The following OECD assessment and recommendations summarise Chapter 7 of the Economic Survey of Ireland 2006 published on 2 March 2006.
The key domestic risk is the housing market. In the past decade, house prices have risen faster than in any other OECD country: average prices have roughly tripled in real terms. Most of this increase is justified by the economic and demographic driving forces such as surging incomes, a rising population and changing living habits, with an additional fillip from low interest rates, but prices may have overshot to some extent. However, this does not imply that they will fall significantly: the housing market is not symmetric, and during a downswing people prefer to take their house off the market rather than sell at a loss. Thus, the most likely scenario is that prices will level out or decline slightly, housing construction will fall back gradually, turnover will decline and the market will remain subdued for some time. But even in such a scenario, government receipts would weaken sharply, so that a substantial structural budget deterioration would come on top of any cyclical weakening.
House price growth remains high
1. Nominal prices deflated using the harmonised consumer price index (base 2005).
Source: Department of the Environment, Heritage and Local Government, Quarterly Housing Statistics and OECD, Main Economic Indicators database, February 2006.
What could happen in the housing market?
While this is the most likely outcome, there are alternative scenarios on the upside and downside that could have significant macro-economic implications. The first is that the housing boom may not run out of steam of its own accord, leading to serious overvaluation and imbalances throughout the economy. The eventual fall-out in this scenario could be severe. With monetary policy now set by the European Central Bank, taxation is the main policy lever left to influence the housing market. Ireland’s tax system is significantly more favourable to housing than in most other OECD countries. To avoid the chances of this scenario unfolding, the government should avoid any tax changes that make housing more attractive; indeed, the tax bias should be phased out over time. Aside from not fuelling the housing market, there are efficiency and equity reasons for reducing the tax advantages. A property tax could be introduced to help fund local infrastructure. This would also redistribute some of the windfall gains that accrue to people living close to new roads and public transport links and shift the cost for local services such as water and sewerage facilities so that businesses and households each pay their fair share. While this makes economic sense, in an Irish context where over 80% of the population own their own homes, it is currently seen as a non-starter. The second scenario is that house prices fall sharply, either because they are more overvalued than they appear or because a negative shock hits the economy. The impact on activity and the budget could be large.
Go to Chapter 8
Return to the Economic Survey of Ireland 2006
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For further information please contact the Ireland Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by David Rae and Boris Cournède under the supervision of Peter Hoeller.