By Alessandro Maravalle and Lukasz Rawdanowicz, OECD Economics Department

Low interest rates prevailing in many advanced economies in recent years have already helped to lower the debt servicing burden, but government debt and interest payments remain large in many OECD countries. Could a further reduction in interest payments be attained by “locking-in” current low interest rates?

The answer is not straightforward as it depends on the future evolution of yield curves and budget balances, which are difficult to predict, and initial conditions related to the level and maturity structure of public debt.

To shed some light on potential debt servicing effects of changing debt maturity, we undertook country‑specific stylised simulations over the next 30 years with different assumptions about the maturity of new debt (Maravalle and Rawdanowicz, 2018). We analyse in principle two alternative debt strategies: temporary lengthening of the debt maturity of newly issued debt, i.e. up to a few years only, and permanent shortening, i.e. for 30 years. In both cases, the average debt maturity of newly issued debt changes by one year compared with the initial country-specific average remaining debt maturity.

The simulations are calibrated to reflect several key characteristics of G7 economies, in particular the current debt maturity structure and fiscal positions. We assume that interest rates will increase and the yield curve will steepen gradually during the first five years and then stabilise afterwards. Such a stylised assumption reflects the expected normalisation of monetary policy.

It turns out that, with the assumed increase in interest rates, a temporary lengthening of the debt maturity would not bring any reduction in debt servicing costs (figure below). The assumed initial increases in interest rates and in the slope of the yield curve are not gradual enough to reap the benefit of locking-in low interest rates. As debt matures gradually over time, the yield curve must remain low and flat for a prolonged period to reduce the overall debt servicing costs in the long term when interest rates will be higher. However, even with a more gradual and protracted interest rate normalisation, such potential fiscal benefits would be still negligible. Nevertheless, lengthening of debt maturity could be motivated by reducing rollover risks or accommodating demand from investors.

In contrast, shortening debt maturity could have non-negligible fiscal benefits for most G7 countries (figure below), but this would come at the cost of higher rollover risks. Gains could be particularly large for countries with high debt and relatively steep yield curves.

Whatever the change in debt maturity and the scenario for the evolution of the yield curve, fiscal gains would materialise only after the first decade, not helping much to lower current budget deficits.

Reference

Maravalle, A. and L. Rawdanowicz (2018), “To shorten or to lengthen? Public debt management in the low‑interest rate environment”, OECD Economics Department Working Papers, No. 1483, OECD Publishing, Paris,

By Randall S. Jones, Korea Desk, OECD Economics Department

Korea’s transformation from one of the poorest countries in the world in the 1950s to a major industrial power and member of the OECD was exceptionally rapid, reflecting good policies, notably sound fiscal and monetary policy, high levels of investment in human and physical capital and an outward orientation that increased its share of world trade. Per capita income increased from 14% of the OECD average in 1970 to 86% in 2016. However, the traditional growth model seems to be losing effectiveness, as income growth has slowed toward the OECD average. Although economic growth typically slows as countries approach the high-income economies, the sharp deceleration from an annual rate of 6.4% over 1991-2001 to 2.9% since 2011 (Figure 1), raises concerns. Moreover, export volume growth slowed from a double-digit annual pace over 1991-2011 to 2.6% since 2011, lagging behind global trade.

Korea’s real per capita income was one-third below the top half of OECD countries in 2016 (Figure 2). The large income gap reflects low labour productivity, which is 46% below the top half in the OECD. Low labour productivity is offset by very long working hours, at the expense of well-being and female employment. The decline in the working-age population beginning in 2017 year will put downward pressure on labour inputs and per capita income growth. Removing obstacles to the employment of women and youth, whose employment rates are below the OECD average is essential to mitigate the impact of demographic factors. In addition, there is large scope to raise Korea’s labour productivity, given its large investments in education and R&D, which is the second highest in the OECD area as a share of GDP. To take full advantage of its investment in innovation, Korea needs to shift from its traditional growth model to a more balanced approach that promotes inclusive growth through reforms to raise productivity in both the large business groups and SMEs.

