of the need to expand some public services to cater for the growing population.”