USA: The gradual recovery of the world economy from the pandemic and Russia's invasion of Ukraine is still on schedule. China's economy is rapidly recovering after being reopened. While the war's effects on the energy and food markets are waning, supply chain disruptions are also easing.
In addition, the widespread and coordinated tightening of monetary policy by most central banks should begin to show results, with inflation returning to target levels.
In our most recent World Economic Outlook, we predicted that growth would peak at 2.8 percent this year before edging up to 3 percent the following year—0.1 percentage points less than our predictions from January.
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The rate of global inflation will decline from 8.7% last year to 7% this year and 4.9 percent in 2024, albeit more slowly than initially predicted.
inflation and growth
The advanced economies are experiencing the most severe economic slowdown. The rate of inflation decline is slower than expected.
The advanced economies are experiencing the greatest economic slowdown this year, particularly the euro area and the United Kingdom, where growth is predicted to fall to 0.8% and -0.3% this year before rising to 1.4% and 1.1%, respectively, next year. In contrast, many emerging market and developing economies are expanding, and year-over-year growth will increase to 4.5 percent in 2023 from 2.8 percent in 2022 despite a 0.5 percentage point downward revision.
However, recent banking instability serves as a reminder that the situation is still precarious. Once more, downside risks rule, and the haze surrounding the global economic outlook has grown thicker.
First off, inflation is much more persistent than was thought just a few months ago. Although global inflation has decreased, this is primarily due to the sharp decline in the cost of food and energy. However, core inflation, which does not include energy and food, has yet to reach its peak in many nations. We anticipate core inflation to slow to 5.1 percent at year's end this year, which is well above target and represents a significant upward revision of 0.6 percentage points from our January update.
Additionally, activity exhibits resilience as labour markets in the majority of advanced economies continue to be very robust. We would anticipate seeing more indications of output and employment softening at this stage in the tightening cycle. Instead, for the past two quarters, our projections for output and inflation have been updated upward, indicating stronger-than-anticipated aggregate demand. This might necessitate tightening monetary policy even more or keeping it tighter than currently anticipated.
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Do we need to be concerned about the possibility of an unchecked wage-price spiral? I still don't think you've convinced me. The fact that nominal wage growth has lagged behind price growth suggests that real wages have fallen. Contrary to popular belief, this is taking place at a time when there is a significant shortage of labour due to the fact that many workers have not fully re-entered the workforce after the pandemic. This implies that real wages should rise, and I anticipate that they will. However, corporate margins have increased significantly in recent years—the flip side of sharp price increases but only modest wage increases—and should, on average, be able to absorb most of the increasing labour costs. That process shouldn't spiral out of control as long as inflation expectations are firmly anchored. It may well, however, take longer than anticipated.
More concerning are the negative effects that the financial sector is already beginning to experience as a result of the sharp tightening of monetary policy over the past year, as we have repeatedly warned might happen. Maybe the surprise is how long it took.
The financial sector had grown too relaxed about maturity and liquidity mismatches after a protracted period of low interest rates and muted inflation. Rapid monetary policy tightening last year resulted in significant losses on long-term fixed-income assets and increased funding costs.
Any financial system's stability depends on its capacity to absorb losses without using taxpayer money. The recent banking turmoil in the United States and the brief instability in the gilt market in the United Kingdom last fall serve as evidence that both banks and nonbank financial intermediaries are seriously vulnerable. Financial and monetary authorities acted swiftly and firmly in both situations, which has so far prevented further instability.
Our World Economic Outlook considers a case in which banks further curtail lending due to rising funding costs and the need to exercise greater caution. As a result, output is decreased by an additional 0.3% this year.
The financial system, however, might be put to even greater test. As they did with Crédit Suisse, a globally systemic but failing European bank, anxious investors frequently search for the next weakest link.
Financial institutions with excessive leverage, exposure to credit risk or interest rates, an excessive reliance on short-term funding, or those that are situated in countries with constrained fiscal space, may be the next target. Likewise, nations with supposedly weaker fundamentals could.
Credit conditions and public finances may be significantly impacted by a sharp tightening of global financial conditions, or a "risk-off" event, particularly in emerging market and developing economies. The dollar would appreciate in a flight to safety, there would be significant declines in global activity amid lower confidence, household spending, and investment, and there would be significant capital outflows.
In such a dire scenario, global growth could slow to 1% this year, which would indicate almost stagnant per capita income. Our calculations place the likelihood of such a result at 15%.
Policymakers now more than ever need to communicate clearly and with consistency.
As long as financial instability is under control, monetary policy should be concentrated on reducing inflation while remaining flexible enough to quickly respond to changes in the financial landscape. The banking crisis has a silver lining in that banks' lending restrictions will help slow overall activity. By itself, this should lessen the necessity of additional monetary tightening in order to achieve the same policy stance. However, any expectation that central banks will prematurely give up the fight against inflation would have the opposite effect: lowering yields, supporting activity more than is necessary, and ultimately making it more difficult for monetary authorities to carry out their duties.
Additionally, fiscal policy can actively participate. Tighter fiscal control would support monetary policy by slowing down economic growth, enabling real interest rates to drop more quickly to their low, natural level. Fiscal consolidation that is properly planned will also aid in restoring much-needed buffers and enhancing financial stability. Even though many nations' fiscal policies are becoming less expansionary this year, more could be done to reclaim fiscal space.
Regulators and supervisors should take immediate action to strengthen oversight and actively manage market tensions in order to prevent remaining financial fragilities from developing into a full-blown crisis. This also entails ensuring proper access to the Global Financial Safety Net for emerging market and developing economies, including the IMF's precautionary arrangements, access to the US Federal Reserve Foreign and International Monetary Authorities repo facility, or, where applicable, central bank swap lines.
According to our Integrated Policy Framework, exchange rates should be allowed to fluctuate as much as possible unless doing so increases the risk to financial stability or jeopardises price stability.
The medium-term growth forecasts appear to be generally slowing down, according to our most recent projections. Growth forecasts for the next five years decreased gradually, from 4.6 percent in 2011 to 3 percent in 2023. A portion of this decline can be attributed to the economies of China and Korea, which were once expanding quickly, slowing down.
Growth slows down as countries converge, which is predictable. However, some of the more recent slowdowns may also be a result of more worrying factors, such as the pandemic's lasting effects, the slower pace of structural reforms, and the growing threat of geoeconomic fragmentation, which could result in increased trade tensions, decreased direct investment, and a slower rate of technological innovation and adoption across fragmented "blocks." A fractured world is unlikely to successfully advance for everyone.
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