References:

OECD (2018), OECD Economic Survey of Korea, OECD Publishing, Paris.

by Hansjörg Blöchliger and Vassiliki Koutsogeorgopoulou, Lithuania Desk, OECD Economics Department

Lithuania is one of the fastest growing economies in the OECD. After a strong rebound in 2017, growth is set to average more than 3% over this year and the next led by buoyant investment. Falling unemployment and rapidly increasing wages support consumption, although a shrinking labour force weighs on growth. Export growth remains solid, although below last year’s peak. Following 10 years of deficits and rising debt, the budget moved to a small surplus in 2016 and has remained positive since then. Lithuania is considered one of the most open and business-friendly economies in the OECD, and financial markets are stable.

Important challenges remain. Productivity is still about 30 percent below the OECD average, even if some recent pick up is encouraging. Export performance has improved but exports are concentrated in low-medium value-added activities and integration into global value chains is weak. Skills often do not match needs by businesses and collaboration between firms and research institutions is weak. Most disquieting, emigration – mostly of the young – continues, depriving the country of its most dynamic people and contributing to skills shortages.

Inequality and poverty are high reflecting widespread labour informality and a pension system that leaves many elderly with low incomes.

The “New Social Model” is Lithuania’s most impressive achievement of the past few years to enhance productivity and inclusiveness. The reform made the labour market more flexible, protects better the unemployed, and ensures sustainability of the pension system. The New Social Model is “inclusive” in the best sense of the word. The reform is also a showcase on how to achieve a large reform with a difficult political process, by creating a win-win situation.

Lithuania should continue its reform vigour to boost productivity and inclusiveness further. Reforms should focus on improving the business environment and making firms more dynamic, including through a more efficient insolvency regime, and by making the education system more responsive to labour market needs. More and better-quality jobs in the formal sector are key to well-being and reducing poverty. More effective support for those in need and active labour market programmes would also help combat poverty. Finally, easing the rules for highly skilled immigrants could help address the negative consequences of emigration, as could strengthening social and economic ties with the Lithuanian diaspora. These issues and policies to address them are analysed in the 2018 Economic Survey of Lithuania.

Further reading

OECD (2018), OECD Economic Surveys: Lithuania 2018, OECD Publishing, Paris.

by Donal Smith, OECD Trade Directorate and Economics Department

The Netherlands is likely to be one of the European countries that is going to be significantly affected by the United Kingdom’s planned departure from the European Union (Brexit). As an open economy with strong trade and investment links to the United Kingdom, the Netherlands is exposed to increases in barriers to trade between the United Kingdom and EU (Vandenbussche et al., 2017). New OECD simulations show the potential extent of this impact, as well as the different sectors of the Dutch economy likely to be affected.

The sector-level impacts will depend on differing UK trade exposures, tariff rates and non-tariff measures (NTMs) applied to different products; varying degrees of global value chain integration of the sectors; and differences in sectors trade diversification opportunities. On trade exposure for example, the agri-food sector has a comparatively high UK exposure. This sector accounts for 23% of the total exports of the Netherlands to the UK while the UK market makes up 12% of total Dutch agri-food exports (OECD 2018).[1]

An illustrative worst-case Brexit scenario – assuming the UK leaves the EU without any trade agreement – is simulated using the OECD METRO model (OECD, 2015).[2] The key advantage of this analysis is that it accounts for changes in both tariff and non-tariff barriers. The scenario assumes that trade relations between the EU and UK default to the World Trade Organisation’s (WTO) Most-Favoured Nation (MFN) rules, that is, the most basic trade relationship. Relative to current arrangements, this corresponds to an increase in tariffs on Dutch trade with the United Kingdom of between 0 and 12  per cent.

