 | Dear maria, We just published a new blog—please find the full text below. |
| (Credit: IMF and Adobe Stock) | By Tobias Adrian, Christopher Erceg, and Fabio Natalucci Central banks aggressively hiked interest rates last year as inflation in many countries rose to the highest levels in decades. Now, falling energy prices are reducing headline inflation and fueling optimism that monetary policy may be eased later this year. Such expectations have caused a sharp decline in global longer-term interest rates and boosted financial markets in advanced economies and emerging markets alike. Though this may make it tempting to conclude that monetary policy is becoming overly restrictive and poised to cause an unnecessary economic contraction, investors may be too sanguine about progress on disinflation. While headline inflation has indeed fallen, and core inflation has receded slightly in some countries, both remain far too high. Central banks must therefore be resolute in their fight against inflation and ensure policy remains appropriately tight long enough to durably bring inflation back to target. Aggressive tightening After many years of low inflation, the surge in inflation during the pandemic recovery came as a surprise. Key factors driving inflation included supply disruptions, high energy prices following Russia’s invasion of Ukraine, and massive monetary and fiscal stimulus that fueled spending on housing and durable goods. Inflation topped 6 percent in more than four-fifths of the world’s economies, while increasingly broad-based price gains lifted expectations for further increases to multi-decade highs.  Central banks in emerging markets responded by sharply tightening policy beginning in 2021, followed by their counterparts in advanced economies. This led to a tightening of financial conditions globally through the fall of last year. As a result, global economic growth is now expected to slow this year, with divergent views on the extent to which unemployment would likely need to rise to cool hot labor markets. Investor optimism Since late last year, however, financial markets have rebounded strongly on retreating energy prices and signs that inflation may have peaked. In some economies, prices for goods included in core inflation measures, such as autos and furniture, have fallen. These signs of progress in reducing inflationary pressures amidst continued strength in labor markets have offered reason to believe that policymakers may have succeeded in taming inflation with little cost to economic growth, a so-called soft landing. In the United States and the euro area, market-based measures of inflation one year ahead have returned to near the central banks’ 2 percent target from 6 percent last spring. Gauges for several other advanced economies have seen similar drops. In emerging markets, such market-based measures of inflation one year ahead have also been falling, albeit at a slower pace.  Expected easing These disinflation hopes have been accompanied by growing expectations that central banks will soon not only stop tightening policy but also reduce rates fairly quickly. In many economies, this has led to yields on long-dated government debt falling below short-dated maturities. Historically, such an inversion of the yield curve often precedes recessions. Analyst assessments in fact point to significant recession risk in many economies, but the expectation is that recessions, should they occur, will be mild.  Growing expectations for lower interest rates and only a shallow economic slowdown have fueled a significant easing in financial conditions in recent months—despite central banks continuing to raise rates. Markets have reflected this relatively benign picture: stock markets have rallied, and credit spreads narrowed considerably. Conundrum for central banks This easing of financial conditions during a central bank tightening cycle creates a conundrum for policymakers. On the one hand, financial markets are signaling that disinflation may occur without meaningful increases in unemployment. Policymakers could embrace that view, and in effect ratify the loosening of financial conditions. Many observers concerned that central banks will be overzealous about tightening monetary policy—and will cause an unnecessarily painful economic downturn—are endorsing such a view. Alternatively, central banks could push back against investor optimism, emphasizing the risks that inflationary pressures may be more persistent than expected. This risk-management approach would require restrictive interest rates for longer, until there’s tangible evidence of a sustained decline in inflation. While doing so could induce a repricing of the policy path and of risk assets in financial markets—possibly causing equity prices to fall and credit spreads to widen—there are three reasons why such an approach is needed to ensure price stability. - History shows high inflation is often persistent—and may possibly ratchet up further—without forceful and decisive monetary policy actions to reduce it.
- While goods inflation has come down, it seems unlikely that the same will happen for services without significant labor-market cooling. Crucially, central banks must avoid misreading sharp declines in goods prices and easing policy before services inflation and wages, which adjust more slowly, have also moderated markedly.
- Experience suggests that prolonged periods of rapid price gains make inflation expectations more susceptible to de-anchoring as such an inflationary mindset becomes more entrenched in the behavior of households and firms.
Policymakers must continue to be resolute Central banks should communicate the likely need to keep interest rates higher for longer until there is evidence that inflation—including wages and prices of services—has sustainably returned to the target. Policymakers will likely face pressure to ease policy as unemployment rises and inflation keeps falling. These challenges could be particularly acute for emerging market economies. To be sure, this is an unusual period in which many special factors are affecting inflation, and it is possible that inflation comes down more quickly than policymakers envision. However, loosening prematurely could risk a sharp resurgence in inflation once activity rebounds, leaving countries susceptible to further shocks which could de-anchor inflation expectations. Hence, it is critical for policymakers to remain resolute and focus on bringing inflation back to target without delay. |
| | | |
|
 |
(Credit: IMF and Adobe Stock)
By Pierre-Olivier Gourinchas
The global economy is poised to slow this year, before rebounding next year. Growth will remain weak by historical standards, as the fight against inflation and Russia’s war in Ukraine weigh on activity.
