13 December 2022
The latest Economic Outlook, Confronting the Crisis, provides a comprehensive and layered picture of the main macroeconomic risks that world economies are facing. The report is objective in characterising the difficult balancing act that governments and central banks need to perform so to contain inflation on the one hand, while avoiding that too restrictive policies provoke an even starker and unintended recession, in the process of containing prices, on the other.
Yet, despite the sober take on the risks that overly restrictive and internationally uncoordinated monetary and fiscal responses might entail, the OECD is quick to call on additional monetary and fiscal tightening.
On monetary policy, the OECD does not seem to consider the supply roots of current inflation, given the political consequences of the Russian invasion of Ukraine, which prompted most advanced economies to introduce sanctions on Russian oil and gas, driving energy market prices up and prompting countries, particularly in Europe, to search for alternative and yet currently insufficient energy suppliers. In such a context, central banks’ tools are inadequate to cope with price pressures, because they cannot address the supply side factors while only weakening aggregate demand in the process of trying, further jeopardising the economy.
While the OECD acknowledges that monetary policy has a lagged impact on inflation and that central banks should stand ready to change course in their policy action, it does not reflect its own considerations into practice. It points out instead that policy rate hikes remain thus far below inflation levels and that further increases are warranted to contain it further. Yet, most recent consumption and industrial production indicators point to a deceleration of economic activity already underway, which will most probably translate into a slowdown of inflation rates, even absent further monetary tightening. To this end, it is also worth noting that medium-term inflation expectations in major economies like the US are in line with historical trends pre-dating the current inflationary spike, therefore they should not represent a cause of worry.
Another point of concern revolves around wages. On several occasions the OECD has confirmed that there is no evidence of a wage-price spiral, and that nominal wage growth has not been keeping up with inflation. At the same time, the cautionary language used by the OECD indicates that the fear of a potential wage-price spiral, even if not supported by facts, is enough to call for containment of wages as a justifiable preventive policy measure to contain inflation. To back up this position, the OECD claims that unemployment will not rise considerably next year, despite the deceleration in economic growth, and that wage pressures will be mounting over 2023-24. The idea that unemployment will not substantially increase hints implicitly to the Phillips curve argument that inflation and unemployment have an inverse relationship, i.e. that if unemployment remains low inflation will keep rising. While the stability of such relationship has been seriously put to question over time, many economic projection models, including OECD ones, still rely on the basic assumption that a traditional Phillips curve holds in the long run.
Further to this, the OECD does not substantiate why wage pressures are expected to mount in the coming two years. It should be noted that whether higher wage demands will be met by employers does not only depend upon labour market tightness but also on the workers’ bargaining power. Decades of labour market flexibilisation and reduction in collective bargaining coverage have considerably weakened workers’ ability to demand better wages and working conditions. This is well explained in the 2022 Employment Outlook, where the drop in collective bargaining coverage is among the factors that explain the increased imbalance in labour bargaining power in favour of employers and the rising negative impact of labour market monopsony on wages and employment levels. None of this is adequately reflected in the Economic Outlook.
Trade unions in OECD economies have thus far shown great restrain in wage hike demands, bearing more than their fair share of the “cost-of-living” crisis. For example, wage growth in the US has been assessing at around 4-5% even if inflation is closer to 8% this year, despite a tight labour market. Meanwhile, in the Euro area collective bargaining agreements are either continuing to set wage growth at a moderate pace (Nordic countries, Italy) or are trying to avoid inflationary spirals, by sharing the cost of high inflation between businesses, governments, and workers. They also combine structural wage increases that align to price stability targets with lump-sum bonuses to temporarily protect workers’ purchasing power (IG- Metal and IGBCE agreements in Germany). Yet, the role of collective bargaining, which has been recognised in the latest Employment Outlook as important for both securing an equitable distribution of the cost-of-living burden and for better labour market outcomes, is completely ignored.
Regarding fiscal policy, the Economic Outlook clarified one year ago that the fiscal impact of structural reforms had to be expansionary, whereas the OECD is now moving back to a simplistic approach of deregulation and flexibilisation, including most likely, albeit not expressly stated, the labour market. As repeatedly proven, any such kind of reform performed in a period of weak economic growth and high uncertainty risks producing more damage and scarring effect than boosting a country’s economic performance, a lesson that the OECD should be remindful of.
In conclusion, it is TUAC’s opinion that the OECD should provide more nuanced policy recommendations at the current time, in line with the complexity of the present macroeconomic situation, avoiding stark monetary and fiscal contraction. This is not only ineffective in containing supply-driven inflation, but it would push economies over the brink of yet another recession.