Simulation results show that Dutch exports to the UK would fall by 17%in the medium-term. The Dutch agri-food sector is estimated to experience a 22% fall in its UK exports (Figure 1). This is driven by a substantial 35% decline in exports in the meat products sector. Smaller materials manufacturing sectors such as wood and leather products and textiles would see a 20% fall in their UK exports. The 2% fall in production in agri-food contributes to a 7% decline in the value of agricultural land. Four of the five sectors that record the largest declines in employment following production falls are in the agri-food sectors.

Of all the non-agri-food sectors, electronic equipment would see the largest decline in total exports at 3% and the largest decline in production at 2.4% in the scenario. Access to supply chains for intermediate imports from the UK for Dutch sectors is also curtailed; intermediate imports from the UK would fall by over 40% in the finance and insurance sector in the scenario.

There are a few sectors which have export gains under this scenario. These include motor vehicles, finance and insurance and transport equipment, these sectors show increases in exports to the rest of the EU as well as the United States. The gas sector expands slightly, but this translates into relatively larger gains of gross exports of 6% (to EU) and 10% (to US).

[1] OECD METRO model data.

[2] This shock implies a scenario could be the result of a disorderly conclusion to negotiations and can be considered something close to a worst case outcome and does not consider the impact via investment.

References

OECD (2018), OECD Economic Surveys: Netherlands 2018, OECD Publishing, Paris.

OECD (2015), “METRO v1 Model Documentation”, TAD/TC/WP(2014)24/FINAL.

Vandenbussche, Hylke and Connell Garcia, William and Simons, Wouter, Global Value Chains, Trade Shocks and Jobs: An Application to Brexit (September 2017). Available at SSRN: https://ssrn.com/abstract=3052259 or http://dx.doi.org/10.2139/ssrn.3052259

By Mark Baker, Netherlands Desk, OECD Economics Department

The Netherlands has experienced a large rise in the number of individuals working as self-employed with the share in total employment rising rapidly over the past decade. This is the largest rise in the OECD countries. This contrasts with trends in most other OECD countries where the share has, on average, fallen over that period. There are a number of positive aspects that can be associated with self-employment, as well as possible negative aspects, implying that any policy responses to address the increasing prevalence should aim to facilitate the former while mitigating the latter.

On the positive side, higher rates of self-employment could be associated with increased entrepreneurial activity, innovation and more labour market flexibility. Flexibility is particularly important in the Dutch context, where the level of protection on permanent contracts is high.  Younger workers and recent migrants, who have limited attachment to the labour market, can use self-employment as an avenue to gain valuable working experience and to potentially transition towards a more permanent position. Self-employment can also be a useful avenue for older workers who want to remain marginally attached to the workforce, and potentially view their existing pension savings as adequate for their retirement. Indeed, older workers have seen the largest rise in terms of self-employment when compared to other age groups.

On the negative side, rising self-employment can also be associated with reduced job quality and job security, and can potentially be used as a method for individuals and employers to avoid tax and social security obligations, and promoting an unfair treatment across different work types. With regards to social security, the self-employed individuals have no obligation to contribute to sickness and disability insurance while employees do. Not only does this significantly reduce the tax wedge for self-employed work, but it exposes the self-employed to increased loss of income risks associated with injury or sickness. Employers are incentivised to hire self-employed contractors and potentially to re-label existing staff as self-employed contractors to lower labour costs, through lower social security contributions, and to avoid the strict protection of employment contracts. Furthermore, self-employment can be used by employers/clients to prevent paying statutory minimum wage rates.

In addition, very large tax deductions exist which further widens the difference in tax treatment between the self-employed and other workers. One of the largest deductions available is  meant to incentivise increased entrepreneurial activity. However, the vast majority of the rise in self-employment has been own-account workers who tend not to scale up their business, by hiring employees, or invest in innovative activities or training, so this deduction is hardly justifiable.

