Let’s start with the good news. Despite the fact that inflationary pressures persist in some countries, the global fight against inflation appears to have been effectively won. We expect headline inflation to peak at 9.4% year-on-year in the third quarter of 2022, before falling to 3.5% by the end of next year, slightly below the average of the past 20 years during the pandemic. Inflation rates in most countries are hovering around central bank targets, paving the way for major central banks to ease monetary policy.
The global economy continued to show signs of extraordinary resilience throughout the disinflationary process. Growth is expected to stabilize at 3.2% in 2024 and 2025, although some low-income and developing countries are likely to see significant downward revisions to growth rates related to escalating conflict. many.
Among developed countries, the United States is growing at a strong 2.8% this year, on track to reach its potential in 2025. In Europe’s developed countries, a modest recovery in growth is expected next year. We should be getting closer to that possibility. The growth outlook for emerging market and developing economies is very stable, with growth expected to be around 4.2% this year and next, driven by the continued strong performance of emerging markets in Asia.
Reducing inflation without causing a global recession is quite an accomplishment. As argued in Chapter 2 of our report, the rise and subsequent fall in inflation is the result of a combination of exceptional shocks. This is due to the widespread supply shock and strong demand pressure that occurred after the pandemic, and the subsequent sharp increase in fresh produce. Material prices soared due to the war in Ukraine.
These shocks led to an upward shift and increase in the slope of the activity-inflation relationship, the Phillips curve. Once the supply shock subsided and restrictive monetary policy began to suppress demand, normalizing labor market conditions allowed inflation to fall quickly without a significant slowdown in activity. .
It is clear that much of the disinflation is due to improvements in labor supply, often associated with increased immigration, as well as corrections to the shock itself. However, monetary policy played an important role in stabilizing inflation expectations and avoiding a vicious wage-price cycle and a repeat of the disastrous inflation experience of the 1970s.
Despite the good news on the inflation front, risks of worsening conditions are increasing and are already dominating the outlook. Escalating regional conflicts, particularly in the Middle East, could pose serious risks to commodity markets. Trends toward unwise trade and industrial policies could result in significant reductions in production relative to our baseline forecasts. Monetary policy could continue for an excessively long period of time, and global financial conditions could suddenly tighten.
A return to a level near the central bank’s target for inflation would pave the way for three shifts in economic policy, providing much-needed macroeconomic maneuverability while risks and challenges remain high. It will be.
The first turning point, monetary policy, has already begun. Since June, major central banks in developed countries have begun lowering monetary policy rates and have shifted to a neutral stance. This will support activity at a time when unemployment rates are rising and labor markets in many developed countries are showing signs of cooling. However, the rise in unemployment has so far been gradual and does not signal an imminent slowdown in economic activity.
Lower interest rates in major economies will ease pressure on emerging market economies, whose currencies are strengthening against the dollar and whose financial conditions are improving. This will help reduce imported inflation and make it easier for these countries to move forward on their own deflationary journey.
However, it is still very important to be cautious. Service inflation remains at excessively high levels, almost double the inflation rate observed before the pandemic. Some emerging market economies are facing a resurgence of inflationary pressures and have begun raising interest rates again.
Moreover, we have entered a world dominated by supply shocks driven by climate, health issues, and geopolitical tensions. It is always difficult for monetary policy to control inflation when it has to deal with shocks of this kind that simultaneously raise prices and reduce output.
Finally, while inflation expectations remain well-held this time around, the next time could be more difficult as workers and businesses become more wary of protecting wages and profits.
The second turn is the turn that affects fiscal policy. Fiscal space is one of the pillars of macroeconomic and financial stability. After years of expansionary fiscal policy in many countries, the time has come to stabilize debt trends and restore much-needed fiscal policy space.
Although lower policy rates provide some fiscal relief by reducing funding costs, it is not enough on its own, especially as long-term real interest rates remain well above pre-pandemic levels. Many countries need to improve their primary fiscal balance (the difference between tax revenues and public spending, excluding debt service).
In some countries, such as the United States and China, current fiscal plans will not stabilize debt trends. In many other countries, fiscal plans drawn up in the wake of the pandemic and cost-of-living crisis looked promising, but there are increasing signs of divergence.
There’s not much room for error. Delays in fiscal consolidation increase the risk of disorderly market adjustments. Furthermore, too sudden a change in fiscal policy tightening could have the opposite effect and adversely affect economic activity.
To be successful, if integration is required, sustained and reliable multi-year coordination must occur without delay. The more reliable and disciplined fiscal adjustment is, the more support monetary policy can provide by lowering policy rates and controlling inflation. But so far there is neither the will nor the ability to carry out disciplined and reliable fiscal adjustments.
The third and most complex turn is growth-enhancing reforms. Efforts must be redoubled to improve growth prospects and increase productivity. Only then will we be able to respond to the multiple challenges we face. Address aging and population decline in many parts of the world. Implement climate change. Building resilience and improving the lives of the most vulnerable people at home and abroad.
Unfortunately, the five-year growth outlook remains lackluster, with growth expected to be 3.1%, the lowest in decades. This primarily reflects a weaker outlook for China, but the medium-term outlook for other regions, including Latin America and the European Union, has also worsened.
Faced with increasing external competitiveness and structural deficiencies in manufacturing and productivity, many countries have adopted industrial and trade policies aimed at protecting workers and the national productive sector. However, external imbalances often reflect macroeconomic factors, such as weakening domestic demand in China and excess demand in the United States. To address these, macroeconomic dashboards must be properly configured.
Furthermore, while industrial and trade policies may stimulate investment and activity in the short term, they often invite retaliation and fail to achieve sustained improvements in living standards, especially when based on debt subsidies. . They should be avoided unless they carefully address clearly identified market failures or very precise national security issues.
Economic growth must be achieved through broad domestic reforms that foster technology and innovation, improve competition and resource allocation, deepen economic integration, and stimulate productive private investment.
But while reforms are more urgent than ever, they often face strong social resistance. How can authorities get the support they need to make reforms successful?
As shown in Chapter 3 of our report, an information strategy can help, but it is not enough. Building trust between governments and citizens (a two-way process during policy design) and including appropriate measures to compensate for potential harm are two important elements.
The need to build trust is an important consideration for us as we look for ways to further improve international cooperation and strengthen multilateral efforts to address common challenges this year, as we celebrate our nation’s 80th anniversary. It’s also a lesson. Bretton Woods Institution.
— This blog is based on the October 2024 World Economic Outlook. For more information on the report analysis chapter, please visit our blog. The global inflation episode offers lessons for monetary policy, and support for economic reforms depends on communication, interaction, and trust.
