Is it time to ease or even reverse monetary contraction? It is becoming a common view that the answer to these questions is “yes”. Markets are certainly behaving as if the days of contraction are over. They may even be right. But, most importantly, they will only be right about the future of monetary policy if economies weaken. The stronger economies are, the more central bankers worry that inflation will not return to 2 percent, and so longer policy is likely to remain tight. So, in essence, one can hope that economies will strengthen, policies will ease, and inflation will disappear, all at the same time. But this best of all possible worlds is far from the most likely.
The International Monetary Fund’s global economic outlook update confirms a more optimistic view of the economic future. Notably, global economic growth is projected to be 3.2 percent between the fourth quarter of 2022 and 2023, up from 1.9 percent between the corresponding quarters in 2021 and 2022. This would be lower than the 2000-19 average of 3.8 percent. However, given the huge shocks and rising inflation, this would be a good outcome.
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True, growth in high-income countries is projected to be just 1.1 percent over the same period, compared to 1 percent in the United States and just 0.5 percent in the euro zone. But the UK economy is the only economy in the G7 forecast to shrink by 0.5% over this period. The UK forecast for 2023 has also been reduced by 0.9%. Consider this one of those “Brexit profits”. Brexit is the gift that keeps on giving.
However, a notable feature of the projections is the strength of emerging and developing countries. Their economies are forecast to grow by 5% between the fourth quarter of 2022 and 2023 (up from 2.5% in the previous period), with emerging and developing Asia growing at 6.2% (up from 3.4%), China. 5.9 percent (up from 2.9 percent) and India with 7 percent growth (up from 4.3 percent). China and India are even expected to generate half of the world’s economic growth this year. If the IMF proves it, Asia is back.
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The reopening of China and the reduction of energy prices in Europe are considered the most important reasons for improving the outlook. Global inflation is also projected to decline from 8.8 percent in 2022 to 6.6 percent in 2023 and 4.3 percent in 2024. The IMF’s chief economist, Pierre-Olivier Guerinchas, even said that 2023 could mark a turning point. Improving conditions in the following years Most importantly, there are no signs of a global recession.
The International Monetary Fund says risks remain to the downside. But the adverse risks have been moderated since October 2022. In an uptrend, there may be stronger demand or lower-than-expected inflation. On the downside, there is the risk of worse health outcomes in China, a sharp escalation of the war in Ukraine, or financial turmoil. To these cases, not only Taiwan, but also the risk of attacking Iran’s nuclear weapons program, which causes the bombing of Persian Gulf oil fields, can be added to these cases.
Some may argue that the downside risks to growth in high-income countries are underestimated: consumers may adjust as the funds they received during Covid run out. But the opposite risk is that the strength of the economies prevents the rapid reduction of inflation to the target. Headline inflation may have peaked. But the IMF notes that “core (core) inflation has not yet peaked in most economies and remains well above pre-pandemic levels.
Central banks face a dilemma: have they already done enough to achieve their goals and stabilize inflation expectations? If the Fed looks at the optimism in the markets, it may conclude that it doesn’t. But, if one looks at the fund’s projections for US growth, it might conclude the opposite. These may not be catastrophic, but they are weak. The same goes for the European Central Bank and even more so for the Bank of England when they look at their economy. These central banks may logically wait to see how far their economies weaken before making further moves. In fact, Harvard hawkish Larry Summers recommends such a pause until then.
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That the global economy is looking a little stronger than expected not too long ago is certainly a good thing. However, for central banks (and investors), this also creates problems. The former’s strategic objective should ultimately be to return the annual inflation rate to 2 percent and, in the process, anchor expectations firmly at that level.
The dilemma for central banks then is whether today’s greater optimism is consistent with achieving this strategic objective, while for investors it is whether the markets’ implicit view of how central banks view the question is correct. In a world where there is an interactive “game” between central banks and economic actors, the effort is to determine whether central banks are doing too much or too little to deliver the economy needed to target core inflation. have done or not Very small.
Given the uncertainty, there is now a good case for taking a wait-and-see stance. But an important point is that in an inflationary world, good news about economic activity today is not necessarily good news for policy and future activity, unless it indicates that the short-run trade-off between output and inflation is also favorable. If so, central banks could start easing policy sooner than previously expected. If not, they will have to become more strict than is now expected. For now, we can hope for the previous result. But it is still far from certain.
martin.wolf@ft.com
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