The European Outlook and Policymaking: Seeing Off Inflation and Pivoting to Longer-Term Reforms
*Presentation attached Good morning to all of you. Thank you for the introduction. It is a pleasure to be here today and for the first time at the Budapest Economic Forum. I am honored to have been invited to speak. Today, I will discuss the outlook for Europe and how we see the risks. Inflation, implications of the geoeconomic fragmentation, and the green transition will be particular areas of focus. I will discuss key policies for securing low inflation and forging a path of higher long-term growth. Progress has been made in taming inflation and the likelihood of a soft landing has increased, both globally and in Europe. But downside risks are significant. Policymakers face the risk of persistent and more volatile inflation. We now live in a more shock prone world. And the longstanding slowdown in productivity growth, the geoeconomic fragmentation and the challenges of the green transition cast doubt on whether European economies can return to the pre-pandemic growth trajectory. These competing challenges and a highly uncertain outlook will test policymakers in Europe. These themes are pertinent to Hungary, which is facing a difficult macroeconomic environment, with still-high inflation and the longest recession since the mid-1990s. Let me start with the European Outlook. Outlook and Near-term challenges At first glance, the European economy seems to be approaching a relatively benign moment. The IMF’s baseline forecast anticipates a continued moderation of inflation in Europe and—contrary to initial expectations of recession—modest growth in 2023 and a slight recovery in 2024. We expect that for Europe as a whole 2023 growth will be 1.3 % (2,7 in 2022), picking up to 1.5% next year. Advanced economies are expected to go from 0.7 % to 1.2%, while Emerging European Economies are expected to have a sharper recovery from about 1 to about 3 %. Aided by easing commodity prices and supply constraints, monetary tightening has cooled headline inflation, providing support to real wages. In most EU countries, the tightening cycle has peaked, with the prospect of an approaching soft landing as growth this year slows but remains in positive territory. However, there are divergencies across European countries: energy-intensive and manufacturing-oriented economies, such as Germany and Hungary, are performing less well. And downside risks continue to prevail everywhere. Headline inflation is falling, but is not expected to return to target until 2025 in many countries, for some even 2026. Core inflation has been persistently high in many European economies, especially in services. Nominal wages are growing rapidly, outpacing inflation in some economies, especially in Eastern Europe. As the pandemic and Russia’s war in Ukraine hit European economies, in only 2 years prices increased by 25 percent, as much as over the 5 years following the global financial crisis. In Hungary, inflation reached 25 percent at end- 2022, and prices have increased by 41 percent cumulatively from end-2020 to August 2023. This rapid and massive price shock eroded workers’ purchasing power and left a large real wage gap. Hence, some wage catch up is reasonable and to be expected. However, we have some concerns. We have decomposed wage growth into inflation expectations and wage catch up in green, the unemployment gap in red, productivity growth in yellow, and in gray other, that is wage growth in excess of what is to be expected from the factors I just mentioned, which as you can see is growing especially in Central, Eastern, and South-Eastern Europe, CESEE. The risk is that wage pressures could translate into additional inflation pressures, especially where wage setting is backward-looking, as is the case in many European emerging markets, and hence harm competitiveness. New IMF research, in our recent World Economic Outlook, also shows that near-term inflation may play a greater role in setting long-term inflation expectations than previously thought. Near-term expectations, in turn, are influenced to a large extent by backward-looking agents, particularly in emerging market economies where such agents are more prevalent. There is also evidence that the pass-through from inflation expectations to inflation tends to be higher when inflation is high. The strength of the labor market is fundamentally good news. Vacancy to unemployment ratios stand at record highs and unemployment rates at record lows in most of Europe. But all of this means additional upward nominal wage pressures are likely and the possibility of a wage-price spiral exists. Let me be clear: we don’t see wage-price spirals likely in advanced European economies, but the risk in Eastern Europe is not negligible. Another driver of high inflation has […]
