Modelling Overheating Risks in the Irish Economy

Thomas Conefrey, Gerard O'Reilly, Graeme Walsh and Luca Zavalloni
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Luca Zavalloni: Central Bank of Ireland

Quarterly Bulletin Articles, 2019, 96-121

Abstract: The Irish economy has recovered at an impressive pace from the economic and financial crisis that began in 2008. In the absence of adverse shocks such as a disorderly Brexit, continued strong growth and further declines in the unemployment rate could result in the emergence of overheating pressures. In this paper, we explore overheating risks in the Irish economy using the Central Bank’s macroeconomic models. We illustrate that rising wages in an upturn could lead to boom-bust dynamics if wages are not flexible downwards when the buoyant economic conditions dissipate. We demonstrate how migration can play an important role in mitigating overheating dynamics in the labour market, while at the same time creating higher demand and additional pressures in other parts of the economy. Although this presents policymakers with difficult tradeoffs, appropriate macroeconomic management can help navigate these challenges while keeping the economy on an even keel. In particular, in the event of continued net inward migration and further expansion in construction activity, fiscal policy can be used to manage excess demand in the economy. This can help ensure that the required level of housebuilding can be accommodated, without placing excessive strain on an economy already operating close to capacity.

Date: 2019-07
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