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Why the OECD and IMF see inflation as the way forward for global economy

Global economic growth

"Inflation" is often a term that carries negative connotations when it comes to analysing the state of the economy, particularly among consumers, many of whom equate it with higher prices and an increased cost of living.

Onlookers may well have been subsequently worried then when the Organisation for Economic Co-operation and Development (OECD) revealed plans to actually increase the rate of inflation, calling on world leaders to use demand-side models.

The plans were outlined by OECD secretary general Angel Gurria, who in a recent interview with Bloomberg insisted that "we should be worried about deflation".

“A lack of demand means you have to do something on the other side - we’ve been focusing on the supply side for many years," he said.

The OECD claims the world economy has been flowing a supply-side measure for too long, adding that focus needs to shift away from this practice.

According to the OECD, the world has been following a supply-side measure for too long and needs to shift its focus away from this practice. Instead, it suggests that a demand-side model may better address a concern over global deflation.

Inspiring growth

The OECD is currently forecasting global economic growth of three per cent this year - a prediction that comes on the back of repeated warnings from the International Monetary Fund (IMF), which claims that its assessment for the year is likely to be downgraded.

While stopping short of predicting another recession, Mr Gurria warned that "conditions are tough".

“Investment is about half the speed it should be growing because of uncertainties and regulatory issues, and ultimately because of the financial side - credit is not flowing," he added.

The state of the world economy has, according to the OECD, caused negative interest rates on bonds and delays in potential rate increases by the US Federal Reserve.

And Mr Gurria believes world leaders are beginning to run out of options in terms of helping to sustain growth without implementing significant structural changes.

“We’ve run out of those easy fixes Now we have to think medium and long term.” He added that world leaders needed to return to “fundamentals again” in order to foster long-term global economic growth."

According to the OECD's chief economist, Catherine Mann, the sluggish global growth is threatening to keep governments around the world from being able to pay pensions and bondholders.

Her recommendation is to continue stimulus from central banks, as well as government spending and tax policies in order to encourage economic expansion, making regulations more consistent from country to country.

Previous forecasts, according to Mann, have also proved inaccurate, including the idea that low unemployment in the United States and other countries would strengthen pay growth.

Mann agreed that the days of an "easy fix" for inspiring inflation were long gone, adding that low interest rates had also failed to inspire investment among businesses.

Time for Plan B

Deflation and its effect on the global economy is an issue that is not just on the minds of the those at the OECD, with meetings of the G-20, the Chinese National People’s Congress, and multiple think tanks all pushing it to the top of the agenda.

As has been the case with most forecasts for the global economy, the decisions taken by China are likely to have one of the most significant impacts.

Despite many of the country's policymakers advising otherwise, China has opted against following conventional Western approaches, such as the use of flexible exchange rates to absorb volatile capital flows.

Some analysts have argued that his decision has helped China to free monetary policy and provide liquidity for domestic structural adjustments.

Despite going against convention, the move satisfied a number of Western economists and, perhaps more importantly, the global financial markets.

The agreement is likely to have been due to the fact that China's approach was still one aimed at encouraging inflation.
However, the initial concern was that if China was to look at a weaker exchange rate in order to escape the effects of deflation, it could in turn spark another round of global competitive devaluations and make the situation even worse.

Fortunately, China’s leaders recognised that if the world remained under the shadow of a balance-sheet recession, the lack of aggregate demand combined with weakening trade, would drag down the country’s growth.

While it is understandable for countries like China to look at taking an approach that helps their own cause, there is no denying that collective action has to be the ultimate goal in order to get the global economy growing again.

Previous efforts have largely fallen short, largely because commercial banks and other lenders have kept the liquidity received from their central banks, which has in turn seen them opt against putting money into the real economy through providing credit to small and medium-size enterprises or investing in long-term infrastructure projects.

Reaching a unified and global consensus could therefore be the key in ensuring the world avoids another global financial crisis.