The winding road to global recovery passes through a thicket of risk – 01/25/2022 – Martin Wolf

While 2021 was a year of strong economic recovery, this recovery was neither universal nor complete. Unfortunately, the outlook for 2022 today looks worse than the IMF forecast last October: the main culprits, she says, are the Covid-19 omicron variant, supply shortages and unexpectedly high inflation. Reductions in forecasts are particularly marked for the United States and China. Uncertainties are high, with risks concentrated on the downside. Above all, it is easier to say that the basic thesis of the fund is more optimistic than pessimistic.

These are my conclusions from the IMF’s World Economic Outlook Update. A year ago, the fund predicted global economic growth in 2021 at 5.5%, with high-income countries growing at 4.3%. Today, he estimates that global growth last year was 5.9%, with growth in high-income countries at 5.0%. The improvement in emerging and developing countries was much smaller: a year ago, growth in 2021 was forecast at 6.3%, against the 6.5% forecast today. In general, the fund comments, whether the results in 2021 would be better than the forecast at the end of 2020 depended on achieving high levels of vaccination: vaccines are as much an economic policy as a health policy.

The reductions in the forecast for 2022 since October last year are not drastic: the world economy is still forecast to grow at 3.9% and emerging and developing countries, at 4.8%. The reductions are 0.5, 0.6 and 0.3 percentage points, respectively. They are especially pronounced for the United States, with growth forecast for 2022 down 1.2 percentage points to 4%, and China, forecast for growth reduced by 0.8 percentage points to 4.8%.

The main factors behind the US reduction are the removal of the Build Back Better fiscal package from the baseline, the sharper-than-expected withdrawal of monetary accommodation, and the shortage of supplies. In China, it’s the disruption caused by a “zero Covid” policy and tension in the real estate sector.

Far more important than these predictions are the assumptions on which they are based. The fund crucially assumes that the pandemic will be brought under control globally by the end of 2022. This implies that vaccination will be achieved in most countries and that vaccines will also continue to be effective. The fund is also still on “temporary time” on high inflation, although it will be worse and last longer than previously expected — both by the IMF and most analysts. But its story remains one of short-term restraint and well-anchored inflation expectations: inflation in high-income countries is forecast to average 3.9% in 2022, before decreasing in 2023. The fund also assumes that China will successfully stabilize its economy.

The risks are on the downside, as the fund also comments. One risk is that Covid is not controlled. The most urgent task is to make vaccination effective, which is a challenge for scientists, companies and healthcare systems. It is also crucial to earn and maintain public trust.

Another risk is that inflation will not be brought under control quickly or easily. It is indeed easy to point to specific shocks, notably energy prices, as the proximate cause of inflation. In 2021, the fund claims, supply shocks reduced world production by 0.5 percentage point and increased inflation by 1 point. But there’s more to it than that. The US labor market data is especially intriguing as employment and labor force participation are relatively low, while other evidence, notably on labor costs and layoff rates, suggests that labor markets are tight.

It is reasonable to assume that supply bottlenecks will decrease, as high prices are in themselves the inducement to higher supply. In the case of energy, prices may remain high, but stabilize or even begin to fall. However, as monetary policy and financial conditions are exceptionally loose by historical standards, substantial tightening may still be needed to stabilize demand. The fund assumes that asset purchases by the US Federal Reserve will end in March and that there will be “three interest rate hikes in 2022 and 2023”. That might not be enough, but it might be too much. Disinflation has historically often led to recessions.

We can add that if the rise in inflation is large and time-consuming, the new doctrine of average inflation targeting will cause a headache. Will the Fed target inflation below 2% to offset any excessive growth?

As the Global Financial Stability Report update adds, financial markets show “forced valuations”—a nice understatement. The tightening of monetary policy, possibly at a faster pace and to levels higher than expected, will soon tell us who was swimming naked in our financial oceans. These financial risks are especially important for emerging and developing countries. A big question may then be what is our ability to deal with financial disturbances.

In addition, there are obvious geopolitical and climate risks. Just look at the Russia-Ukraine imbroglio. An especially interesting question is how to manage a world where most countries have decided to live with Covid, while China has decided to suppress it. This suggests a permanent closing of borders to the movement of people. It would be a new iron curtain—an iron quarantine.

In general, a steady recovery should be expected, albeit at a slower pace than was anticipated a few months ago. But we were also reminded of the risks. These are sharply to the downside. Furthermore, the “normal” we can return to is not the old one. The world changed.

Translated by Luiz Roberto M. Gonçalves

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About Yadunandan Singh

Born in 1992, Yadunandan approaches the world of video games thanks to two sacred monsters like Diablo and above all Sonic, strictly in the Sega Saturn version. Ranging between consoles and PCs, he is particularly fond of platform titles and RPGs, not disdaining all other genres and moving in the constant search for the perfect balance between narration and interactivity.

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