Will we really extinguish inflation with a recession or not, and what are the overall economic prospects are just some of the questions that trouble every company. Monetary policy decisions, indirectly and fiscal ones, as they must be aligned, directly affect growth projections, but also entrepreneurs’ investment decisions. All these are tough challenges that are easier to overcome if we have relatively precise projections of future movements.
More about macroeconomic forecasts will be discussed at one of the largest business gatherings in the region, Lider’s ‘Day of Big Plans’, which will be held on September 27 at the Westin Hotel in Zagreb. Senior economist and head of the OECD’s Country Studies Division Phil Hemmings will participate, and ahead of the conference, we spoke with his colleague, OECD senior economist Tim Bulman.
Inflation is still the number one topic, so despite the fact that it was 5.3 percent in the eurozone in August, the same as in July, the ECB continues to raise interest rates. Analysts assure that only until the end of the year, next year the pace of increases should at least slow down. How reliable are those estimates?
In the latest OECD Economic Outlook published in June, we emphasized that the most important task remains the fight against inflation and its permanent reduction. In many economies, including Croatia, lower energy prices help reduce overall inflationary pressures and household budgets. However, core inflation proves to be quite resilient, largely due to profit growth in some sectors and still high pressures for wage growth in the labor market.
Therefore, the job of bringing down inflation, despite partial results, is not yet finished. Delaying the reduction of inflation risks further tightening of monetary and fiscal policy in the future. Therefore, in most OECD countries, monetary policy must remain restrictive until we see clear signs that core inflationary pressures have been permanently reduced. In our projections, we anticipated further tightening in the eurozone and the US by the end of 2023, and the decisions and communication of central banks are in line with our projections. However, we are more pessimistic than most central banks, so we assess that there is indeed a risk that interest rates will have to rise further.
What exactly is currently pushing inflation, which components? The labor market, worker shortages, and pressure for wage growth? Or…?
Initially, we know that the spike in global energy and food prices at the onset of Russia’s aggression against Ukraine further amplified the effects of supply chain disruptions that broke due to the pandemic lockdown of the global economy. As employee demands for wage alignment with inflation began to rise, inflation expectations also grew, which in turn spurred new demands for alignment. Although most energy and food prices have started to slowly decline, core inflation is slowly decreasing due to these pressures.
The fact is that wages are rising across the developed world. Given that labor shortages are a persistent problem, will this remain a longer-term fuel for inflation?
Wage increases certainly contribute to rising cost pressures, along with already significantly increased input costs. However, at the same time, high demand has allowed companies in some sectors and countries to further increase their margins. Thus, we are witnessing a mix of influences, both profits and labor costs are rising, along with a decrease in the tax burden per unit of product.
However, overall, if we look at shares in national income, there have been only small changes in the shares of wages and profits compared to the pre-pandemic period. In some countries, especially in the US, we first witnessed an increase in unit profits, and only after that did unit wages begin to rise, so we cannot claim that wages drive inflation. First, profits increased, and only then did the pressures for wage growth follow.
