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“A once-in-a-century pandemic, the outbreak of geopolitical conflict and extreme weather events disrupted supply chains, sparked energy and food crises, and forced governments to take unprecedented measures to protect lives and livelihoods.” ”, the latest World Economic Outlook report from the International Monetary Fund (IMF) describes economic developments since the beginning of 2020.
However, the world economy has shown resilience; Unfortunately, unsurprisingly, high-income countries—blessed with more room for maneuver—show more of this, while developing countries have less resilience. In summary, “while the former recovered ground with the activity and inflation projected before covid, the latter present more permanent scars.”
A notable fact is that the increase in inflation decreased at a low cost in terms of production and employment. However, core inflation also shows signs of rigidity, notes the IMF. A crucial aspect is that “the rise in basic prices of services, which stands at 4.2 percent, is 50 percent higher than before the pandemic in the main advanced and emerging market economies (except the United States)” . The pressure to bring wages back in line with prices is the main driver of robust underlying inflation in services. But as output gaps close, the IMF expects this wage pressure to also subside.
Both the sudden rise in inflation and its fall require explanations. These, the report argues, include a faster-than-expected decline in energy prices and a sharp rebound in labor supply, driven by unexpected (and unpopular) increases in immigration.
A more subtle explanation is that the interaction of rising post-pandemic demand with supply constraints made the relationship between economic slack and inflation (known as “the Phillips curve”) steeper (or, in the parlance of economists, “less elastic”). Thus, inflation rose more than expected when demand rose, but fell faster when it met supply. Monetary policy played a role in both directions, stimulating and then restricting demand, but also, when tightened, reinforcing the credibility of inflation targets.
A notable feature since 2020 has been the changing relationship between monetary and fiscal policy. During the pandemic, both were ultra-lax, but after 2021, monetary policy tightened, while fiscal policy remained loose, especially in the US. Higher interest rates then increase fiscal deficits; However, there is a great divergence with the eurozone in terms of fiscal prospects: according to IMF projections, US public debt will increase to almost 134 percent of GDP in 2029; In the eurozone, the ratio of public debt to GDP is expected to stabilize at around 88 percent in 2024, although with large differences between countries.
Another characteristic is that, since Russia’s attack on Ukraine in February 2022, the growth rate of trade between “blocs” has fallen more than the internal one, with one focused on the US and Europe and another on China and Russia.
The IMF has not changed its vision much and projects global growth close to 3 percent. This assumes that there are no major negative shocks, that trade grows in line with production, inflation stabilizes, monetary policies are relaxed and fiscal measures are tightened. Its forecasts show US growth will fall from 2.5 percent in 2024 to 1.9 percent in 2025, while it will rise to 1.3 percent in the eurozone. Over the past period, developing Asia’s growth is estimated to be 5 percent, China’s 4.7 percent, and India’s 6.5 percent.
Downside risks are abundant. Past monetary policy may hit harder than expected, perhaps with recessions. If inflation is more robust, monetary policy will be more restrictive, which may affect financial stability. The impact of higher interest rates on debt sustainability may be larger, especially in emerging and developing countries. China’s macroeconomic problems may be greater, as its real estate cuts and compensatory policy measures are still limited. If Donald Trump wins and launches his trade measures, the chances of a trade war must also be considerable, with unpredictable consequences for the economy and international relations.
Also, will the US election be decided peacefully? The intensification of wars or the outbreak of others are also possible. Such events can lead to new spikes in commodity prices, compounded by rapid changes in the global climate.
This is all scary, but the potential benefits are worth noting. Reform and renewed confidence can lead to increased investment. Artificial intelligence and the energy revolution can drive investment and growth. It is even possible that humanity will decide that it has better things to do than increase hostility and stupidity to ever higher levels.
The IMF underlines the need to ensure a soft landing for inflation and monetary policy, as well as the need to stabilize public finances, while promoting growth and reducing inequality. In the medium term, he hopes for stronger structural reform, including improving access to education, reducing labor market rigidities, increasing labor force participation, reducing barriers to competition, supporting startups and advancing digitization. No less important, it wants to accelerate the green transition and improve multilateral cooperation.
If only a divinity would force humanity to be so sensible. In practice, as always, it depends on us.
