A Brief Overview of OECD Economic Outlook: Interim Report for September 2021

Economic growth has accelerated this year, stimulated by strong political support, continued introduction of effective vaccines and gradual resumption of many economic activities, especially in the service sectors. Global GDP has now exceeded its pre-pandemic level, but output in mid-2021 was still 3.5% lower than predicted before the pandemic.

According to forecasts, the global economic recovery will continue, but will remain uneven. Global GDP growth will increase to 5.7% in 2021 and 4.5% in 2022. Economic effects of the delta variant have been relatively moderate in countries with high vaccination rates, but in other countries have reduced short-term dynamics and increased pressure on global supply chains and costs. However, according to forecasts, these factors will weaken over time, and decline in growth rates in the second half of 2021 will be offset by a faster recovery in 2022.

Consumer price inflation has also increased globally in recent months, driven by rising commodity prices, supply-side constraints, stronger consumer demand as the economy resumes and reversal of some sectoral price declines in the first months of the pandemic. Inflation has risen particularly rapidly in the United States, Canada and the United Kingdom, and even with some easing of price pressures over the next year, average annual inflation is projected to be around 2-3 percent in 2022. Annual inflation in the United States has exceeded 5% altogether, but remains at relatively low levels in many other advanced economies, especially in Europe and Asia. Core consumer price inflation is expected to remain below 2% in the Eurozone and Japan, but will increase as the recovery progresses. Among the largest emerging market economies, unexpected improvements were noticeable in Argentina, Brazil, Mexico, Russia and Turkey and are likely to continue for some time. However, tightening monetary conditions in many of these economies should help limit domestic pressure on prices, especially by the second half of 2022. Consumer price inflation in China remains moderate, despite a rapid rise in producer prices due to a sharp decline in domestic food prices.

In part, the current rise in inflation reflects underlying effects that followed the decline in prices at an early stage of the pandemic. In many emerging market economies, high energy and food prices have led to higher inflation, reflecting both strong price increases and a relatively high share of commodities in consumer spending.

Core consumer price inflation (excluding food and energy) has also increased, but in a typical advanced economy it remains at level similar to that observed before the pandemic. The recent price increases have been particularly noticeable for durable goods, where demand has exceeded supply, especially for automobiles, and in some recently reopened service sectors with intensive contact. However, in general, service price inflation remains moderate and below the medium-term policy goals for overall inflation in many advanced economies.

Short-term inflation risks are on the rise, especially if pent-up consumer demand is stronger than expected, or if it takes a long time to overcome supply shortages. Impact of past increases in transport costs and commodity prices is already significant in the G20 countries, which largely explains the rise in inflation over the past year, and is likely to continue for most of 2022, even if there are no further increases in spending. Distribution of observed price changes has shifted upward as well. An increasing share of goods in the price basket (by weight) currently has a price increase of 4% or more, especially in the United States and the United Kingdom. Share of goods with declining prices also decreased, indicating a reduction in deflation risks.

Baseline forecasts depend on the pandemic development, pace and global spread of vaccine introduction, as well as on the recovery of all economies over time.  Distribution of risks is now more balanced than a year ago, but significant uncertainty remains as well.

On the other hand, faster global progress in introduction of effective vaccines will increase the confidence and spending of consumers and companies, and will also contribute to a greater reduction in household savings than assumed in the baseline projections. In this kind of scenario, starting from the fourth quarter of 2021, when household savings rates decline by another 2 percents in a typical advanced economy, global output could fully return to the pre-pandemic path. Global GDP growth will increase significantly to more than 6.3% in 2022, and in a typical economy, unemployment will return to pre-pandemic levels. However, stronger demand will also put upward pressure on inflation, potentially boosting G20 price inflation by more than 75% next year.

