Careful Calibrations: Narrow Path for Global Recovery Requires Decisive Action

Authors: Ayhan Kose, Ekaterine T. Vashakmadze*

The world economy is navigating uncharted waters as it continues to suffer from a series of destabilizing shocks. After more than two years of the COVID-19 pandemic, the war in Ukraine and its global effects have steepened the slowdown in global growth. A decisive and wide-ranging policy response will be needed to boost growth and mitigate the multiple risks confronting the global economy.

According to the latest projections by the World Bank, the world economy is expected to experience its sharpest deceleration following an initial recovery from a global recession in more than 80 years. Global growth is projected to slow from 5.7 percent in 2021 to 2.9 percent in 2022 — significantly lower than the 4.1 percent that was anticipated in January. Global growth is expected to hover around that pace over 2023-24, as the war in Ukraine disrupts activity, investment, and trade; pent-up demand fades; and fiscal and monetary policy accommodation is withdrawn.

In advanced economies, growth is projected to decelerate sharply from 5.1 percent in 2021 to 2.6 percent in 2022. Growth is expected to further moderate to 2.2 percent in 2023, largely reflecting the further unwinding of the fiscal and monetary policy support provided during the pandemic.

Growth in emerging market and developing economies is projected to roughly halve this year, slowing from 6.6 percent in 2021 to 3.4 percent in 2022—well below its annual average of 4.8 percent over 2011-19. Forecasts for the 2022 growth have been revised down in 70 percent of these emerging market and developing economies, including most commodity importing countries as well as four-fifths of low-income countries.

The global outlook is subject to various interlinked downside risks. Intensifying geopolitical tensions could further disrupt economic activity, generate policy uncertainty and, if persistent, lead to fragmentation in global trade, investment and financial systems.

Supply disruptions from the pandemic and the war in Ukraine have led to a spike in energy and food prices. Food shortages could worsen and spark social unrest, while new, more virulent variants of COVID-19 could emerge and disrupt activity.

Additional adverse shocks would increase the possibility that the global economy will experience a period of low growth and high inflation. In the 1970s, getting out of such stagflation required steep increases in interest rates by major advanced-economy central banks, which triggered a global recession and a string of financial crisis in EMDEs.

The current juncture resembles the 1970s in three key aspects: persistent supply-side disturbances fueling inflation preceded by a protracted period of highly accommodative monetary policy in major advanced economies, prospects for weakening growth, and vulnerabilities in emerging economies to the monetary policy tightening that will be needed to rein in inflation.

However, the current global environment also differs from the 1970s in multiple dimensions. The percentage increases in commodity prices are smaller. Labor markets are also much more flexible, reducing the likelihood of price-wage spirals becoming entrenched. In addition, the energy intensity of activity has fallen considerably since the 1970s, making the global economy more resilient to energy supply shocks.

More importantly, unlike the 1970s, central banks in advanced economies and many emerging markets now have clear mandates for price stability, and, over the past three decades, they have established a credible track record of achieving their inflation targets. As a result of improvements in monetary policy frameworks, long-term inflation  expectations have become much less sensitive to sudden changes in inflation.

While somewhat less affected than other regions, East Asia and the Pacific is not immune to the global slowdown. Growth in the region is projected to decrease to 4.4 percent in 2022 — 0.7 percentage point lower than forecasts in January. Higher global commodity prices are contributing to inflation and widening current account deficits in some countries with high dependence on food and energy imports. Meanwhile, China’s growth has been hit by renewed outbreaks of COVID-19, with supply chain disruptions and weakening import demand moderating trade flows across the region. External financing conditions have tightened, and risk premiums have edged up following faster-than-expected monetary policy tightening in the United States. Growth in the region is projected to stabilize at an average of 5.2 percent in 2023-24, but the recovery will remain incomplete in many countries.

Against this gloomy background, the path for a sustained recovery is becoming increasingly narrow, requiring decisive global and national policy actions. This will involve global efforts to limit the harm to those affected by the war in Ukraine, to cushion the blow from surging oil and food prices, to speed up debt relief, and to expand vaccinations in low-income countries.

It will also involve refraining from distortionary policies such as price controls and export bans, which could worsen the recent increase in commodity prices. The challenging combination of higher inflation, weaker growth, tighter financial conditions, and limited fiscal policy space will also require reprioritizing spending toward targeted relief for vulnerable populations.

The narrow path to recovery will once again test the resilience of the global economy. It is not easy to quickly implement these policy prescriptions. However, delaying the necessary measures would have painful consequences. Policymakers need to act now to carefully calibrate policies, design credible macroeconomic frameworks, and clearly communicate the measures they plan to implement.

*M. Ayhan Kose is chief economist and director of the World Bank’s Prospects Group. Ekaterine T. Vashakmadze is senior country economist of the World Bank’s Prospects Group. 

first published on China Daily via World Bank

Ayhan Kose
Ayhan Kose
M. Ayhan Kose is chief economist and director of the World Bank’s Prospects Group.