Global economy in 'perilous phase', IMF says

Wednesday, 12 April 2023

Finance Minister Grant Robertson faces questions about the economy after news it shrank 0.6% in the final three months of last year. (First published 16/03/23)

The International Monetary Fund (IMF) has painted a grim picture of the outlook for the global economy over the next few years.

Its latest World Economic Outlook said global economic growth would bottom out at 2.8% this year before rising to 3% in 2024.

The rate of inflation would decrease globally, but more slowly than expected, from 8.7% in 2022 to 7% this year and 4.9% in 2024.

The IMF said the economy would not return to the rates of growth that prevailed before the pandemic in the medium term.

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The forecast for 2028 is only 3% growth, the lowest medium-term forecast in any report since 1990.

That was due in part to the pace slowing in previously rapidly growing economies such as China and Korea, as well as global labour force growth and issues such as Brexit and the Ukraine invasion.

For New Zealand, it forecasts 1.1% GDP growth this year in real terms and 0.8% next year. It also says New Zealand’s unemployment rate will hit 5.3% by 2024, higher than Australia and Asian countries.

Pierre-Olivier Gourinchas, IMF economic counsellor, said the slowdown would be concentrated in advanced economies, particularly the euro area and the United Kingdom.

He said, below the surface there was turbulence building and the situation was “quite fragile” – as highlighted by the recent bout of banking instability, including the collapse of United States banks.

Pierre-Olivier Gourinchas, director of research at the International Monetary Fund.

“Inflation is much stickier than anticipated even a few months ago. While global inflation has declined, that reflects mostly the sharp reversal in energy and food prices. But core inflation, excluding the volatile energy and food components, has not yet peaked in many countries.”

But Gourinchas said he was unconvinced about the need to worry about an uncontrolled wage-price spiral because workers were not yet receiving significant enough rises to become a concern.

“Nominal wage inflation continues to lag far behind price inflation, implying a steep and unprecedented decline in real wages.

“Given the tightness in labour markets, this is unlikely to continue, and real wages should recover. Corporate margins have surged in recent years–this is the flip side of steeply higher prices but only modestly higher wages –and should be able to absorb rising labour costs on average. As long as inflation expectations remain well anchored, that process should not spin out of control. It may well, however, take some time.”

He said a bigger concern for financial stability was the sharp increase in interest rates having serious side effects.

“Following a prolonged period of muted inflation and extremely low interest rates, last year’s rapid tightening of monetary policy has triggered sizeable losses on long-term fixed-income assets.

“The stability of any financial system hinges on its ability to absorb losses without recourse to taxpayers’ money. The financial instability last fall in the gilt market in the United Kingdom and the recent banking turbulence in the United States with the collapse of a few regional banks illustrate that significant vulnerabilities exist both among banks and non-bank financial institutions.”

He said nervous investors would often look for the next weakest link, as they did with Credit Suisse.

”A sharp tightening of global financial conditions–a ‘risk-off’ shock– could have a dramatic impact on credit conditions and public finances especially in emerging market and developing economies, with large capital outflows, a sudden increase in risk premia, a dollar appreciation in a rush toward safety, and major declines in global activity amid lower confidence, household spending, and investment.”

He said, in that sort of severe scenario, global GDP per capital could come close to falling, an outcome the IMF estimated had probability of about 15%.

“We are therefore entering a perilous phase during which economic growth remains low by historical standards and financial risks have risen, yet inflation has not yet decisively turned the corner. More than ever, policymakers will need a steady hand and clear communication.

“The appropriate course of action is contingent on the state of the financial system. As long as the latter remains reasonably stable, as it is now, monetary policy should stay firmly focused on bringing inflation down.”

The report said current increases in interest rates were likely to be temporary and when inflation was brought back under control, central banks were likely to ease monetary policy and bring interest rates back to pre-pandemic levels.