Despite these headwinds, the outlook is less gloomy than in our October forecast, and could represent a turning point, with growth bottoming out and inflation declining.
Economic growth proved surprisingly resilient in the third quarter of last year, with strong labor markets, robust household consumption and business investment, and better-than-expected adaptation to the energy crisis in Europe. Inflation, too, showed improvement, with overall measures now decreasing in most countries—even if core inflation, which excludes more volatile energy and food prices, has yet to peak in many countries.
Elsewhere, China’s sudden re-opening paves the way for a rapid rebound in activity. And global financial conditions have improved as inflation pressures started to abate. This, and a weakening of the US dollar from its November high, provided some modest relief to emerging and developing countries.
Accordingly, we have slightly increased our 2022 and 2023 growth forecasts. Global growth will slow from 3.4 percent in 2022 to 2.9 percent in 2023 then rebound to 3.1 percent in 2024.
For advanced economies, the slowdown will be more pronounced, with a decline from 2.7 percent last year to 1.2 percent and 1.4 percent this year and next. Nine out of 10 advanced economies will likely decelerate.
US growth will slow to 1.4 percent in 2023 as Federal Reserve interest-rate hikes work their way through the economy. Euro area conditions are more challenging despite signs of resilience to the energy crisis, a mild winter, and generous fiscal support. With the European Central Bank tightening monetary policy, and a negative terms-of-trade shock—due to the increase in the price of its imported energy—we expect growth to bottom out at 0.7 percent this year.
Emerging market and developing economies have already bottomed out as a group, with growth expected to rise modestly to 4 percent and 4.2 percent this year and next.
The restrictions and COVID-19 outbreaks in China dampened activity last year. With the economy now re-opened, we see growth rebounding to 5.2 percent this year as activity and mobility recover.
India remains a bright spot. Together with China, it will account for half of global growth this year, versus just a tenth for the US and euro area combined. Global inflation is expected to decline this year but even by 2024, projected average annual headline and core inflation will still be above pre-pandemic levels in more than 80 percent of countries.
The risks to the outlook remain tilted to the downside, even if adverse risks have moderated since October and some positive factors gained in relevance.
On the downside:
- China’s recovery could stall amid greater-than-expected economic disruptions from current or future waves of COVID-19 infections or a sharper-than-expected slowdown in the property sector
- Inflation could remain stubbornly high amid continued labor-market tightness and growing wage pressures, requiring tighter monetary policies and a resulting sharper slowdown in activity
- An escalation of the war in Ukraine remains a major threat to global stability that could destabilize energy or food markets and further fragment the global economy
- A sudden repricing in financial markets, for instance in response to adverse inflation surprises, could tighten financial conditions, especially in emerging market and developing economies
On the upside:
- Strong household balance sheets, together with tight labor markets and solid wage growth could help sustain private demand, although potentially complicating the fight against inflation
- Easing supply-chain bottlenecks and labor markets cooling due to falling vacancies could allow for a softer landing, requiring less monetary tightening
Policy priorities
The inflation news is encouraging, but the battle is far from won. Monetary policy has started to bite, with a slowdown in new home construction in many countries. Yet, inflation-adjusted interest rates remain low or even negative in the euro area and other economies, and there is significant uncertainty about both the speed and effectiveness of monetary tightening in many countries.
Where inflation pressures remain too elevated, central banks need to raise real policy rates above the neutral rate and keep them there until underlying inflation is on a decisive declining path. Easing too early risks undoing all the gains achieved so far.
The financial environment remains fragile, especially as central banks embark on an uncharted path toward shrinking their balance sheets. It will be important to monitor the build-up of risks and address vulnerabilities, especially in the housing sector or in the less-regulated non-bank financial sector. Emerging market economies should let their currencies adjust as much as possible in response to the tighter global monetary conditions. Where appropriate, foreign exchange interventions or capital flow measures can help smooth volatility that’s excessive or not related to economic fundamentals.
Many countries responded to the cost-of-living crisis by supporting people and businesses with broad and untargeted policies that helped cushion the shock. Many of these measures have proved costly and increasingly unsustainable. Countries should instead adopt targeted measures that conserve fiscal space, allow high energy prices to reduce demand for energy, and avoid overly stimulating the economy.
Supply-side policies also have a role to play. They can help remove key growth constraints, improve resilience, ease price pressures, and foster the green transition. These would help alleviate the accumulated output losses since the beginning of the pandemic, especially in emerging and low-income economies.
Finally, the forces of geoeconomic fragmentation are growing. We must buttress multilateral cooperation, especially on fundamental areas of common interest such as international trade, expanding the global financial safety net, public health preparedness and the climate transition.
