The evolution of the pandemic remains uncertain
Significant uncertainty remains about the evolution of the pandemic. On the upside, faster global progress in deploying effective vaccines would boost confidence and spending by consumers and companies and encourage an unwinding of the additional household savings accumulated since the outset of the pandemic. This would improve growth prospects in 2022 and 2023, with global output returning to the path expected prior to the pandemic and unemployment falling more sharply in the typical economy. At the same time, stronger demand could raise financial market expectations of an earlier start to interest rate increases in the advanced economies, which could create particular difficulties for some emerging-market economies. A major downside risk is that the speed of vaccine deployment, and the effectiveness of
CHL MEX USA BRA GBR CRI CHE SWE SVN DEU ITA AUS CAN ESP CZE SVK AUT BGR TUR LVA KOR FRA GRC IRL ROU ISL BEL NZL DNK FIN EST NLD ISR HUN POL COL LTU PRT LUX NOR JPN
% pts
2019Q4 to 2023Q4 2019Q4 to 2021Q3
C. Change in labour force participation rate
existing vaccines, will be insufficient to stop the transmission of COVID-19 variants of concern, resulting in a need for new or modified vaccines or repeated campaigns to provide booster doses. In such circumstances, stricter containment measures might need to be re-employed (as is currently occurring in a number of European countries), lower-income economies could continue to lag behind in vaccine deployment, and output and per capita incomes would remain weaker than the pre-crisis path for an extended period. New mobility restrictions and port closures could hamper global trade, as persisting shutdowns in key economies reduce the availability of supplies along supply chains and lengthen supplier delivery times. Such further supply disruption might also create additional upward pressure on some prices.
Inflation could continue to surprise on the upside
Headline consumer price inflation is projected to peak in the majority of advanced and emerging-market economies by the first quarter of 2022, before moderating gradually (Figure 1.21). Large increases in commodity prices, including recent jumps in energy costs, supply shortages, and higher transportation costs are key factors that have pushed up prices around the world. In the major economies, higher shipping costs and commodity prices are estimated to be adding over 1½ percentage points to consumer price inflation in the latter part of 2021, accounting for around three-quarters of the jump in inflation since the fourth quarter of 2020 (OECD, 2021c). The impact of these input price rises on consumer price inflation is expected to fade gradually through 2022-23, with key bottlenecks easing as capacity expands and the rebound in consumer demand growth moderates. Broader cost pressures, particularly in labour markets, are projected to remain moderate but pick up slowly as the recovery proceeds, with unit labour costs in the OECD economies rising by around 1¼ per cent in 2022 and 1¾ per cent in 2023.
Figure 1.21. Inflation is projected to peak by early 2022 in most countries but remain above pre-pandemic levels
Note: The harmonised consumer price index for the euro area; the personal consumption expenditure deflator for the United States; and the overall consumer price index for the remaining countries shown separately.
1. Advanced economies include OECD countries except Chile, Colombia, Costa Rica, Mexico and Turkey.
Source: OECD Economic Outlook 110 database; and OECD calculations.
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For 2022 as a whole, the consumer price inflation across the OECD is projected to rise to 4¼ per cent, and to 3½ per cent in the major advanced economies. As the effects from past input price rises drop out, and supply constraints wane, inflation is projected to moderate to around 2% in the typical advanced economy by 2023. Inflation is projected to remain above 2% in the United States, the United Kingdom and Canada, prompting some gradual tightening of monetary policy. In the euro area, inflation is projected to settle between 1¾-2 per cent by 2023.
The risks around the baseline scenario are high. It is possible that the resolution of supply constraints will permit a faster-than-projected unwinding of some of the sharp price increases seen over the last year, resulting in a faster decline in inflation. Such an outcome would be benign for the global economy, although it would heighten the challenge of achieving monetary policy objectives in countries that already have underlying inflation below central bank targets.
The main risk, however, is that inflation continues to surprise on the upside, forcing the major central banks to tighten monetary policy earlier and to a greater extent than projected. Such an outcome could stem from a number of possible factors, including prolonged supply disruptions, an upward shift in inflation expectations, labour market pressures, or if prices for a wider range of goods and services start to rise substantially.