The Dutch government has been active in constructing different policies to target some of these issues. Regulatory policies associated with the self-employment statement system have been reformed in recent years. To combat the potential for employers to re-brand employees as contractors, the government plans to introduce a minimum tariff system, whereby any individual earning below a stated minimum tariff, comparable to the minimum wage rate, will be deemed an employee for tax and regulatory purposes. This will be difficult to implement, however, given the potential difficulties in monitoring the hours worked of self-employed individuals.

Recommendations from the 2018 OECD Economic Survey of the Netherlands aim at ensuring a more level playing field, particularly in terms of the tax treatment, between the self-employed and other workers. The government should phase out the permanent self-employment tax deduction while also introducing coverage for sickness and disability insurance for self-employed workers.  Additional to the self-employment specific recommendations, the Survey calls for a reduction in the tax burden, particularly for lower-income workers, by lowering social security expenses and also reducing the high level of employment protections through a reduction in severance pay for employees dismissed under reasonable grounds.

References:

OECD (2018), OECD Economic Surveys: The Netherlands 2018,  OECD Publishing, Paris.

Isabelle Joumard, responsable du bureau Tunisie, Département d’Économie de l’OCDE

L’ouverture de la Tunisie aux échanges internationaux a fortement progressé depuis le milieu des années 90, témoignant des avantages comparatifs du pays. Les exportations ont sensiblement augmenté, tirées par le secteur manufacturier, avec une transformation en faveur de secteurs plus intensifs en technologie et en compétences.  De plus, l’analyse des échanges commerciaux sur la base de la valeur ajoutée remet en cause la perception selon laquelle les activités à faible teneur en valeur ajoutée dominent. Cette analyse montre aussi que le degré d’intégration de la Tunisie dans les chaines de valeur mondiales est similaire à celui de pays de l’OCDE, le Portugal notamment, et supérieur à celui de nombreux pays émergents. La montée en gamme et la diversification des exportations augurent de plus d’un potentiel de croissance de l’économie tunisienne élevé.

Cette bonne performance à l’exportation est pour l’essentiel le fait d’entreprises entièrement exportatrices (dites offshores). Le secteur offshore dégage un excédent commercial croissant. La contribution des entreprises du secteur à la création d’emplois formels a aussi augmenté – en 2016, les entreprises du secteur offshore contribuaient à hauteur de 34% des emplois formel du secteur privé – alors que le travail informel reste un problème majeur (environ 50% des jeunes). Néanmoins, ces entreprises sont pour l’essentiel localisées proches des ports, contribuant à la concentration géographique de l’activité économique. En outre, l’effet d’entrainement sur le reste de l’économie est faible : les entreprises offshore s’approvisionnent peu sur le marché local et servent rarement la demande locale. La complexité des procédures douanières, fiscales et administratives est perçue par les entreprises comme une barrière aux échanges avec les entreprises du régime onshore. De leur côté, les entreprises du secteur onshore sont pénalisées par des difficultés lors du passage en douane de leurs produits et des services logistiques peu performants.

La levée des contraintes à l’exportation rencontrées par les entreprises du secteur onshore et le décloisonnement entre régimes offshore et onshore permettraient à la Tunisie de se hisser dans les chaines de valeur mondiales et d’en tirer plus d’avantages, notamment en termes de progrès technologique, de création d’emplois et de richesse.

Références :

Joumard I., S. Dhaoui et H. Morgavi (2018), « Insertion de la Tunisie dans les chaines de valeur mondiales et rôle des entreprises offshore », Document de travail du Département d’Économie N°1478.

OCDE (2018), Étude économique de l’OCDE sur la Tunisie.

by Jan Stráský and Guillaume Claveres, OECD Economics Department,  Euro Area/European Union desk

After years of crisis, we are now experiencing an economic expansion in Europe. But further crises are certain to come, sooner or later, and improvements in the euro area’s resilience to economic shocks will require further policy changes. Notably, it is important to allow that the cost of significant economic shocks is shared as widely and fairly as possible, both within private and public sectors, what we call for simplicity public and private risk-sharing. In this post, based on the 2018 Economic Survey of the Euro Area, we focus on potential for private risk sharing through the banking sector. The lack of risk sharing in this sector was a major cause of the euro area crisis during the great financial recession since governments became overly exposed to difficulties faced by their banking sectors. Better risk sharing would reduce the risk that a banking crisis triggers government insolvency, reinforcing the solidity of the euro area.