This time around, the global economic outlook hasn’t worsened. That’s good news, but not enough. The road back to a full recovery, with sustainable growth, stable prices, and progress for all, is only starting.
 |  | | France |
Photo Credit: tigristiara/iStock by Getty Images After a strong economic recovery from the pandemic, France was hit by an energy shock driven by Russia’s invasion of Ukraine. Inflation rose and economic activity slowed. Nevertheless, the economy has remained resilient and inflation well below other EU countries due to more limited reliance on Russian gas and a strong policy response—including price controls on gas and electricity, tax reductions on fuel products, transfer payments, and measures to support businesses. This cushioned the impact of the energy price shock but has been costly for the government and not well targeted. Due partly to the support measures, France’s budget deficit has remained high and debt has risen in relation to gross domestic product. Public debt levels are also increasing relative to euro area peers. To move the budget closer to balance and set the debt ratio on a declining path, France should undertake gradual but substantial fiscal consolidation over the medium term. This could begin by taking advantage of the phase-out of pandemic support to start reducing the fiscal deficit modestly in 2023. It could then be followed by steady consolidation underpinned by expenditure reforms, while leaving space to accelerate green and digital investment. The government has made significant progress putting forward reforms to boost growth potential while reducing fiscal costs, including revised unemployment benefits that will help raise labor supply, and a comprehensive pension reform that aims to balance the pension system and increase the employment rate of older workers by moving the effective retirement age closer to the EU average. Other areas for fiscal reform could include areas where expenditure far exceeds that of peers or where outcomes are substandard, including tax exemptions, social benefits, healthcare, and subnational spending. Beyond fiscal measures, other reforms could boost growth potential, such as steps to accelerate the green transition, improvements to product and service markets to boost competitiveness, and efforts to upskill workers and increase the efficiency of the educational system. The banking sector has weathered the crisis well and supported the economic recovery, but global financial stability risks are increasing. The authorities recently decided to raise the counter-cyclical buffer, a capital requirement, to increase the cushion against any sudden deterioration of financial conditions. Continued vigilance will be required to guard against any emerging weaknesses in banks’ lending portfolios. RELATED LINKS |
| |
|
| Dear maria, We just published a new blog—please find the full text below. |
| (Photo: Chunyip Wong/iStock by Getty Images) | By Burcu Hacibedel and Ritong Qu Corporate debt rose by more than $12 trillion in advanced and emerging economies during the pandemic as companies borrowed to strengthen their balance sheets and survive the economic shock. But steep rises in interest rates and more expensive debt service are stretching firms’ finances, even as global debt declines as a share of gross domestic product. This build-up of risk in the corporate sector and a doubling of funding costs for even the safest issuers could pose serious problems for many economies and their financial systems. A new machine-learning model developed by IMF staff predicts the probability of corporate distress spilling over into systemic economic risk, based on lessons from previous crises in 55 advanced and emerging economies since 1995. We identify around 50 indicators—from firms’ debt ratios to credit expansion and overvalued assets—that might have power to predict future crises and then train the model. As the Chart of the Week shows, the number of countries at medium or high risk of spillovers from corporate debt defaults and other forms of company distress increased sharply last year due to tighter global financial conditions. This reversed a decline in risk seen in 2021 when policymakers raced to support stricken companies with cash and debt forbearance.  Thirty-eight of the economies tracked by our early-warning model are at medium risk and seven economies, mostly from Europe and Asia, are at high risk of systemic corporate distress. More countries are at high risk than before the pandemic. Moreover, the proportion of large economies in this category has increased, with high-risk countries accounting for 21 percent of world GDP in the third quarter of 2022, up from just 1 percent at the end of 2019. Only nine economies are seen as low risk. After a sharp rise in 2020-21, international debt issuance by non-financial companies fell by $136 billion in the year to June 2022 as firms found it costlier to access finance, figures from the Bank for International Settlements show. Further tightening of global financial conditions would increase the risks faced by both advanced and emerging economies. Spillovers from corporate distress could include slower economic growth, rising unemployment, pressure on vulnerable households, volatile asset prices and a spike in non-performing loans at financial institutions. And the situation could be made worse by other factors, such as dollar appreciation, which would add to pressures faced by many emerging economies. Time to act What can governments do? First, countries where companies are failing or likely to should build effective insolvency systems and facilitate market-led restructuring of heavily indebted firms to contain systemic risks, as discussed in a previous IMF blog. Countries’ crisis preparedness and insolvency frameworks matter greatly and could be strengthened particularly in emerging economies. Second, countries should continue to use macro and microprudential policies that target high-risk sectors and borrowers. To limit the possibility of spillovers to the financial sector, countries should also use lender-side macroprudential policies for banks and other financial institutions. For example, by improving transparency of lenders’ assets and liabilities, refraining from further lending to firms that cannot pay existing debts, strengthening capital buffers, and conducting comprehensive stress tests. |
|
|
