In normal times, Ukraine and Russia provide about 30 per cent of all wheat exports. Photo / Bloomberg
OPINION:
It is far from the worst consequence of Putin's war on Ukraine, but it is bad enough.
The OECD estimates that the war will cut global economic growth by more than a percentage point this year and add about 2.5 percentage points to inflation rates that are already at feverish levels from Covid.
Its advice to policymakers is that central banks must above all guard their credibility and keep inflation expectations well anchored, while governments should ensure their fiscal response follows the three Ts: measures that are timely, temporary and well targeted.
Before the Russian invasion, the OECD was forecasting a return to normality for the world economy by 2023, with growth rates similar to those prevailing before the pandemic and inflation converging on levels close to central banks' objectives, albeit later and from higher levels than previously expected.
Not any more. "The war in Ukraine has created a new negative supply shock for the world economy just when some of the supply chain challenges seen since the start of the pandemic were starting to fade," the OECD said in a report last week.
Russian and Ukraine between them account for about 30 per cent of global exports of wheat, 20 per cent for corn, mineral fertilisers and natural gas, and 11 per cent for oil.
So the OECD has poked higher commodity prices into its mathematical model of the global economy, based on what could be observed over the first two weeks of the war compared with average levels in January.
They include a 33 per cent rise in world oil prices and an 11 per cent rise in metals prices.
And with wheat prices up 90 per cent, corn prices up 40 per cent and fertiliser prices assumed to be 30 per cent higher, it is little wonder IMF managing director Kristalina Georgieva's brutal conclusion is: "War in Ukraine means hunger in Africa".
If sky-high petrol prices have you thinking about an electric vehicle, it is a pity that the batteries require high-purity nickel, of which Russia is a major producer.
And it turns out Ukraine is a major global supplier of neon, a gas used in the production of semiconductors, shortages of which have curtailed manufacturing of, among other things, cars.
This inflationary shock comes on top of that already raging as a result of Covid-related disruptions to supply chains and the monetary and fiscal responses to the pandemic.
The annual inflation rate in February was already 7.5 per cent in the United States, a 40-year high, and 5.9 per cent in the euro area.
While the forecasts were for some easing of those rates over the year ahead, the OECD now reckons the impact of the war in the first full year will be to add 2.5 percentage points to the inflation baseline for the world as a whole and 2 per cent on average for the OECD's members.
It cautions that these numbers are only an initial look at the potential impact of the conflict based on market dislocations observed in the first two weeks of the war.
"They do not incorporate many factors which could intensify the adverse effects of the conflict, such as further sanctions or consumer and business boycotts, disruptions to shipping and air traffic, the unavailability of key products from Russia, trade restrictions such as export bans on food commodities, or undermined consumer confidence."
Confronted by this grim outlook, what should policymakers do?
Faced with an adverse supply shock of uncertain duration and magnitude from higher commodity prices, monetary policy should remain focused on ensuring inflation expectations are well anchored, the OECD says.
The Reserve Bank's monetary policy committee evidently agrees. In their meeting last month, when they agreed to raise the official cash rate a quarter of a percentage point and pencilled in another 2.5 percentage points to come, they concluded that "the most significant risk to be avoided at present was longer-term inflation expectations rising above the target and becoming embedded in future price setting".
ANZ economists consider a surge in the various measures of inflation expectations to be one of the more alarming features of the economic data over the past year.
In their latest Business Outlook survey, a net 74 per cent of respondent firms expect to raise their prices.
"The horse, if it hasn't already bolted, is at least trotting at a fair clip and already a fair way from where it's meant to be," they said.
"Although the RBNZ's longer-term measures [of inflation expectations] are still close-ish to 2 per cent, that reflects a very small, unusually well-informed group of 33 respondents." When they looked into what indicators have the most explanatory power as influences on inflation expectations, prices at the pump head the list.
For governments, the OECD's advice is that "temporary, timely and well-targeted fiscal measures, where feasible, provide the best policy option to cushion the immediate impact of the crisis on consumers and businesses, especially with rising inflation limiting the room for monetary policy manoeuvre".
The Government's time-limited cuts to fuel taxes announced last week would seem to fit that bill. As a start, anyway.
By contrast, National's proposal to drop the top tax threshold altogether and raise the other three by 11.5 per cent is the opposite of what the OECD recommends, being neither temporary nor aimed at those hardest hit by inflation.
For someone on the median wage it would mean an increase in take-home pay of $800 a year. It is the equivalent of a 2 per cent pay rise, albeit at the expense of government spending rather than their employer's bottom line.
But when consumer prices are rising nearly 6 per cent a year and heading higher, it would only compensate for less than four months' inflation.
Then what? Back to square one. Their real wage would resume its decline and they would still face the same marginal tax rate they do now. Meanwhile, ASB's economists reckon the average household will need $150 a week this year to cover inflation and higher mortgage rates.
The income tax — on which New Zealand governments are way too reliant — would be left less progressive.
And the revenue cost of $1.7 billion would gobble up all of what the OECD reckons governments can afford to spend — around 0.5 per cent of GDP — to offset about half of the estimated decline in output from the Ukraine war without adding significantly to inflation.
The council has also been served with judicial review proceedings.