Let’s start with the good news. The fight against global inflation appears to have been largely won, even as price pressures persist in some countries. It expects headline inflation to peak at 9.4% year-on-year in the third quarter of 2022, before falling to 3.5% by the end of next year, slightly below the pre-pandemic 20-year average. Inflation rates are currently close to central bank targets in most countries, paving the way for monetary easing across major central banks.
The world economy remained unusually resilient throughout the disinflationary process. Growth is expected to stabilize at 3.2% in 2024 and 2025, although growth rates have been revised downward significantly in some low-income and developing countries, often linked to escalating conflict. .
Among developed countries, the US growth rate is strong at 2.8% this year, but will return to its potential growth rate in 2025. In developed European countries, a gradual recovery in growth is expected next year, with output approaching its potential growth rate. The growth outlook for emerging markets and developing countries is very stable, at around 4.2% this year and next, continuing the strong performance of emerging Asia.
The fact that inflation has fallen without causing a global recession is a major achievement. As argued in Chapter 2 of our report, the spike and subsequent decline in inflation reflects a unique combination of shocks. Widespread supply disruptions coupled with strong demand pressures following the pandemic, followed by a sharp rise in commodity prices due to the war in Ukraine. .
These shocks led to an upward shift and a steepening of the activity-inflation relationship and the Phillips curve. Once supply disruptions eased and tight monetary policy began to suppress demand, normalization of the labor market allowed inflation to fall quickly without a significant slowdown in economic activity.
Clearly, much of the disinflation is due to improvements in labor supply as well as the mitigation of the shock itself, which is often associated with increased immigration. But monetary policy played a crucial role in anchoring inflation expectations, avoiding a harmful wage-price spiral, and avoiding a repeat of the disastrous inflation experience of the 1970s.
Despite the good news on inflation, downside risks have increased and currently dominate the outlook. Escalating regional conflicts, particularly in the Middle East, could pose serious risks to commodity markets. Unfavorable trade and industrial policy shifts could result in significant reductions in production relative to our baseline projections. Monetary policy could remain too tight for too long, leading to a sharp tightening of global financial conditions.
Inflation returns to levels close to the central bank’s target, paving the way for a triple pivot in policy. This would provide much-needed macroeconomic breathing room at a time when risks and challenges remain elevated.
The first pillar of monetary policy has already begun. Since June, major central banks in developed countries have begun lowering policy interest rates and have shifted to a neutral stance. This will support activity at a time when labor markets in many developed countries are showing signs of cooling due to rising unemployment rates. But so far, the rise in the unemployment rate has been gradual and does not indicate an imminent economic slowdown.
Lower interest rates in major economies will ease pressure on emerging market economies as their currencies strengthen against the US dollar and financial conditions improve. This will help curb imported inflation and make it easier for these countries to pursue their own deflationary paths.
But vigilance remains the key. Service sector inflation remains too high, almost double its pre-pandemic level. Some emerging market economies are facing a resurgence of inflationary pressures and have begun raising interest rates again.
Moreover, we are now entering a world dominated by supply disruptions due to climate, health, and geopolitical tensions. In the face of such a shock that simultaneously increases prices and decreases output, it is always difficult for monetary policy to control inflation.
Finally, while inflation expectations held firm this time, the next one could be more difficult as workers and businesses become more wary of protecting wages and profits.
The second axis is fiscal policy. Fiscal space is the cornerstone of macroeconomic and financial stability. After years of accommodative fiscal policies in many countries, now is the time to stabilize debt situations and rebuild much-needed fiscal buffers.
Although lower policy rates provide some fiscal relief by lowering funding costs, this is not enough, especially as long-term real interest rates remain well above pre-pandemic levels. Many countries need to improve their primary fiscal balance (the difference between fiscal revenue and public spending excluding debt service).
For some countries, including the United States and China, current fiscal plans have not stabilized debt trends. In many other regions, early fiscal plans showed promise after the pandemic and cost-of-living crisis, but there are increasing signs of deviation.
The road is narrow. Delays in fiscal consolidation increase the risk of disorderly market-imposed adjustments, while an excessively rapid shift toward fiscal tightening could be self-defeating and have a negative impact on economic activity.
Success requires sustained, reliable, multi-year coordination without delay when integration is required. The more reliable and disciplined fiscal adjustment, the more supportive role monetary policy can play by easing policy interest rates while containing inflation. However, it lacks the will and capacity to achieve disciplined and reliable fiscal adjustment.
The third axis, and the most difficult, is towards reforms that foster growth. More needs to be done to improve growth prospects and increase productivity. Because this is the only way we can meet the many challenges we face. Address aging and population decline in many parts of the world. Tackling climate change. Building resilience and improving the lives of the most vulnerable people at home and abroad.
Unfortunately, growth prospects for the next five years remain lackluster, at 3.1%, the lowest in decades. Much of this reflects a weaker outlook for China, but the medium-term outlook for other regions, including Latin America and the European Union, has also worsened.
Faced with increasing external competition and structural weaknesses in manufacturing and productivity, many countries have implemented industrial and trade policies to protect domestic workers and industries. However, external imbalances often reflect macroeconomic factors, namely weak domestic demand in China and excess demand in the United States. To deal with these, macro dials must be configured appropriately.
Furthermore, while industrial and trade policies may stimulate investment and activity in the short term, they often lead to retaliation, especially when relying on debt subsidies, and to support sustained increases in living standards. cannot be realized. They should be avoided if they do not carefully address clearly identified market failures or narrow national security concerns.
Economic growth must instead come from ambitious domestic reforms that foster technology and innovation, improve competition and resource allocation, increase economic integration, and stimulate productive private investment.
But while reforms are as urgent as ever, they often face significant social resistance. How can policymakers garner the support they need to make reforms successful?
As Chapter 3 of our report shows, information strategies can help, but their effectiveness is limited. Building trust between governments and citizens (a two-way process throughout policy design) and including adequate compensation to offset potential harms are essential features.
Building trust is a key lesson that should resonate as we think about how to further improve international cooperation and strengthen multilateral efforts to address common challenges in a year that marks the 80th anniversary of the Bretton Woods system. be.
—This blog is based on the October 2024 World Economic Outlook. For more information, see the blog post on the report’s analysis chapter: Global inflation episode offers lessons for monetary policy and support for economic reforms Relies on communication, engagement, and trust.