For better or for worse, banks remain at the core of the financial system in Europe. Diversification towards other sources of financing and better access to finance for small and medium enterprises are important goals, which in the longer-term will be substantially facilitated by completion of the capital markets union project. In parallel, the efforts to improve the functioning of the European banking system, including the conditions for creation of Pan-European banks, must continue.

The euro area banks are now much better capitalised than before the financial crisis and benefit from stronger and unified supervisory standards. Even so, additional reforms to complete the banking union are necessary. The Single Resolution Mechanism that restructures failed banks while preventing wider repercussions in the financial system needs an effective backstop to ensure its credibility. The backstop should be fiscally-neutral over the medium term, meaning that any pay out should be recouped from future banks’ contributions. As the next step, euro area countries should put in place a pre-funded common European deposit insurance scheme. Such a tool would increase financial stability benefits for all participating countries by spreading the risks across a large and more diverse pool of financial institutions and reducing the likelihood that individual pay outs will overwhelm the system. It would also further improve monetary policy transmission in the euro area by making different forms of money more homogenous across euro area countries.

To limit the risk of some banks subsidising others, the insured banks should pay to the European deposit insurance scheme a variable insurance premium that would require risker banks – based, among other things, on the level of loss-absorbing capacity, stability and variety of funding sources, business model and management quality – to pay higher contributions. In addition, the risk premia should also be sensitive to the amount of systemic risk in the national banking system.

Risk reduction in the banking sector will eventually have to go beyond the reduction of still-elevated non-performing loans in some countries and prevention of the build-up of new non-performing loans. The recent gyrations in some European sovereign debt markets have shown that the potentially harmful links between banks and their own states that amplified the euro area crisis are still present. Large exposures of banks to the sovereign debt of their home country, linking the health of the banking sector to the health of public finances, continue to exist in many euro area countries and need to be addressed (Figure 1).

The reduction in banks’ holdings of government bonds would make banks’ financing costs dependent on their own riskiness, rather than geographical location, potentially reinforcing cross-border activity and banks’ ability to exploit the economies of scale. Such change, which would need to be gradual, including long phase-in periods and involving only the newly issued debt, could be achieved by introducing an additional capital requirement increasing with concentrated sovereign bond holdings of banks (BCBS, 2017; Véron, 2017). Banks with higher holdings of sovereign debt would be required to hold additional capital as protection against associated risks. In order to give banks an alternative safe asset to invest in, potential changes should be considered in parallel with the introduction of a European safe asset. Although some existing proposals suggest the creation of synthetic safe assets, such instrument may be too sensitive to cyclical variation in investors’ demand. Other ways of creating a European safe asset without risk mutualisation thus may be needed.

The Banking Union needs to be completed and the time to act is now. The three missing legs the Banking Union should stand on are the fiscal backstop to the Single Resolution Fund, the European deposit insurance scheme and the reduction of the harmful links between banks and their own states.

References:

OECD (2018), OECD Economic Surveys: Euro Area 2018, OECD Publishing, Paris.

BCBS (2017), “Discussion Paper – The regulatory treatment of sovereign exposures”, Basel Committee on Banking Supervision, Basel. https://www.bis.org/bcbs/publ/d425.pdf

Véron, N. (2017), “Sovereign concentration charges: a new regime for banks’ sovereign exposures”, A paper prepared for the Economic and Monetary Affairs Committee of the European Parliament, Brussels. http://www.europarl.europa.eu/RegData/etudes/STUD/2017/602111/IPOL_STU(2017)602111_EN.pdf

by Douglas Sutherland, Senior Economist, US Desk, Economics Department.

