Dutch economy cools due to high inflation and lower global trade

This is according to the new Economic Developments and Outlook published by De Nederlandsche Bank (DNB).

Inflation is expected to have peaked in 2022. Price increases are likely to be less dramatic in the year ahead, given the anticipated energy prices and government measures. Inflation is projected to average 11.5% in 2022, mainly due to the exceptionally high rise in energy prices. This will be followed by declines to 4.9% in 2023 and 5.0% in 2024, which is when the government-imposed energy price cap ends. Core inflation (which excludes price increases in energy and food) is set to remain high due to pass-through from energy inflation to the prices of other goods and services, the tight labour market and the economy's high capacity utilisation rate. Despite the anticipated cooling, the economy is likely to continue running above capacity.

The labour market will remain extremely tight in the coming years, with unemployment projected to rise from 3.6% in 2022 to 4.2% in 2023, before edging down to 4.0% in 2024. This tightness, as well as high inflation, are driving wage rises higher. The increase in negotiated wages in the corporate sector is expected to accelerate from 2.9% in 2022 to 3.9% in 2023 and 4.0% in 2024.

The COVID-19 crisis did not derail public finances. The government’s measures to support purchasing power will push up the budget deficit to 3.0% of GDP in 2023. Public debt will fall just below 50% of GDP in 2023 and continue to decline to 47.7% of GDP in 2024. 

Policy recommendations

Do not opt for long-term compensation of energy costs for large groups of households and businesses...

Compensatory policies must be focused only on those households that would face financial difficulties without income support. If support is provided widely and untargeted, slowing down inflation is much more difficult. Tightening monetary policy is more effective if fiscal policy is not expansionary at the same time. Also, support to energy-intensive companies must be limited. This will become increasingly costly if energy prices remain high. It also has wider economic drawbacks, as it supports non-viable businesses in a tight labour market. 

... and support the sustainability drive for households and businesses.

Households and businesses are struggling with high energy bills. This burden can be reduced by saving energy and making energy-inefficient homes and businesses more sustainable. The government should take the lead and play a larger, more central role here, providing more central coordination, as these efforts must be speeded up with a view to phasing out compensation. In the longer term, the government needs to accelerate the transition to more fossil-free energy. This requires coordinated efforts on the part of the government, the trade unions and the corporate sector to counter labour market shortages. If they fail to do so, the transition will be hampered by current and future scarcity of qualified staff. 

Mitigate purchasing power loss with income growth.

Given that the labour income ratio is falling, there may be scope for additional wage increases in some industries. That said, automatic compensation of higher prices by means of higher wages is not the right way forward, as this could fuel a wage-price spiral.

Return to fiscal discipline.

It is important that the government returns to compliance with the existing requirements and its own agreements on fiscal discipline as soon as possible. This means that its compensation package must have permanent funding from the government budget. If ample and unfunded compensation continues, this may eventually increase the public debt ratio. Given the tight labour market, any tax increases should not affect labour supply. This means wealth tax increases would be more obvious. 

Alternative scenario with higher energy prices and lower global trade

Energy and food prices may remain high for longer than assumed in our projections. Under such a scenario, in which world trade growth also slows down, GDP growth in 2023 and 2024 will on average be 0.8 percentage points lower than projected. In addition, inflation will rise above 9% in 2024, some 4.5 percentage points higher than in our projections. Furthermore, if the energy price cap were extended by one more year, household purchasing power would be supported for longer, but the fiscal deficit would worsen. 

For more information, please contact Bouke Bergsma by email at bouke.bergsma@dnb.nl or by telephone at +31 (0)653 258 400.