THE ‘R’ WORD has been back in the business headlines lately, with some economists forecasting another major economic downturn in Ireland.

Some of the impacts of Ireland’s last recession are still apparent now and although the economy was showing significant growth before the pandemic, the uncertainty of the last two-and-a-half years, as well as the outbreak of a war in mainland Europe, is causing concern.

But are we really heading into a recession – and what would that look like in 2022?

This week our The Explainer podcast asked that very question. We were joined by Stephen Kinsella, Head of the Economics Department at the University of Limerick and Chief Economics Writer with The Currency – here’s what he had to say.

What is a recession?

Kinsella said there are a number of meanings to the word ‘recession’:

•  The most technical definition is a two quarter decline in Gross Domestic Product (GDP). That’s a measure of the value of all goods and services sold in a given period. So, if the economy produces €100 worth of output in one quarter, then just €97 in the next and €96 in the one after that, the economy is technically in recession.
• The slowing of economic activities such as sales, consumption, house purchases, investing, production. 
• A feeling that things are getting worse. An economy could be doing well, GDP may be growing, but prices are also rising so consumers are still worse-off. So, the rate of growth of the economy could be 2% but prices are rising by 5% and consumers are still 3% worse-off. 

What caused the last recession?

The last banking crisis was caused by excessive amounts of bank credit, Kinsella explained. 

“Banks were able to borrow at very low levels from abroad, that allowed them to sell loans to everyone in Ireland, we bought and sold bits of the country to and from each other. And that raised the amount of credit that everyone had and the amount of economic activity that everyone had.

“The government responded by lowering income taxes and lowering all other kinds of taxes, supporting the economy on the basis of stamp duty, which is basically transaction taxes from those sales.

“Eventually, the international banking system was so over leveraged – had lent out so much money – that there was simply no more left to give. And then the Irish banks, instantly starved of this foreign capital, were pretty much insolvent, meaning the value of their assets and the value of their liabilities was totally different.

“The State then had to step in to make things better for the for the banks, and to protect all the loans and deposits that have been given out. In so doing the state found itself insolvent.”

Kinsella said this pushed the economy into “really serious trouble” and the government had to to enter an IMF, European Commission, European Central Bank bailout.

Years of austerity followed, until 2014 when the economic started rapidly growing again.

Why are people taking about the ‘inverted yield curve’?

A yield is a percentage return on a bond, which is like an IOU. The ‘yield curve’ is a representation of the percentage return on bonds (the yield) and the time remaining until those bonds mature.

Every so often that curve on the chart inverts.

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“What is happening there is the market is saying, okay, alright, it looks like the US economy is going to go into a recession in, say, two years’ time,” he explained.

“So if you thought that was going to be the case, what you would do is you would buy or sell US bonds, depending on what you thought was going to happen to the US economy.

This changes the percentage return on those bonds. When that curve moves quickly, Kinsella said that is a “pretty good predictor of the US economy and other economies going into recession”.

It has been a good predictor of recessions over the last 30 to 40 years, he said – and recently the yield curve has inverted. 

The European Central Bank recently raised interest rates – how does that tie into all of this?

The Eurozone inflation rate is running above 8%. The ECD has a legal mandate under the Maastricht Treaty of keeping inflation at around 2%. The purpose of raising interest rates is to depress demand and prevent the rise of inflation. 

However Kinsella said it is not clear that the interest rate hike will have the desired impact and it may actually induce a recession because people may decide not to borrow. 

The President of the ECB has stated that if inflation does not calm down, interest rates will continue to rise. 

How is Ireland’s economy doing?

Kinsella said Covid was a “serious shock” to the economy as it forced the government to “borrow hugely” to support the household and firm sectors.

He said it was an “incredible piece of policy success” that at one point during the pandemic the State was suporting more than one million people every week.

We are now saddled with a lot of Covid-related debt, but a lot of it is “quite cheap” debt.

The economy is moving into surplus, meaning we are spending less than we are taking in, which Kineslla said is “pretty awesome” because of the “enormous deficit” we had two years ago

All of that deficit has been closed by corporation taxes, however. The vast majority of that comes from around ten to 15 companies.

This means one of the main risks to our economy is a slowdown in the international economy. 

The departure of one of the major multinationals would “devastate” the Irish economy, he said.

Another risk relates to the European energy system and the potential increase in the price of fuel.

The economy is in much better shape than it was in 2008, banks are well capitalised and the extent of credit in the economy isn’t as bad, Kinsella said. 

How significant a role is China’s zero-Covid policy playing?

This policy is having a major impact on supply chains and it could cause problems for Christmas, Kinsella said.

“Right now it’s July, and a lot of the stuff that’s being produced for Christmas is actually being manufactured now,” he said.

“And so whatever the next Christmas toy, the Cabbage Patch, kid of 2022, is being manufactured in the factory in China right now. Whether there will be extreme shortages of children’s toys for Christmas is actually an open question right now.”

He said shortages caused by lockdowns in China mean products cannot be bought and sold and that means no taxes coming from those products. And, we don’t have “as much stuff to buy”, prices will increase, that is how supply and demand works. 

What about the war in Ukraine?

This is having an impact in two ways:

• Ukraine is a huge exporter of food – though we don’t import a lot of food from there and much of Europe’s food does not come from Ukraine. But the rest of the world relies on Ukraine more. If Egypt, for example, is trying to buy grain on the international market because it can no longer source it from Ukraine, that pushes up the price and means products like bread all across the world are more expensive, even in Ireland. 
• Restrictions on the price of gas and oil are expected to continue into winter and possibly into the new year. That would vastly ramp up the impact of a recession, because the price of the main input into many productive processes (oil and gas) will be rising. People will still need to put fuel in their cars and use it to heat their homes, but it will be more expensive. One positive, Kinsella said, is that because of the Covid pandemic many workplaces are set up for remote working and a reliance on that over the winter months may offset the impact of this. 

What could be the longterm fallout if there is another recession?

Kinsella said he has spoken to most members of government and they understand the “deep and abiding need not to short-term cut capital expenditure” such as building roads, hospitals etc.

A large increase in the use of technology could be one longer-term impact. 

“If Covid taught us anything it’s that we can transact much of the business of the State, and much of the business of our lives, electronically,” Kinsella said.

“I think if we have a situation where it costs a fortune to move around the place, we will simply move less.”

He said he does not believe we will see the return of austerity. 

“I think we’ve realised that austerity does nothing except create anger and populist policies that give us things like Trump and Brexit – and nobody wants another Trump or another Brexit,” he said.

“So I think everyone’s realised you can influence policies to make government borrowing cheaper, that will mean that governments can continue to do what they need to do.”