Case and Deaton (2017) highlighted increasing midlife mortality due to suicides and drug and alcohol abuse since the late 1990s contributing to relatively modest gains in life expectancy. In the past decade, overdose deaths have surged, particularly as (illicit) synthetic opioids have become more available. Opioid-related deaths touch urban and rural communities alike and are spreading to affect all demographic groups.

Opioids are far more commonly prescribed in the United States than elsewhere in the OECD. Between 1999 and 2014, opioid prescriptions in the United States quadrupled. This was compounded by relatively liberal policies on the number of opioids being prescribed, the long duration of treatment and aggressive marketing. Ultimately millions of individuals were exposed to addictive substances, either the intended patient or through unused drugs being taken by family members or others.

Opioid prescriptions are substantial in the United States

The consequences of the opioid epidemic are felt through deaths, the impact on livelihoods and by breaking up homes and communities. Opioid use appears to be connected to labour market conditions with prescription rates typically higher where labour force participation is lower. Krueger (2017) found that around one-fifth of the non-participating prime age males were regularly taking opioid painkillers. While causality is difficult to establish opioid addiction ultimately impairs participation. This contributes to costs to the economy of lost wages and productivity, as well as fiscal costs from foregone revenue and spending on emergency care and the treatment of addiction. Estimates suggest an annual cost of around $80 billion, but if the loss of life is also taken into account then the cost of the crisis in 2015 could be over $500 billion (CEA, 2018).

Such losses of lives and enormous impact on society justify taking action. To address the immediate challenge, making drugs that can reverse the effects of overdoses more widely available can reduce avoidable deaths. Efforts to tighten access to opioids will reduce the inflow of patients developing opioid dependence. For those already suffering from addiction, medically-assisted treatments are proven options, but may require relaxing administrative barriers in order to expand their reach. These efforts will need to be complemented by re-integrating former addicts into employment and housing to prevent relapse. Research on the causes and effects of widespread addiction should also be encouraged.

References:

Case, A. and A. Deaton (2017), “Mortality and Morbidity in the 21st Century”, Brookings Papers on Economic Activity,

CEA (2017), The Underestimated Cost of the Opioid Crisis, The Council of Economic Advisers, Washington, D.C.,

Krueger, A. (2017), “Where Have All the Workers Gone? An Inquiry into the Decline of the U.S. Labor Force Participation Rate”, Brookings Papers on Economic Activity

OECD (2018), Economic Surveys: United States, OECD Publishing, Paris.

by Makoto Kasai and Łukasz Rawdanowicz, OECD Economics Department[1]

As discussed in the latest OECD Economic Outlook, the prolonged undershooting of inflation targets, despite massive monetary policy stimulus and stronger economic growth and lower unemployment, raises issues about the appropriateness of current inflation targeting frameworks in advanced economies. While the frameworks differ in detail and implementation, they are principally based on medium-term inflation objectives of 2%.

Various modifications of, and alternatives to, inflation targeting frameworks have been advocated to make monetary policy more effective and credible. While none of them is without drawbacks, and it is not clear if they would provide substantial improvements from those used at present, periodic reviews of current frameworks would be useful.

Raising the inflation target

Based on theoretical models with forward-looking expectations, raising the inflation target has been suggested as a way to boost inflation expectations and in turn inflation outcomes (Blanchard et al., 2010; Ball, 2014; Baker et al., 2017).

Higher inflation targets, if effective in raising actual inflation, are estimated to lower the probability of hitting an effective zero lower bound (ZLB) and thus reduce the potentially large economic costs of stagnations (Kiley and Roberts, 2017; Dorich et al., 2018; Ball, 2014). Although, in principle, the economic costs caused by the ZLB could be mitigated by adopting unconventional measures, the overall effectiveness of these measures remains debatable.

However, higher target and actual inflation could also entail economic costs, though estimating the level of inflation where costs start to dominate is difficult. Moreover, if a central bank changes its inflation target once, further revisions may be expected, leading to de-anchoring of inflation expectations and undermining the effectiveness of the inflation targeting framework.

