Opinion – Why? Economês in good Portuguese: Deceleration and inflation in the global economy

In its note to the G20 meeting of ministers and central bank governors last week, the International Monetary Fund (IMF) highlighted a slowdown in the pace of the global economic recovery. Having revised its forecast for global economic growth this year downwards (4.4%) in January, the IMF cited indicators pointing to the continued weakening of the recovery.

The main downside risks suggested earlier have materialized, affecting the recovery prospects. Mismatches between demand and availability of supply in multiple sectors, bottlenecks in freight transport and increases in energy and food prices pushed inflation up.

In several economies this rise in prices extended to all categories of consumption. While supply-side shocks could be considered temporary and gradually reversible throughout the year, the perception became that the mismatches between supply and demand would also be reflecting excesses in aggregate demand.

This has already led monetary authorities to issue signs of shifting towards less accommodative policies. More gradually in the eurozone, while bets among analysts on the US Federal Reserve’s future decisions even include 6 or 7 increases in its base rates this year, perhaps including even the start of shrinkage of the asset portfolio on its balance sheet. (a “quantitative tightening” following the end of “quantitative easing”). A rise in March – 25 or 50 basis points – is already being taken for granted.

In another paper released by the IMF last week, it is estimated that supply shocks accounted for half of the rise in European producer prices in 2021, with the rest linked to sharp increases in demand. In the United States, evidence of overheating demand led, since the end of last year, to the replacement of the narrative of “temporary” inflation —as it comes from reversible supply-side shocks— with another in which the point of discussion is the speed and intensity of tightening in financial conditions ahead.

Inflation has also risen in emerging and developing economies, although in most cases not because of excess demand. Its fiscal and monetary stimulus in response to the pandemic did not have the scale achieved in advanced countries, and the recovery of emerging and developing economies in 2021 lagged well behind that of advanced ones. Lower capital inflows and, in some cases, sovereign debt rating downgrades resulted in currency devaluation and domestic import price shocks. On the other hand, they shared with the advanced companies the impacts of the rupture of supply chains and the high prices of energy and food commodities. In a large part of the group, the increase in domestic interest rates has already started last year, as in Brazil.

The IMF note to the G20 also notes that fiscal support against the pandemic crisis is gradually being withdrawn. It even talks about prospects for a fiscal package in the United States that is smaller than previously envisioned.

It certainly could not be expected that the exceptional pace of global growth last year, after the drop in 2020, could be replicated in 2022. However, the note notes that much of the responsibility for the downward revision of projections in January stemmed from slower growth estimates in the United States and China. In the case of this, they list the continuity of stress in the real estate market, the low dynamism in private consumption and the restrictive character of the “covid-zero” policy.

It is also worth noting the slower pace of recovery in emerging and developing countries and the increase in the distance between their per capita incomes and those of advanced countries, as part of the permanent losses in GDP with the pandemic. According to the World Bank’s “Global Economic Outlook” report in January, in 2023 only one of its regions – Europe and Central Asia – is expected to come close to the level of GDP that was projected before the pandemic. Latin America and the Caribbean, the Middle East and North Africa, as well as Sub-Saharan Africa, will all be at least 4% below what would be the corresponding level. The drama is expected to be even greater in South Asia, with 8% less.

Both the World Bank and the IMF highlight large disparities in vaccination rates between countries as a major factor in uneven recoveries. They also highlight the deeper and longer character of the scars left by the pandemic on the labor markets of non-advanced economies.

The challenge lies ahead for central banks to find their balance paths between tightening financial conditions and slowing growth, in order to avoid a subsequent recession. A complicating factor is the time lag between monetary policy decisions and their effects, while an easing of supply constraints in combination with a strong deceleration in demand can lead to very abrupt drops both in the pace of inflation and in the level of economic activity. Central banks will have to cross the river one stone at a time…

Despite some recent tightening, global financial conditions have remained accommodative, while vulnerabilities remain high. In the case of emerging and developing countries, high levels of public and private sector indebtedness increase vulnerabilities and expose them to the risk of some significant tightening of global financial conditions. But even in the advanced ones, it should not be taken for granted that asset prices and the corporate financial situation will emerge unscathed from more drastic adjustments in the face of the reorientation of monetary policies.