Existing supply disruptions could continue to be more severe, prolonged and widespread than expected, or new sources of bottlenecks could emerge. The most likely cause of such a continued impairment of supply chains is a worsening of COVID-19 dynamics, whether globally or in specific countries that are important to global value chains, particularly in Asia. A renewed worsening of the pandemic could lead to a repeat of the shift in demand from services to goods seen in many countries in the first phase (Figure 1.23), creating another squeeze in goods markets with restricted supply and surging demand, and giving further impetus to inflation. Continued disruptions to energy supply that help to keep energy prices high for longer would also heighten inflation pressures (see below).
Inflation expectations may become entrenched at levels above central bank targets. Household inflation expectations in many countries have moved up as realised inflation has increased, especially over a one-year horizon. Business expectations of inflation have also generally increased, though by less. Measures of expectations derived from asset prices have tended to show only a modest increase, especially over longer horizons (5-10 years). Household and corporate wage expectations also generally remain moderate, though marginally higher than before the pandemic (Figure 1.11).
Another potential consequence of continued upside inflation surprises is that the acceleration in price increases becomes broad-based. Past experience in OECD countries suggests that increases in inflation associated with sharp rises in a relatively small number of items tend to be short-lived, while the longer-lasting inflationary periods are characterised by a more-uniform distribution of price increases across components of the index. One common method for eliminating the influence of large but narrowly focussed price changes is to calculate trimmed means, but central banks employ varying methodologies to calculate such measures. Estimates of trimmed mean inflation across a number of OECD countries using a consistent methodology suggest that there is some broad-based inflationary pressure in the United States and the United Kingdom, but less in the euro area or Japan (Box 1.4).
A particular source of risk for a broadening of inflationary pressure is housing. Housing costs, primarily rents, account for a large share of household expenditures. Historically, increases in housing costs have tended to be very stable, and so far little of the upward pressure on headline inflation has come from this source, but the large weight of housing in price indices means that there is scope for inflation to move higher if rents begin to rise more quickly.5 Housing, together with food and energy, which have been major sources of upward pressure on consumer prices over the past year, also comprises a larger share of expenditures for lower-income households (Figure 1.24). Inflationary pressure in these components is likely to be keenly felt by many households, potentially contributing to higher inflation expectations and higher wage demands.6
Higher inflation expectations, tighter labour markets, or skill shortages could all trigger stronger wage pressures than projected currently, leading to further price increases or squeezed profit margins. These types of linkages were seen in the 1970s, with upward pressures on inflation from a number of different factors, including the oil price shock in 1973-74, leading to persistently higher wage and price inflation for several years. Changes in labour market institutions since the 1970s have, however, reduced this risk in many countries, though not eliminated it, with a decline in the coverage of collective bargaining agreements, the removal of many automatic wage indexation mechanisms and a reduction in employees’ bargaining power due to lower union membership.7 In the medium term, there are also risks that some of the structural forces helping to place downward pressure on inflation in the past two decades may reverse. In particular, a reconstitution of global supply chains by moving some activities to closer but higher-cost locations would unwind some of the effects on inflation from the globalisation of economic activities since the mid-1990s (Koske et al., 2008; Andrews et al., 2018). Competitive pressures in product markets might also weaken, including from abroad, in the absence of further reforms to allow market exit and entry in the aftermath of the pandemic.
International mobility restrictions and the large decline in cross-border migration since the onset of the pandemic could also have long-lasting consequences on labour market pressures as sizeable net migration inflows have been an important source of labour force growth over a long period in many countries. Migrants tend to be concentrated in certain sectors, with foreign-born labour accounting for over 10 per cent of the manufacturing labour force in many OECD economies, as well as a high number of seasonal workers in agriculture. A reduction in migration flows can thus increase wage pressures at the sectoral level. For developing economies, restrictions on cross-border mobility also tend to reduce remittances from abroad. These important flows could decline by 14% in 2021 relative to pre-COVID levels (World Bank 2021).
5 Direct comparability of the full impact of housing rents on inflation across countries is hampered by measurement issues (Grossmann-Wirth and Monnet, 2017).
6 In the United States and Canada, survey evidence suggests that the wage growth expectations of lower-income workers, and workers with a lower level of completed education, have recently risen more sharply than those of other workers.
7 On average in the OECD countries, trade union density declined from 33% in 1975 to 16% by 2018 (OECD, 2019), although this decline was not uniform across countries. The share of workers covered by collective bargaining agreements has also declined in OECD countries, from 45% in the mid-1990s to 32% by 2017. In the euro area, only 3% of private sector employees are now estimated to have automatically indexed wages. There is often indexation for minimum wages, or a formal role for inflation in wage bargains, but this still accounts for a minority of employees (Koester and Grapow, 2021).