While low inflation targets helped to reduce inflation in the 1990s (and its subsequent stabilisation), it is uncertain if the opposite would work. Indeed, Japan’s experience with increasing the inflation target from 1% to 2% in 2013 followed by massive quantitative and qualitative monetary policy easing, after the prolonged period of subdued inflation, demonstrates the practical challenges. Even if realised and expected inflation have indeed increased, they have remained below the target.

Price level targeting

Under price level targeting, a period of lower inflation should be followed by a period of higher inflation so as to neutralise the impact on the price level. In the current context, it is equivalent to committing temporally to a higher inflation target, but with the benefit of avoiding the cost of permanently higher inflation. As with raising inflation targets, the benefits of this framework depend on the ability of central banks to affect inflation expectations and outcomes. If this is the case, the framework will help to raise inflation expectations and avoid the ZLB in the future. If this is not the case, or if the economy experiences persistent positive supply-side shocks, it could result in prolonged periods of very easy monetary policy with risks to future financial stability.

Symmetric operation of inflation targeting

Central banks’ commitment to symmetric operation of monetary policy around their inflation targets is in a sense a milder variant of price level targeting. While the major central banks have symmetric price stability objectives in the medium term, some of them are perceived to have a bias in operating their monetary policy to maintain inflation close to but below their targets (Evans, 2017). This bias might have weakened their ability to raise inflation expectations and to achieve the target. This concern arguably prompted the US Federal Reserve and the ECB to emphasise the symmetric inflation goal in their communication (Draghi, 2016).

Nominal GDP level targeting

Nominal GDP level targeting, if effective, shares the advantages of price level targeting while it can avoid central banks’ overreacting to supply shocks (Bean, 2013). In spirit, it is similar to the dual mandate of the US Federal Reserve. It is expected to work well in the situation where maintaining short-term price stability is not enough to achieve stable growth of the economy in the medium to long run. Nominal GDP level targeting, however, shares drawbacks with the above propositions, and adds complications as nominal GDP is even more difficult to control than inflation. Moreover, GDP data tend to be revised substantially and are not available at a high frequency.

Inflation target range

An inflation target range with the upper band above 2% would have some similarity to the arrangements discussed above in the current context. This is especially the case with respect to the symmetric operation of inflation targeting, by signalling that higher inflation could be tolerated.

However, a framework with a target range allows the authorities to operate monetary policy more flexibly, reflecting the fact that monetary authorities have only a limited ability to predict inflation and control inflation expectations and outcomes (Andersson and Jonung, 2017). This flexibility is useful when the persistence and size of idiosyncratic shocks are uncertain or when changes in the monetary policy stance could aggravate financial stability risks. As long as inflation is expected to stay within the range, monetary authorities would not need to change their stance, while – as with point inflation targeting – they would be expected to act when inflation risks deviating from the range.

With a relatively narrow and low range, this framework could still be consistent with the price stability objective and would not involve negative welfare effects, justifying a less active monetary policy stance. Consequently, it might help to lower the risk of hitting the ZLB, as central banks over time could keep their powder dry. This framework could also improve central banks’ credibility, as there will be a higher probability of inflation staying within a range rather than at a point target. With the current frameworks, even small deviations of inflation from the target point tend to be interpreted as a failure of monetary policy and raise expectations of monetary authorities’ reacting.

On the other hand, the inflation targeting framework based on a range could potentially lower central banks’ influence on inflation expectations as it could be perceived as weakened commitment to price stability. The target range could make it difficult to understand the reaction function of central banks. Indeed, a point inflation target may be easier to communicate and may be more effective in influencing inflation expectations of households and businesses.

References

Andersson, F. N. G. and L. Jonung (2017), “How Tolerant Should Inflation-Targeting Central Banks Be? Selecting the Proper Tolerance Band – Lessons from Sweden”, Lund University Department of Economics Working Paper, No. 2017: 2.

