bne IntelliNews – IMF BLOG: Policymakers need a steady hand as storm clouds gather over the global economy
A third of the global economy is likely to contract this year or next amid falling real incomes and rising prices.
The global economy continues to face daunting challenges, shaped by the Russian invasion of Ukraine, a cost of living crisis caused by persistent and growing inflationary pressures, and the slowdown in China.
Our global growth forecast for this year is unchanged at 3.2%, while our projection for next year is lowered to 2.7%, 0.2 percentage points lower than the July forecast.
The 2023 slowdown will be broad-based, with countries accounting for around a third of the global economy poised to contract this year or next. The three largest economies, the United States, China and the Eurozone will continue to stall. Overall, this year’s shocks will reopen economic wounds that were only partially healed after the pandemic. In short, the worst is yet to come and, for many, 2023 will look like a recession.
In the United States, tighter monetary and financial conditions will slow growth to 1% next year. In China, we lowered our growth forecast for next year to 4.4% due to the weakening real estate sector and continued lockdowns.
The slowdown is most pronounced in the eurozone, where the war-induced energy crisis will continue to wreak havoc, reducing growth to 0.5% in 2023.
Almost everywhere, rapidly rising prices, especially of food and energy, are causing severe hardship for households, especially the poor.
Despite the economic slowdown, inflationary pressures are proving stronger and more persistent than expected. Global inflation is now expected to peak at 9.5% this year before decelerating to 4.1% by 2024. Inflation also extends well beyond food and energy. Global underlying inflation fell from an annualized monthly rate of 4.2% at the end of 2021 to 6.7% in July for the median country.
Downside risks to the outlook remain high, while policy trade-offs to deal with the cost of living crisis have become more difficult. Among those highlighted in our report:
- The risk of miscalibration of monetary, fiscal or financial policies has increased sharply in a context of high uncertainty and growing fragility.
- Global financial conditions could deteriorate and the dollar strengthen further if financial market turmoil erupts, pushing investors into safer assets. This would significantly aggravate inflationary pressures and financial fragilities in the rest of the world, especially emerging markets and developing economies.
- Inflation could once again prove more persistent, especially if labor markets remain extremely tight.
- Finally, the war in Ukraine is still raging and a further escalation may exacerbate the energy crisis.
Our latest outlook also assesses the risks surrounding our baseline projections. We estimate that there is about a one in four chance that global growth next year will fall below the historic low of 2%. If many risks materialize, global growth would fall to 1.1% with near-stagnant per capita income in 2023. By our calculations, the probability of an equally unfavorable outcome, or worse, is 10% to 15%.
Cost of living crisis
Growing price pressures remain the most immediate threat to current and future prosperity by compressing real incomes and undermining macroeconomic stability. Central banks are now focusing on restoring price stability, and the pace of tightening has picked up sharply.
There are risks of under-tightening and over-tightening. Insufficient tightening would further boost inflation, erode the credibility of central banks and unanchor inflation expectations. As history teaches us, this would only increase the potential cost of controlling inflation.
Excessive tightening risks plunging the global economy into an unnecessarily deep recession. Financial markets could also be struggling with too rapid a tightening. Yet the costs of these policy mistakes are not symmetrical. The hard-earned credibility of central banks could be shaken if they again misunderstand the stubborn persistence of inflation. This would prove much more detrimental to future macroeconomic stability. Where appropriate, financial policy should ensure market stability. However, central banks must keep a firm hand with a monetary policy resolutely focused on controlling inflation.
Formulating the appropriate fiscal response to the cost of living crisis has become a serious challenge. Let me mention a few key principles.
First, fiscal policy should not run counter to monetary authorities’ efforts to reduce inflation. This would only prolong inflation and could cause severe financial instability, as recent events have illustrated.
Second, the energy crisis, particularly in Europe, is not a transitory shock. The geopolitical realignment of energy supplies as a result of the war is broad and ongoing. The winter of 2022 will be difficult, but the winter of 2023 will probably be worse. Price signals will be essential to curb energy demand and stimulate supply. Price controls, untargeted subsidies or export bans are fiscally costly and lead to excess demand, insufficient supply, misallocation and rationing. They rarely work. Fiscal policy should instead aim to protect the most vulnerable through targeted and temporary transfers.
Third, fiscal policy can help economies adapt to a more volatile environment by investing in productive capacities: human capital, digitalization, green energy, and supply chain diversification. Their expansion can make economies more resilient to future crises. Unfortunately, these important principles do not always guide policy at this time.
The effects of a strong dollar
For many emerging markets, the strength of the dollar is a major challenge. The dollar is now at its highest level since the early 2000s, although the appreciation is more pronounced against the currencies of advanced economies. So far, the upside appears to be driven primarily by fundamental forces such as US monetary policy tightening and the energy crisis.
The appropriate response in most emerging and developing countries is to calibrate monetary policy to maintain price stability, while allowing exchange rates to adjust, conserving valuable foreign exchange reserves in case conditions really deteriorate. financial.
As the global economy heads into turbulent waters, now is the time for emerging market policymakers to batten down the hatches.
Eligible countries with sound policies should urgently consider improving their liquidity buffers, including by requesting access to IMF precautionary instruments. Countries should also strive to minimize the impact of future financial turmoil by combining, where appropriate, macroprudential and preventive capital flow measures, in line with our integrated policy framework .
Too many low-income countries are over-indebted or close to over-indebted. Progress towards orderly debt restructurings through the Group of Twenty Common Framework for the Most Affected is urgently needed to avert a wave of sovereign debt crisis. Time may soon run out.
The energy and food crises, coupled with extreme summer temperatures, are stark reminders of what an uncontrolled climate transition would look like. Progress on climate policies, as well as on debt resolution and other targeted multilateral issues, will prove that targeted multilateralism can, indeed, achieve progress for all and successfully overcome the pressures of geo-economic fragmentation.
Pierre-Olivier Gourinchas is the economic adviser and director of research of the IMF. He is on leave from the University of California, Berkeley where he is the SK and Angela Chan Professor of Global Management in the Department of Economics and the Haas School of Business. Professor Gourinchas was Editor-in-Chief of the IMF Economic Review from its inception in 2009 to 2016, Editor-in-Chief of the Journal of International Economics between 2017 and 2019, and Co-Editor of the American Economic Review between 2019 and 2022. He is in leave from the National Bureau of Economic Research where he was director of the international finance and macroeconomics programme, researcher at the Center for Economic Policy Research CEPR (London) and member of the Econometric Society.