OECD raises inflation forecasts and cautions on risk of prolonged rises

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High inflation is set to continue over the next two years, the OECD warned on Tuesday, requiring skilful handling by policymakers to ensure price rises are a temporary blip while the economic recovery remains on track.

In its latest economic outlook, the Paris-based club of nations projected that inflation would be significantly higher in 2021 and in 2022 than it had previously forecast for most G20 countries, but that this need not become a persistent problem.

Publishing largely optimistic growth projections for advanced economies, the OECD predicted activity would reach the levels forecast before the pandemic by the end of 2022, said Laurence Boone, OECD chief economist.

“The speed of the recovery has increased inflationary pressures, quickly pushing up prices to where we expected them to be before the pandemic,” the OECD said in its outlook. “Policymakers in advanced economies should monitor these developments without delay.”

Boone added that, for now, managing inflation would be “a very difficult balancing act”.

The OECD forecasts that the average inflation rate across the G20 leading economies would hit 4.5 per cent in the fourth quarter of the year, with 1.5 percentage points of that figure caused by the effects of higher shipping costs and commodity prices.

Since its last forecasts in June, the OECD has revised up inflation predictions for 2021 and 2022 by more than 0.3 percentage points for most countries. The US forecast for inflation in 2021 has risen from 2.9 per cent in June to 3.6 per cent. For the UK, the equivalent figures were 1.3 per cent in June and 2.3 per cent this month for inflation this year.

For 2022, the inflation forecasts have also risen sharply since June. In France and Germany, the forecast rose from 0.8 and 1.6 per cent, respectively, to 1.4 and 2.6 per cent.

The OECD said the most urgent task was to communicate to the public that rising inflation had many temporary features and was mostly an adjustment of prices to levels that had always been expected after temporary dips during the pandemic.

Boone said that supply bottlenecks would ease as coronavirus vaccination rates rose, especially in emerging economies. With huge pandemic-related government support largely in the past, demand was unlikely to run out of control.

Although the main concern before the virus was that inflation was too low, the message now was that prices would settle at higher rates than before the pandemic — “and that is a good thing” — but they would not remain as high as they were likely to go in the months ahead.

Boone said consistent communication on the temporary nature of much of the inflation would help prevent businesses and households from thinking it was fair to raise prices and demand higher wages, something that would make higher inflation last longer and become more damaging.

Governments also had a role to play, she added, in ending the pandemic narrative that they could finance anything simply by borrowing.

Welcoming efforts in the US and in Europe to spend more on addressing climate change and digital transformation, she said: “It is important that governments communicate how they are going to do that. Right? That it’s not free money forever.”

US president Joe Biden is seeking to finance spending on infrastructure with higher taxes but faces a potentially difficult time in Congress over the weeks ahead.

The OECD said that providing countries navigated higher inflation in the coming months, the good news was that the recovery had been “extraordinarily fast”, with advanced economies likely to suffer minimal longer-term damage.

This would be fine for countries that were performing well before the pandemic, such as the US, she added, but not good enough for those countries for which recovery to the pre-pandemic path still meant high unemployment and weak growth.

“Many economies will be roughly where they were before, but with more debt,” Boone said.

The outlook for emerging economies was significantly worse, the OECD said, because they were still struggling with high rates of coronavirus infection and low levels of vaccination, leaving them more vulnerable both to weak recovery and high inflation.

But with greater credibility in their institutions, such as their central banks, and early action to stem inflation, the OECD thought they would still emerge from the coronavirus crisis better than the financial crisis of 2008-09.