There is no respite for the global economy. Two years ago, it was shaken by the onset
of the pandemic, as an overwhelming health crisis turned into an overwhelming
economic crisis. While the after-tremors of the pandemic still reverberate, two new
shocks hit home in the year under review: the unexpected resurgence of inflation
and the tragic war in Ukraine. Last year’s Annual Economic Report (AER) raised the
prospect of a bumpy pandexit; bumps have turned out to be a one-two punch.
These tumultuous events are bound to have far-reaching consequences. Are
we perhaps witnessing a regime change, from a low- to a high-inflation regime? Is
the global economy flirting with stagflation? And are we seeing signs of an end to
the post-World War II globalisation era? Meanwhile, the crypto universe is in
turmoil, reminding us that there are important developments in the monetary
system that we cannot neglect.
On the macro front, policy is facing daunting challenges. In some ways,
they
are not new; but in others, they are unique. As Mark Twain quipped, “History does
not repeat itself, but it often rhymes.” The world economy experienced stagflation
in the 1970s, following a shift away from a low-inflation regime. The new element is
that, against the backdrop of historically low interest rates, debt levels – private and
public – have never been as high. This is far from inconsequential. Moreover, the
monetary and financial system is in the throes of the digital revolution. This, too,
albeit in a different way, is far from immaterial.
Our AER tackles these issues head-on. What happened in the year under review?
What are the risks ahead? What can policy do? And where is the monetary system
heading as the digital revolution proceeds? What vision should guide policy?
Never say never
Resilient but losing momentum and buffeted by non-economic forces: in a nutshell,
this is how global growth evolved over the review period.
Growth proved resilient for much of 2021.
In fact, in 2021 as a whole, the world economy expanded at its fastest rate in
almost 50 years
. And the expansion was broad-based. This confirmed the unique
nature of the Covid-19 recession. An artificial suppression of activity due to the
health emergency gave way to a strong rebound once the containment measures
were lifted. In addition, the outsize policy support, both monetary and fiscal,
provided a major impulse. The scenario in which economic scars would have held
back growth did not materialise.
Growth lost momentum as the review period progressed.
First was the spread of a new virus variant (Omicron) in late 2021, which
prompted countries to put in place new containment measures. As it turned out, the
impact was smaller than initially feared. The virus proved milder than expected and
so did the necessary policy-induced restraint on activity. The main exception was
China. The strict anti-Covid measures caused a major slowdown in growth, adding
to the effect of regulatory measures designed to rein in the real estate sector.
x BIS Annual Economic Report 2022
Then was the outbreak of the Russia-Ukraine conflict in February 2022.
Probably the most significant geopolitical event since the fall of the Iron Curtain,
the war is first and foremost a humanitarian tragedy. But its near-term impact on
economic activity is also substantial. The impact has not been felt so much through
the sanctions-induced drop in Russia’s GDP – although the imprint on world growth
is material. Nor has it been felt, so far, through its direct financial consequences –
although more may be in store (see below). Rather, it has operated mainly through
soaring commodity prices – notably energy and food – as well as concerns about
the war’s broader ramifications.
This shock is inherently stagflationary. To be sure, its impact on growth is
uneven across the world. Commodity exporters fare better than importers. But, for
the world as a whole, the outcome is unambiguously contractionary. Since
commodities are a key production input, an increase in their cost constrains output.
At the same time, soaring commodity prices have boosted inflation everywhere,
exacerbating a shift that was already well in train before the onset of the war.
Indeed, the most remarkable development during the review period was the
return of inflation.
The biggest challenge for central banks post-Great Financial
Crisis (GFC) had been to lift inflation back to target. As events unfolded, however,
what initially appeared a temporary blip, driven by Covid-induced idiosyncratic
price adjustments, turned into a much broader surge, across prices and countries.
By April 2022, three quarters of economies were experiencing inflation above 5%.
Inflation was back, not as a long-sought friend, but as a threatening foe.
Just like most observers, we at the BIS did not quite anticipate the strength and
persistence of the surge. To be sure, in last year’s AER we did explore a plausible
high-inflation scenario. In the end, however, the scenario fell short of reality.
Why the miss? Humility is in order. But probably the best explanation involves
the confluence of three forces – an explanation that necessarily cannot do justice to
cross-country differences (see Chapter I for details). First, the surprisingly strong
rebound in aggregate demand, beyond what was implicit in the scenario. The huge
policy stimulus combined with households’ pent-up spending turbocharged activity.
Second, a surprisingly persistent “pivot” or rotation of demand from services to
goods. Although people did spend, they did not flock back to contact-intensive
services, such as restaurants and hotels, as widely as expected. Finally, there were
some surprising difficulties in adjusting supply. Their most visible manifestation are
the “bottlenecks” that held back production around the world. Think, in particular,
of those that hit raw materials and semiconductors as well as freight and transport.
While, initially, the disruptions reflected primarily pandemic-related measures,
demand strength then took over.
Bottlenecks in global value chains aggravated these constraints. Complex
production networks, sprawling across the world and structured to cut costs,
betrayed their fragility as the disruptions hit them. Moreover, firms started hoarding
inventories as a precaution.
The shift from just-in-time to just-in-case inventory
management exacerbated shortages.
Against this backdrop, central banks started to normalise policy, albeit at
speeds that partly reflected varying country-specific conditions. First off the blocks
were several central banks in emerging market economies (EMEs), mostly in central
and eastern Europe and in Latin America. Because of the slower recovery and a
better inflation record, those in Asia moved later and more cautiously. Among
advanced economies (AEs), the Federal Reserve was one of the first to respond as
inflation pressures intensified. The ECB signalled that it would start removing
accommodation later in 2022 while the Bank of Japan stuck to its exceptionally
accommodative policy. The main exception was the People’s Bank of China, which
eased policy to support flagging growth.
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Near-term prospects
What are the near-term prospects for the global economy?
Context is of the essence. For the first time in the post-World War II era, the
global economy is facing the threat of higher inflation, and hence the need to keep
it in check, against the backdrop of elevated financial vulnerabilities. Looming large
among these are historically high debt levels, both private and public, and rich
valuations, notably for residential property.
There is a narrow path ahead. It is possible to envisage a smooth resolution of
the economic tensions. In this scenario, inflationary pressures ease spontaneously
due to an end to bottlenecks alongside a reversal in the war-induced increases in
commodity prices. This reduces the size of the required monetary policy tightening
and mitigates the associated slowdown in economic activity – a soft landing. But the
outcome could be less benign. The worst-case scenario would be stubborn inflation
pressures that prompt a stronger tightening. This could trigger a larger slowdown,
including a recession, alongside financial stress – a stagflationary hard landing.
Hence a natural sequence of questions.
Will higher inflation become entrenched?
How far could growth falter? Will the financial sector come under strain?
