Policymakers Need Steady Hand as Storm Clouds Gather Over Global Economy

IMF Blog, October 11, 2022

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Global growth forecast for this year is unchanged at 3.2 percent.
Projection for next year is lowered to 2.7 percent—0.2 percentage points lower than the July forecast.
Countries accounting for about one-third of the global economy are poised to contract this year or next.
United States: growth slowed to 1 percent next year due to tightening of monetary and financial conditions.
China: next year’s growth forecast lowered to 4.4 percent due to a weakening property sector and continued lockdowns.
Euro area: growth reduced to 0.5 percent in 2023 as the energy crisis takes a heavy toll.
Global inflation is now expected to peak at 9.5 percent this year before decelerating to 4.1 percent by 2024.
Global core inflation rose from an annualized monthly rate of 4.2 percent at end-2021 to 6.7 percent in July for the median country.

The risk of monetary, fiscal, or financial policy miscalibration has risen sharply amid high uncertainty and growing fragilities.
Global financial conditions could deteriorate, and the dollar strengthen further, if turmoil in financial markets erupts, adding to inflation pressures and financial fragilities in emerging markets and developing economies.
Inflation could prove more persistent, especially if labor markets remain extremely tight.
Further escalation of the war in Ukraine could exacerbate the energy crisis.
Probability assessments:
- About a one in four probability that global growth next year could fall below the historically low level of 2 percent.
- If many risks materialize, global growth would decline to 1.1 percent with quasi stagnant income-per-capita in 2023.
- Likelihood of such an adverse outcome, or worse, is 10 percent to 15 percent.

Central banks are laser-focused on restoring price stability; the pace of tightening has accelerated sharply.
Risks of policy mistakes:
- Under-tightening would further entrench inflation, erode central bank credibility, de-anchor expectations, and increase eventual costs of control.
- Over-tightening risks pushing the global economy into an unnecessarily severe recession and may strain financial markets.
- The costs of misjudging persistent inflation (undermining central bank credibility) are judged more detrimental to future macroeconomic stability than over-tightening risks.
Fiscal policy principles for the cost-of-living crisis:
- Fiscal policy should not work at cross-purpose with monetary authorities’ efforts to bring down inflation.
- The energy crisis, especially in Europe, is not a transitory shock; the geopolitical realignment of energy supplies is broad and permanent. Winter 2022 will be challenging, but winter 2023 will likely be worse.
- Use price signals to curb energy demand and stimulate supply; avoid price controls, untargeted subsidies, or export bans because they are fiscally costly and lead to excess demand, undersupply, misallocation, and rationing.
- Fiscal policy should protect the most vulnerable through targeted and temporary transfers.
- Fiscal policy can help adaptation by investing in productive capacity: human capital, digitalization, green energy, and supply chain diversification to make economies more resilient.

The dollar is now at its strongest since the early 2000s, with appreciation most pronounced against currencies of advanced economies.
The rise appears mostly driven by fundamental forces such as tightening US monetary policy and the energy crisis.
Recommended responses for emerging and developing countries:
- Calibrate monetary policy to maintain price stability while letting exchange rates adjust.
- Conserve foreign exchange reserves for when financial conditions really worsen.
- Eligible countries with sound policies should urgently consider improving liquidity buffers, including by requesting access to precautionary instruments from the Fund.
- Minimize future financial turmoil through a combination of preemptive macroprudential and capital flow measures, where appropriate, in line with the Integrated Policy Framework.

Too many low-income countries are in or near debt distress; progress toward orderly debt restructurings through the Group of Twenty’s Common Framework is urgently needed to avert a wave of sovereign debt crisis.
The energy and food crises, coupled with extreme summer temperatures, are stark reminders of what an uncontrolled climate transition would look like.
Progress on climate policies, debt resolution, and other targeted multilateral issues can demonstrate that focused multilateralism can achieve progress and succeed in overcoming geoeconomic fragmentation pressures.

Pierre-Olivier Gourinchas, October 11, 2022