The Irish Economy Amid Brexit and US Trade Wars — Inflation-Unemployment, Tariff Welfare and Policy Options

Answers

(a)(i) CPI vs unemployment trend [2] — compare

The two move inversely: CPI rose while unemployment fell. In extent, the CPI’s rise was very slight whereas the fall in unemployment was steep.

(a)(ii) Explaining the relationship [4] — explain

A buoyant economy raised consumption (up 2.9%), shifting aggregate demand right (AD₀→AD₁). National income rises, so firms demand more factors including labour — unemployment falls. As the economy is not yet at full employment, the price level rises only slightly.

Rising consumption shifts AD right (AD₀→AD₁) in the intermediate range; output rises Y₀→Y₁ (unemployment falls) with only a slight rise in the price level — the inverse CPI-unemployment relationship.

(b) Impact of the US-China trade war on Irish firms [3] — analyse

Through derived demand: the US 25% tariff on Chinese electronic devices reduces those Chinese exports. Since over a third of Ireland’s semiconductors are exported to China as components for those devices, the fall in Chinese device sales reduces demand for Irish semiconductors — lowering their price, quantity and hence total revenue.

(c) Effect of a tariff on UK imports on consumers, producers and society [8] — discuss

A tariff is a tax on imports that raises the price from the world price P to P+tariff.

A tariff raises price from P_world to P_world+tariff: domestic supply expands and imports contract. Consumers lose surplus (areas under demand between the two prices); domestic producers gain surplus; government gains tariff revenue (central rectangle); society bears the two deadweight-loss triangles.

Consumers lose: higher prices and lower quantity, a loss of consumer surplus; Extract 8 estimates a 2-3% price rise and €892-€1,360 higher annual bills. Producers gain: domestic output and price rise, raising revenue and producer surplus. Government gains tariff revenue. Society loses the two deadweight-loss triangles. Additionally, if Irish producers source inputs from the UK (23% of imports), the tariff raises their costs — cost-push inflation that curtails output and employment and raises the cost of living. Judgement: the tariff contradicts comparative advantage, sustaining inefficient producers; the Department of Finance projects Ireland 4.5% poorer in ten years. On balance Ireland loses, the more so in the short run, with the long run depending on how it manages its trade position.

(d) Two reasons for worry [3] — explain

First, declining US growth: as US growth dissipates, Irish exports to the US and US investment (FDI) in Ireland fall, lowering AD. Second, Brexit uncertainty: it constrains investment and has knocked consumer confidence, lowering C and I. Both cut components of AD, lowering national income.

(e) Policy options to mitigate the external threats [10] — assess

The external threats — falling exports, US FDI withdrawal, and tariffs (raising costs) — lower AD and/or raise costs, hurting growth, employment and prices.

Demand-management policy. Expansionary fiscal policy (higher G, lower income/corporate/consumption taxes) raises C, I and G — and tax incentives could induce American pharmaceutical firms to stay rather than relocate. Expansionary monetary policy (lower interest rates) raises C and I. Both lift AD and, via the multiplier, national income. Limitations: effectiveness is bounded by the multiplier; fiscal policy is constrained by the budget and risks crowding out; and, crucially, Ireland is in the EU, so monetary policy is set by the ECB, not unilaterally — and weak confidence from Brexit and the trade war may make C and I unresponsive, with a possible liquidity trap.

Supply-side policy. R&D grants and subsidised education and training raise productivity, lowering unit costs to offset tariff-driven cost rises and raising SRAS/LRAS for growth. Limitations: heavy expenditure with high opportunity cost, uncertain R&D outcomes, and long time lags — ineffective in the short run.

Trade and diplomacy. Trade diversification toward other markets, and negotiating easier post-Brexit border arrangements with the UK to lower the cost of routing exports through the UK landbridge to Europe. Limitation: requires diplomatic cooperation with the UK and others.

Judgement. With a domestically healthy economy (Extract 6), Ireland has room to use demand-management policy to support C and I. But the source of the threat is largely external and beyond Ireland’s control — tariffs under Brexit or US-EU disputes are EU-level matters, and monetary policy rests with the ECB. The most controllable lever is diplomacy: negotiating border arrangements with the UK to pre-empt Brexit disruption. In the long run, however, Ireland’s exposure to tariffs it cannot set may force a strategic reconsideration of how its EU membership and trade position shape its economy — so no single policy suffices, and the optimal response combines short-run demand support and diplomacy with long-run supply-side resilience.