As Inflation Recedes, Global Economy Needs Policy Triple Pivot

IMF Blog, October 22, 2024

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As Inflation Recedes, Global Economy Needs Policy Triple Pivot

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Bibliographic details

• Authors: Pierre-Olivier Gourinchas
• Published: October 22, 2024

Global outlook and inflation dynamics

• Headline inflation peaked at 9.4 percent year-on-year in the third quarter of 2022 and is projected to fall to 3.5 percent by the end of next year.
• Global growth is projected to hold steady at 3.2 percent in 2024 and 2025.
• Growth in the United States is 2.8 percent this year, but expected to revert toward its potential in 2025.
• Emerging markets and developing economies: growth around 4.2 percent in 2024 and 2025, with continued robust performance from emerging Asia.
• Five-year-ahead growth prospects remain lackluster at 3.1 percent.
• The surge and subsequent decline in inflation reflected a combination of shocks: broad supply disruptions after the pandemic and sharp commodity price spikes caused by the war in Ukraine.
• Supply disruptions and tight monetary policy led to a normalization in labor markets that allowed inflation to decline rapidly without a major slowdown in activity.
• Much disinflation came from the unwinding of shocks and improvements in labor supply, often linked to increased immigration; monetary policy also kept inflation expectations anchored.

Downside risks and structural challenges

• Downside risks increasingly dominate the outlook, including:
  • An escalation in regional conflicts, especially in the Middle East, posing serious risks for commodity markets.
  • Shifts toward undesirable trade and industrial policies that can significantly lower output relative to the baseline.
  • Monetary policy remaining too tight for too long, and the potential for abrupt tightening of global financial conditions.
• Inflation in services remains too elevated, almost double pre-pandemic levels.
• A few emerging market economies face a resurgence of inflationary pressures and have started to raise policy rates again.
• The world is now dominated by supply disruptions—from climate, health, and geopolitical tensions—which make it harder for monetary policy to contain inflation while preserving output.
• Inflation expectations were well-anchored this episode, but may be harder to anchor next time as workers and firms become more vigilant about protecting pay and profits.

Policy triple pivot (overview)

• With inflation near central bank targets, policymakers should pursue a coordinated "triple pivot":

1. Monetary policy: move toward neutral and allow for easing where appropriate. 2. Fiscal policy: stabilize debt dynamics and rebuild fiscal buffers. 3. Growth-enhancing reforms: boost productivity, technology, competition, and private investment.

First pivot — Monetary policy

• Major central banks in advanced economies have started cutting policy rates since June, moving toward a neutral stance.
• Lower interest rates in major economies will ease pressure on emerging market economies by strengthening their currencies against the US dollar and improving financial conditions, thereby reducing imported inflation.
• Labor markets in many advanced economies are showing signs of cooling, with rising unemployment rates; the rise in unemployment has been gradual so far and does not point to an imminent slowdown.
• Vigilance required because:
  • Services inflation remains elevated.
  • Some emerging markets are re-tightening policy.
  • Supply shocks complicate monetary responses.

Second pivot — Fiscal policy

• Fiscal space is a cornerstone of macroeconomic and financial stability; after years of loose fiscal policy, it is time to stabilize debt dynamics and rebuild fiscal buffers.
• Declining policy rates provide some fiscal relief by lowering funding costs, but this is not sufficient while long-term real interest rates remain far above pre-pandemic levels.
• Primary balances need to improve in many countries.
• For some countries, including the United States and China, current fiscal plans do not stabilize debt dynamics.
• Early post-pandemic fiscal plans showed promise in many countries, but there are increasing signs of slippage.
• The policy trade-off is narrow:
  • Delaying consolidation increases the risk of disorderly market-imposed adjustments.
  • An excessively abrupt fiscal tightening could be self-defeating and hurt economic activity.
• Success requires sustained and credible multi-year adjustments without delay where consolidation is necessary; credible fiscal adjustment enables monetary policy to support activity while keeping inflation in check.
• The willingness or ability to deliver disciplined and credible fiscal adjustments has been lacking.

Third pivot — Growth-enhancing reforms

• The hardest pivot is toward ambitious domestic reforms to improve growth prospects and lift productivity; needed to:
  • Rebuild fiscal buffers.
  • Cope with aging and shrinking populations.
  • Tackle the climate transition.
  • Increase resilience and improve lives of the most vulnerable.
• Many countries’ five-year growth prospects are weak; China’s weaker outlook contributes significantly, but medium-term prospects in other regions (including Latin America and the European Union) have also deteriorated.
• Some countries are implementing industrial and trade policies to protect domestic workers and industries; such measures:
  • Can sometimes boost short-run investment and activity, especially if debt-financed.
  • Often lead to retaliation and fail to deliver sustained improvements in living standards.
  • Should be avoided unless they carefully address well-identified market failures or narrowly defined national security concerns.
• Sustainable growth must come from reforms that boost technology and innovation, improve competition and resource allocation, further economic integration, and stimulate productive private investment.
• Reforms face significant social resistance; Chapter 3 shows that information strategies help but are insufficient. Building trust between government and citizens and including proper compensation to offset potential harms are essential for reform success.

Policy recommendations and strategic priorities

• Coordinate the three pivots to create macroeconomic breathing room:
  • Continue cautious monetary easing toward neutral where appropriate, while monitoring services inflation and emerging-market pressures.
  • Implement sustained, credible multi-year fiscal adjustments to stabilize debt dynamics and rebuild buffers; avoid both undue delay and excessively abrupt tightening.
  • Prioritize growth-enhancing structural reforms that raise productivity, with policies to build trust, ensure inclusion, and provide compensation where reforms impose short-term costs.
• Resist protectionist industrial and trade measures except when narrowly justified by market failures or national security concerns.
• Strengthen international cooperation and multilateral efforts to address shared challenges, building on trust and engagement.

This blog is based on the October 2024 World Economic Outlook.

References

• Chapter 2
• debt dynamics
• setting the macro dials appropriately
• Chapter 3
• World Economic Outlook