Use fiscal firepower to ease burden on poorest citizens, says the OECD

Governments should use their fiscal firepower to protect the poorest citizens from devastating rises in food and energy prices, the OECD said on Thursday in the first estimate by an international organization of the economic costs of Russia’s invasion of Ukraine.

Targeted support for the poor would almost halve the expected average 1 per cent hit to rich economies’ gross domestic product from the war but cause only a small rise in inflation, the OECD said, making it by far the most effective means of intervention.

Such support was most urgent in eastern Europe and the Baltic states, where spending on food and energy accounted for more than 40 per cent of the total among the poorest 20 per cent of households, it added.

Laurence Boone, chief economist of the OECD, told the Financial Times that she understood that governments, including in France, Germany and Sweden, were considering broad-based tax cuts on fuel, since it was an “emergency situation”.

But she said that there would be a much greater and more positive impact by providing “cost-efficient, targeted and ideally temporary help” in the form of temporary increases to social security payments to poorer households to help them cope with higher energy prices.

This would not fuel inflation, Boone added. “If [the support] is just helping people pay for energy and food, it is not going to push demand ahead of effective supply, ”she said.

Instead, it might reduce people’s demands for higher wages, limiting inflationary impacts that are caused by additional spending. “If we manage to help lower-income and lower-middle class households through this period, it will also help to prevent a wage price spiral. That is super important, ”Boone said.

She added that the support was especially important in the Baltic states and eastern Europe.

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The OECD’s forecasts were backed on Thursday by François Villeroy de Galhau, governor of the Banque de France, who said France’s economy was likely to lose 1 per cent of national income but there was little recession risk. He said the damage did not require a “whatever it takes” monetary policy response.

The OECD used a simulation model to estimate the economic effects of Russia’s invasion on the global economy. It included the recent rise in commodity prices, a 50 per cent depreciation of the Russian ruble against the dollar, declines in eastern European currencies, large drops in the economic output of Russia and Ukraine and higher Russian interest rates.

This scenario leads to a 1 percentage point drop in global GDP, but with greater damage to the eurozone economy and smaller in the US. Compared to the pre-invasion outlook, inflation was 2 percentage points higher in 2022 in the scenario, with greater effects in poorer countries where people spend more of their incomes on food and energy.

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For the US, which has the most serious inflation problem among advanced economies, the OECD did not suggest “a general [fiscal] stimulus ”, according to Boone, but a delay in its deficit reduction plan.

These policies, alongside collective financial support in Europe to help countries most affected by the arrival of millions of refugees, would have the most effective impact in lessening the domestic economic damage of the war in Ukraine, the OECD added.

In the longer term, the priority for advanced countries should be to promote renewable energy sources and diversify energy demand from Russia. This was also more difficult in many eastern European countries because they had a higher dependence on imported fossil fuels than most other advanced economies.

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