Baker, D. et al. (2017), “Prominent Economists Question Fed Inflation Target”, letter to the Federal Reserve Board of Governors, The Center for Popular Democracy, June 2017. http://populardemocracy.org/sites/default/files/Rethink%202%25%20letter.pdf

Ball, L. (2014), “The Case for a Long-Run Inflation Target of Four Percent”, IMF Working Papers, No 14/92.

Bean, C. (2013), “Nominal Income Targets – An Old Wine in a New Bottle”, speech at the Institute for Economic Affairs Conference on the State of the Economy, London, February.

Blanchard, O., G. Dell’Ariccia and P. Mauro (2010), “Rethinking Macroeconomic Policy”, Journal of Money, Credit and Banking, 42(1), 199-215.

Dorich, J., N. Labelle, V. Lepetyuk and R. R. Mendes (2018), “Could a Higher Inflation Target Enhance Macroeconomic Stability?”, Bank of Canada Staff Working Paper, 2018-17.

Draghi, M. (2016), “Delivering a Symmetric Mandate with Asymmetric Tools: Monetary Policy in a Context of Low Interest Rates”, speech at the ceremony to mark the 200th anniversary of the Oesterreichische Nationalbank, Vienna, June.

Evans, C. L. (2017), “Low Inflation and the Symmetry of the 2 Percent Target”, Speech at UBS European Conference, London, November.

Kiley, M. T. and J. Roberts (2017), “Monetary Policy in a low interest rate world”, Brookings Papers on Economic Activity, March 2017.

OECD (2018), OECD Economic Outlook, Volume 2018 Issue 1: Preliminary version, OECD Publishing, Paris.

[1]. The opinions expressed and arguments employed are those of the authors and not necessarily of their respective institutions. Makoto Kasai currently works for the Bank of Japan.

by Andres Fuentes Hutfilter and Naomitsu Yashiro, OECD Germany Desk

Germany’s strong and steady growth is set to stay – real GDP is projected to grow by 2.1% this year and next. Strong domestic demand and exports drive growth. As a strong exporter of capital goods, Germany is benefiting from the global recovery of trade and investment and the recovery in the euro area. Low interest rates and immigration boost residential construction. At 3.4% unemployment is record low, allowing wages to grow above inflation (Figure 1). Wages have grown across the board, breaking the trend of rising inequality and allowing private consumption to expand steadily. Germany also provides many jobs to immigrants, now mostly from Europe. Poverty is lower in Germany than in most OECD countries. But many workers are still on low wages, especially among women, the low and the middle-skilled (Figure 2). This may hold back growth if workers have little chance to move out of low-wage jobs. During the years of strong performance the government and businesses have reduced debt. Households also continue to save, in part for old age. The external counterpart of this is the large current account surplus.

In this context, policy makers in Germany must ensure that strong social and economic outcomes are sustained in the future and inequality and poverty risk are reduced further, in the light of several challenges: Trend productivity growth has slowed, in Germany and elsewhere. As elsewhere in the OECD, productivity across firms has increasingly diverged between leaders and other firms. In Germany SMEs are 20 to 30% less productive than large firms and business creation has slowed. New technologies must be exploited more to benefit the whole society, and to realise strong growth consistent with the low-carbon transition. Entrepreneurship should be fostered through a more flexible insolvency regime, good e-government services and better access to high speed Internet. At the same time, technological change requires workers to adapt to new and changing jobs throughout their life time by updating skills. Across the OECD, middle-skill jobs have been the most affected by changes in tasks and automation. Technological change requires workers to adapt throughout their life time. The strong fiscal position provides room in the near term to fund spending priorities that will raise growth and wellbeing durably. Boosting investment in skills and technology and employability at higher age can also help reduce the current account surplus. The new government’s coalition agreement contains welcome steps in this direction.

References: 

OECD (2018), Economic Surveys: Germany, OECD Publishing, Paris.