Saturday 13 Apr 2024
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This article first appeared in Forum, The Edge Malaysia Weekly on January 29, 2024 - February 4, 2024

Last month, I wrote about the central role of inflation trends in the outlook for the world economy in 2024 and beyond. Of course, there are many additional risks, which is why the forecasting community is hedging its projections with sensible caveats about various “known unknowns”. Chief among these are the ongoing conflicts in the Middle East and Ukraine, the uncertainty about China and the looming elections in Europe, the US and elsewhere.

With respect to inflation, I offered a cautiously optimistic outlook based on recent reports showing that many underlying indicators appeared to be moving in a promising direction. Since then, however, the latest monthly inflation data (for December) in the eurozone, the UK and the US have surprised on the upside. That has given pause to many policymakers, investors and analysts after weeks of markets pricing in large interest rate cuts this year.

Finally, I concluded by mentioning that it would be a pleasant surprise if wage gains in many countries persisted, despite the improving inflation outlook, without contributing to a fresh, more sustained rise in prices. Of course, most economists and central bankers would put little stock in this scenario unless there was clear evidence of a much-needed uptick in productivity across the Western world (and beyond). Without additional productivity, they would warn, real (inflation-adjusted) wage gains cannot be sustained without becoming inflationary.

Nonetheless, I find myself holding on to the same hope I had last month. After all, productivity data arrive with a lag, so it would be quite risky for central bankers to react too strongly to continued wage gains, such as by declaring that they will maintain a more restrictive monetary policy than they otherwise would have done.

Specifically, there are three good reasons to adopt a wait-and-see posture. First, although forecasters failed to anticipate the persistent weakness in productivity over the past two decades, it is only recently that they seem to have given up signalling an expectation that it will start to recover. Second, there are obvious reasons for thinking that productivity will eventually improve, even if most have given up hope. Just look at the big developments in artificial intelligence, the shift to alternative energies, the change in working patterns since the start of the pandemic and policymakers’ renewed focus on initiatives explicitly designed to boost productivity. True, the data have yet to show that these developments are bearing fruit, but again, the gains from new technologies often take time to work their way through the economy and into official statistics.

The third reason to hold off on monetary tightening concerns the social and human aspects of the wage and productivity issue. As we know from debates about the sources of growing anxiety and economic insecurity across many democracies, median real wages have performed poorly in recent decades. This trend has clearly played a big role in the public’s growing disillusionment with “capitalism” and “globalisation”, and in the rising support for more radical and populist political parties and movements. It follows that an increase in real wages would help to moderate political attitudes. Repressing wages simply because of a belief that they are unjustified would be dangerous.

Will the improvement in inflation be sustained? Though the December inflation figures came in higher than expected, the preceding months had shown sharper-than-expected declines. If one examines the smoother underlying measures of trend inflation as well as surveys of inflation expectations, the outlook remains quite promising.

As for the other cyclical factors, three things stand out to me as we approach the end of January. Firstly, Chinese economic data and financial market performance remain generally disappointing despite stronger efforts by the authorities to support a robust recovery.

Secondly, in the US, most (though not all) economic indicators continue to come in stronger than expected. That is a relief, even if it isn’t alleviating the uncertainty among many commentators who worry that the recent positive trends may not be sustainable. Markets, too, have had a jittery start to the year. According to the so-called five-day rule (where a net gain for the S&P 500 in the first five trading days of January bodes well for the next 12 months), there is only a 50% chance that this will be a positive year for stocks. Yes, this is far from a scientific truth. But, as I have noted previously, a positive start has predicted a positive year more than 85% of the time, going back decades.

Lastly, despite the worrying issues in the Middle East and Ukraine, commodity-price volatility has remained remarkably subdued. Perhaps there are some odd technical supply-demand factors that account for this. But whatever the case, the relative stability is discernible across many markets. Most key commodities, as well as the recognised major commodity indices, are down compared with a year ago. That, too, is slightly reassuring. — Project Syndicate


Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development

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