July 28, 2022
Inflation remains a major concern as the world’s three largest economies are halting, with important consequences for the global outlook.
The global economy, still reeling from the pandemic and Russia’s invasion of Ukraine, is facing an increasingly gloomy and uncertain outlook. Many of the downside risks flagged in the IMF’s April World Economic Outlook have begun to materialize.
Higher-than-expected inflation, especially in the United States and major European economies, is triggering a tightening of global financial conditions. China’s slowdown has been worse than anticipated amid COVID-19 outbreaks and lockdowns, and there have been further negative spillovers from the war in Ukraine. As a result, global output contracted in the second quarter of this year.
Under our baseline forecast, growth slows from last year’s 6.1 percent to 3.2 percent this year and 2.9 percent next year, downgrades of 0.4 and 0.7 percentage points from April. This reflects stalling growth in the world’s three largest economies – the United States, China and the euro area with important consequences for the global outlook.
In the United States, reduced household purchasing power and tighter monetary policy will drive growth down to 2.3 percent this year and 1 percent next year. In China, further lockdowns, and the deepening real estate crisis pushed growth down to 3.3 percent this year – the slowest in more than four decades, excluding the pandemic. And in the euro area, growth is revised down to 2.6 percent this year and 1.2 percent in 2023, reflecting spillovers from the war in Ukraine and tighter monetary policy.
Despite slowing activity, global inflation has been revised up, in part due to rising food and energy prices. Inflation this year is anticipated to reach 6.6 percent in advanced economies and 9.5 percent in emerging market and developing economies – upward revisions of 0.9 and 0.8 percentage points respectively, and is projected to remain elevated longer. Inflation has also broadened in many economies, reflecting the impact of cost pressures from disrupted supply chains and historically tight labor markets.
The risks to the outlook are overwhelmingly tilted to the downside:
- The war in Ukraine could lead to a sudden stop of European gas flows from Russia;
- Inflation could remain stubbornly high if labor markets; remain overly tight or inflation expectations de-anchor, or disinflation proves more costly than expected;
- Tighter global financial conditions could induce a surge in debt distress in emerging market and developing economies;
- Renewed COVID-19 outbreaks and lockdowns might further suppress China’s growth;
- Rising food and energy prices could cause widespread food insecurity and social unrest;
- Geopolitical fragmentation might impede global trade and cooperation.
In a reasonable alternative scenario where some of these risks materialize, including a full shutdown of Russian gas flows to Europe, inflation will rise and global growth decelerate further to about 2.6 percent this year and 2 percent next year – a pace that growth has fallen below just five times since 1970. Under this scenario, both the United States and the euro area experience near-zero growth next year, with negative knock-on effects for the rest of the world.
Policy priorities
Inflation at current levels represents a clear risk for current and future macroeconomic stability and bringing it back to central bank targets should be the top priority for policymakers. In response to incoming data, central banks of major advanced economies are withdrawing monetary support faster than we expected in April, while many in emerging market and developing economies had already started raising interest rates last year.
The resulting synchronized monetary tightening across countries is historically unprecedented, and its effects are expected to bite, with global growth slowing next year and inflation decelerating. Tighter monetary policy will inevitably have real economic costs, but delaying it will only exacerbate the hardship. Central banks that have started tightening should stay the course until inflation is tamed.
The outlook has darkened significantly since April. The world may soon be teetering on the edge of a global recession, only two years after the last one. Multilateral cooperation will be key in many areas, from climate transition and pandemic preparedness to food security and debt distress. Amid great challenge and strife, strengthening cooperation remains the best way to improve economic prospects and mitigate the risk of geoeconomic fragmentation.
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