According to a thorough new study by the World Bank, as central banks around the world simultaneously raise interest rates in response to inflation, the world may be edging towards a global recession in 2023 and a string of financial crises in emerging market and developing economies that would harm them permanently.
According to the report, central banks have been rising interest rates this year with a degree of coherence not seen in the previous fifty years. To lower global inflation to pre-pandemic levels, however, the currently anticipated trajectory of interest rate increases and other policy interventions may not be sufficient. Investors anticipate central banks to boost global interest rates by more than 2 percentage points over their 2021 average through 2023, to about 4 percent.
Interest Rate Increases
The study indicates that if supply disruptions and labour market pressures don’t abate, those interest rate hikes could leave the global core inflation rate at roughly 5% in 2023, which would be nearly twice the five-year average prior to the pandemic. The report’s model suggests that central banks may need to increase interest rates by an extra 2 percentage points in order to reduce global inflation to a rate that is consistent with their aims. If financial market stress were to accompany this, global GDP growth would fall to 0.5 percent in 2023—a per-capita contraction of 0.4 percent that would technically qualify as a worldwide recession.
The analysis emphasises the highly complicated conditions that central banks are now fighting inflation in. A number of past global recession indicators are already sounding the alarm. Following a post-recession rebound, the world economy is currently experiencing its greatest decline since 1970. Compared to the period leading up to previous global recessions, the loss in worldwide consumer confidence has already been much more severe. The three largest economies in the world—the US, China, and the euro area—have all seen a significant slowdown. Given the situation, even a slight blow to the world economy over the course of the ensuing year might send it into a recession.
The report analyses the current trajectory of economic activity and proposes possibilities for 2022–2024 by drawing on lessons learned from previous global recessions.
Prior Global Recessions
By analysing the economic activity’s current trajectory and making suggestions for 2022–2024, the research builds on the knowledge gained from prior global recessions. In order to stimulate activity during slowdowns like the one we are presently going through, countercyclical policy is frequently necessary. The prospect of inflation and the limited fiscal headroom, however, are forcing policymakers in many countries to reduce policy support even as the global economy slows substantially.
The study concludes that central banks should continue their efforts to keep inflation under control since it is possible to do so without causing a worldwide recession. However, it will demand coordinated action from a range of policymakers.
This may serve to stabilise inflation expectations and lessen the amount of tightening required. Central banks in advanced economies should be aware of the consequences of monetary tightening on other countries. They should tighten macroprudential rules in emerging market and developing economies and increase foreign exchange reserves.
The effects of monetary policy on growth can be amplified as a result. Additionally, decision-makers should implement dependable medium-term economic plans and offer vulnerable households specific assistance.
To effectively combat inflation, additional economic decision-makers will need to take substantial action to increase global supply.