Simultaneous rate increases and global recession risks

World Bank Report. The risk of global recession in 2022 haunted policy makers who observed that their growth expectations deteriorated rapidly in an environment of increasing inflation. Growth forecasts for the US, Eurozone and China have also been significantly lowered. These developments do not bode well for averting a global recession, as there has been a significant weakness in global growth during the year preceding every global recession since 1970, all occurring simultaneously with a recession in the United States.

Concerns about high inflation and the growing risk of unstable inflation expectations have already led to significant monetary policy tightening in many countries. The global economy is in the midst of one of the most harmonious periods of monetary and fiscal tightening in the last fifty years. These policy actions are necessary to contain inflationary pressures and are similar to the anti-inflation policies implemented in the late 1970s and early 1980s prior to the 1982 global recession.

If the degree of global monetary policy tightening currently projected by markets is not sufficient to bring inflation down to targets, experience from past global recessions shows that the necessary additional tightening could cause significant financial stress and trigger a global recession in 2023. The global recession will also translate into a sharp decline in growth in EMDEs. In light of the increasing vulnerabilities in many of these economies, they will face serious challenges associated with financial stress (Guenette, Kose, Sugawara, “Is a Global Recession Imminent?”, 2022).

During the 1982 global recession, tightening monetary policy in advanced economies sharply increased the cost of borrowing, particularly in Latin America and the Caribbean (Kose et al., 2021). A steep growth slowdown further weakened solvency, and more than three dozen debt crises erupted in EMDEs in the 1980s (Guenette, Kose, Sugawara, “Is a Global Recession Imminent?”, 2022). These crises were accompanied by a decade of growth loss in the Latin America and Caribbean region. GDP per capita in the region only reached its pre-crisis level in 1993.

The analysis shows that the global economy could survive a recession even if additional monetary policy beyond current market expectations is needed to keep inflation down. However, this will require additional tightening to be applied in a way that creates orderly harmony in financial markets. More importantly, policymakers need to use the full menu of options available to curb inflation and reduce the likelihood of a sharper decline in growth.

Monetary policy. While maintaining their independence, central banks should clearly communicate their policy decisions within credible monetary policy frameworks. This will help stabilize inflation expectations more strongly, reducing the degree of policy tightening required to drive inflation down. In the long run, the benefits of price stability, including reduced policy uncertainty and macroeconomic volatility, will outweigh the costs of tight monetary policy in the near term.

Fiscal policy. The pace and magnitude of the withdrawal of financial support must be fine-tuned and closely aligned with credible medium-term fiscal plans. In addition, policymakers in EMDEs need to address concerns over long-term debt sustainability by strengthening fiscal frameworks, increasing debt transparency, improving debt management functions, and increasing resource mobilization and spending efficiency. At the same time, fiscal policy needs to provide targeted relief to protect households, rather than introducing disruptive measures such as subsidies and price controls.

Synchronous policies. The simultaneous tightening of money and fiscal policies all over the world will probably be complementary in reducing inflation. However, since they are very synchronized among countries, they can produce cumulative effects larger than envisaged in accelerating the slowdown in global growth both in tight financial conditions and global growth. More tight financial conditions will have a particularly negative impact on more vulnerable EMDEs. This means that national policy makers should take into account the potential spread of global synchronized domestic policies.

Financial policies. Policymakers need to rebuild their foreign exchange reserve buffers and reframe prudent policies to prepare for potential financial stress. Such policies can also help lower inflation by reducing demand pressures. Due to tightening financial conditions, the banking system's exposure to exchange rate volatility and rollover risk should be carefully monitored and, if necessary, contained with prudent policies. Credit quality and non-performing loans should be reported transparently so that immediate corrective action can be taken. Banks' capital and liquidity buffers must be robust enough to absorb shocks.

Supply-side measures. While fiscal, monetary and financial policies can help manage short-term demand pressures, policymakers must also face supply constraints that affect energy markets, labor markets and international trade. These supply-side measures can help fight inflation and have the added benefit of improving productivity and long-term growth prospects. These measures are particularly important in the current context, as the pandemic has exacerbated the downward trend in potential growth (Guenette, Kose, Sugawara, “Is a Global Recession Imminent?”, 2022). If the ongoing global slowdown turns into a recession, the global economy may suffer permanent output losses even greater than its pre-pandemic trend (Guenette, Kose, Sugawara, “Is a Global Recession Imminent?”, 2022). This will have serious implications for long-term growth prospects in EMDEs, which have already been hit hard by the pandemic-induced global recession.

ALMPs that facilitate the reallocation of displaced workers and the hiring of workers at home and abroad can encourage increased labor force participation, reduce price pressures and contribute to growth (OECD, 2021).

Globally coordinated efforts can help increase commodity supply. For energy commodities, policy makers can leverage strategic stocks, accelerate transitions to low-carbon energy sources, and take measures to reduce energy consumption (IEA, 2022). Policymakers also need to actively participate in efforts to alleviate global supply bottlenecks. One of the most pressing priorities in this context is the need to renew support for a rules-based international economic order that guards against the threat of protectionism and fragmentation that could further distort trade networks.

Vulnerabilities, crises, and growth. A. Vulnerabilities in EMDEs (medians based on a sample of up to 155 EMDEs), B. Financial crises in EMDEs (Total number of banking, currency, and sovereign debt crises in EMDEs in respective periods ), C. Potential growth forecasts (Potential growth forecasts based on the production function approach as described in Kılıç Çelik, Köse and Ohnsorge (2020). Example covers 82 countries – 29 developed economies and 53 EMDEs), D. Evolution of global GDP (Data shown as an index (2019 = 100) Pandemic preliminary forecasts are based on growth projections from the January 2020 long-term consensus forecasts over 2020-24)… Source: Consensus Economics, International Monetary Fund, Kilic Celik, Kose, and Ohnsorge (2020), Laeven and Valencia (2020), Oxford Economics, World Bank

Conclusion? There are analyzes that simultaneous monetary policy implementations and fiscal policy interventions other than the market mechanism will create a global recession effect that will set the stage for financial crises in 2023. Despite all this, if the central banks are not successful in reducing inflation, it is possible that the global economy will remain in a stagflation spiral. For this reason, the analysis of inflation, its causes, sources and areas of struggle should be analyzed well and accurately. At this point, inaction and excessive action will be damaging on the global economy at similar rates and through different channels.

The fact that inflation is above the expected and targeted levels forces the central banks of many developed countries, especially the Fed, to raise interest rates above the usual levels. The global economy's entry into recession may depend on the size of the rate hikes and the length of time that interest rates will remain high.

Kaynak: Tera Yatırım-Enver Erkan
Hibya Haber Ajansı