Opinion: increased spending by the Government when the economy is operating near capacity increases the price of goods and services
Nobel Prize winning economist Milton Friedman once said that "inflation is made in Washington because only Washington can create money". Friedman was referring to the fact that the price of goods and services goes up because of changes in the money supply. Government spending can increase the money supply via what economists call velocity. This is where money injected into the economy can circulate through multiple transactions, increasing the growth in the money supply relative to productivity which can produce inflation.
This is exactly why the Irish Fiscal Council Advisory explicitly warned the Government not to breach their own spending rule of 5% for fear of the upward pressure it would place on domestic prices. Guess what the Government did anyway in the recent budget? Yet again we saw a budget used as a vote-winning instrument rather than an effective means of managing the long-term interests of the Irish economy and its citizens.
The Irish Fiscal Council Advisory noted that the Irish Government had engaged in a net spending increase of 9.2% for 2024 and 5.8% for 2025. They also observed that the 2025 growth rate could rise to up towards 8.8% given the further potential €3 billion from the sale of AIB shares which could be spent on capital for the Land Development Agency, Uisce Éireann and EirGrid. All in all, this means the Government have done as they have since 2022 and broken their 5% net spending rule
The issue with overspending at the moment is that the economy is operating very near capacity. This can be seen in the steady increases we have had over the past few years in employment (see below). This meant that we had a record number of jobs at the time of the budget which meant we also had a record number of citizens with incomes to spend on goods and services.
Further increases in spending from the Government at a time like that ensures that the growth rate of the money supply will exceed the growth rate of productivity because there is less room for gains in productivity given the record high employment rates. Consequently this will see a further increase to the price of goods and services, which could exacerbate the cost of living crisis.
Growth in the Consumer Price Index for Ireland was recorded at 0.7% between September 2023 and September 2024 which was down from the annual increase of 1.7% recorded a month prior in August. This was a good sign because it meant that the growth of prices were beginning to slow, which would have helped to reduce the growing cost of living.
But further Government breaches in spending is just going to add fuel to this fire. What's more frustrating about this is that Minister for Finance, Jack Chambers, knew this was the case because he stated in September that the Government would not repeat the mistakes of the past. Well they have!
It seems that the Irish Government is forever to be torn between managing the cost of living and the use of excessive Government spending to buy votes. Furthermore, the Government doesn’t even seem to be using the money they are spending wisely.
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From RTÉ Radio 1's This Week, reporter Gavin O'Callaghan looks at how people are coping with the cost of living crisis
The continuation of the Help to Buy scheme until 2029 is a not-so-lovely example of how the Irish Government are happy to see further upward pressure placed on house prices by simply giving people money to buy unaffordable accommodation thereby further facilitating those high prices. A more preferable strategy would see Government spending redirected towards increasing the supply of houses, which would reduce the cost of accommodation across the board.
Unfortunately, it seems to continually be the case the short-term interests of politicians are never aligned with the long-run interests of the economy and its citizens. The old proverb about people willing to plant the seeds of trees which they may never get to sit in the shade of comes to mind when you look at the Irish economy.
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The views expressed here are those of the author and do not represent or reflect the views of RTÉ