Potential consequence of this scenario is that increased inflationary pressures in 2022 may raise financial market expectations for an earlier start of monetary policy normalization and create difficulties for some emerging market economies. Clear instructions from the monetary authorities that additional inflationary pressure is only temporary will help to consolidate inflationary expectations and limit the revaluation of financial markets.

Main risk of decline is that the speed of vaccine introduction and effectiveness of existing vaccines will not stop a transmission of more contagious variants of concern that then require new or modified vaccines. In such circumstances, stricter containment measures may need to be applied again, private sector confidence and spending will be lower than in the base period, and part of the capital will be written off. In such scenario, volume of production will remain below the pre-crisis level for a long period. Global GDP growth may decline to less than 3% in 2022, while G20 inflation will also fall below 3%, and unemployment will continue to rise as well.

However, faster progress in introduction of vaccines or a sharper reduction in household savings would increase demand and reduce unemployment, but also potentially increase short-term inflationary pressures. Slow progress in introduction of vaccines and the continued spread of new viral mutations will lead to weaker recovery and greater job losses.

Macroeconomic policy support is still needed, while the short-term outlook is still uncertain and labor markets have not yet recovered. Combination of strategies depends on economic development in each country. Policy makers are required to provide clear guidance on the expected path to achieving medium-term goals and the likely sequence of future policy changes to help consolidate expectations, maintain investor confidence and ensure adequate support for the economy.

More attention should be paid to medium-term goals rather than to supporting emergency policies in cases where recovery is well underway and vaccination efforts are almost complete. In other countries, where recovery or vaccination rates are less advanced and containment measures are still in place, targeted policy support is still needed to help support the demand and incomes of workers and companies in intensive contact sectors.

Accommodative monetary policy should be maintained, but clear guidance is needed on the horizon and extent to which any excess inflation will be allowed, as well as on timing and sequencing of possible steps towards normalization of monetary policy.

Temporary inflation over time due to temporary pressure on production capacity should continue to be accepted, provided that the main price changes are contained and inflation expectations remain well anchored. Maintaining accommodative monetary policy for a longer time will be easier for central banks, including the US Federal Reserve, that have already announced that they will seek to exceed the inflation target for some time.

Higher long-term interest rates in advanced economies may further limit the room for maneuver in many emerging market economies, especially those facing strong upward pressure on inflation as a result of higher commodity prices and currency depreciation in the past. Accommodative monetary policy can be maintained in countries with strong macroeconomic policy frameworks and broad base of local investors, provided that inflation expectations remain well anchored. In other cases, further interest rate increases may be required to ensure stability and mitigate the potential negative effects of financial market risks.

Fiscal policy should remain flexible and depend on the state of the economy. Premature and abrupt termination of of economic support policies should be avoided while the short-term prospects are still uncertain. Any reduction in budget spending in 2022 should be due to conditional cuts in crisis-related spending as the economy strengthens and vaccination coverage expands, rather than on substantial discretionary consolidation measures. The debt-servicing burden remains low, facilitated by the space provided by accommodative monetary policy, despite high deficits and rising debt levels. This makes it possible to provide sustained financial support in order to ensure a full and long-term recovery, while interest rates remain low.

A sound financial framework that provides clear guidance on the medium-term path to debt sustainability, and likely policy changes along the way, will help maintain confidence and increase transparency in budget decisions.

Support for macroeconomic policy should be accompanied by effective and targeted structural reforms. The need to consider sectoral developments caused by the pandemic at minimal cost and eliminate the potential long-term costs associated with disruption of school education during the pandemic exacerbates the long-term problems that arose before COVID-19, which require structural policy measures. Many OECD countries were characterized by high and often growing inequality in income and/or wealth, and all of them faced many problems related to the economy digitalization and need to eliminate the threat of climate change. Governments need to take this opportunity at a time when macroeconomic policies are favorable and demand is growing rapidly to accelerate reforms. This will ensure that the emergency support mobilized to deal with the current crisis, including plans to increase public investment, also contributes to achievement of long-term goals.

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