Optimism is scarce in our mega-threatened world
- The world economy faces a ‘polycrisis’ as the Great Moderation recedes further and a Great Stagflation threat looms large. Growth is harder to achieve and inflation harder to quell because covid supply snarls were accompanied by shifts from free trade to secure trade and efficiency to resilience.
Since the publication of Megathreats in October 2022, the themes I emphasized have gone mainstream. Everyone now acknowledges that economic, monetary and financial threats are rising and interacting in dangerous ways with various other social, political, geopolitical, environmental, health and technological developments. Hence, in December 2022, the Financial Times chose “polycrisis" as one of its buzzwords of the year. Whatever one’s preferred term (others have adopted “permacrisis" or “confluence of calamities"), there is growing recognition that not only the global economy, but also human survival is at risk.
As I warned in Megathreats, the so-called Great Moderation (a long period of low macroeconomic volatility following the mid-1980s) has given way to the Great Stagflation. In 2022, we witnessed a surge of inflation in advanced economies and emerging markets, a sharp slowdown of global growth that continued into 2023, and signs of severe private- and public-sector debt problems as central banks raised policy rates to stabilize prices.
Thanks to this monetary-policy tightening, inflation has fallen around the world; moreover, the impact of stagflationary short-term negative supply shocks—the pandemic, the commodity-price spike following Russia’s invasion of Ukraine, and China’s ‘zero-covid’ policy—has been gradually fading throughout 2023. But inflation remains well above the 2% target in advanced economies, and a dozen other medium-term negative aggregate supply shocks discussed in Megathreats have grown more severe.
For example, de-globalization has continued, with more countries shifting from free trade to secure trade, and from economic integration to decoupling and ‘de-risking.’ Reshoring, near- shoring, and ‘friend-shoring’ imply a trade-off between efficiency and resilience, with just-in-time global supply chains being replaced by ‘just-in-case’ arrangements.
Moreover, societal ageing in Europe, Japan and China is reducing the supply of workers at a time when immigration restrictions are hampering the flow of labour from poor to rich countries—all of which increases labour costs. Climate change is already fuelling energy and food insecurity, increasing energy and food costs, and the world still has not done nearly enough to prepare for future pandemics.
Then there are the new under-appreciated risks posed by AI-enhanced cyber-warfare and disinformation, as well as longstanding problems such as the simmering backlash against rising wealth inequality (which may lead to wage-increasing fiscal policies and support for populist politicians). Finally, as the US leans more heavily on the dollar as a foreign-policy tool, de-dollarization remains an acute risk.
Thus, despite the short-term moderation of covid-related shocks, the world still faces major stagflationary risks (lower growth and higher inflation), most of which are likely to become stronger over the next decade.
The party is over: I had also warned that high and rising private and public debt ratios, which reached 330% of GDP globally in 2022 (420% in advanced economies and over 300% in China), mark a dramatic shift from the pre-2021 period, when debt ratios were high, but debt-service ratios were low. The decade of secular stagnation after the global financial crisis was characterized by low aggregate-demand growth, large private and public savings, and low investment rates. Slow growth led to low inflation-adjusted interest rates, while near-zero or even negative policy rates, combined with quantitative and credit easing, kept nominal and real rates very low—and often negative—both on the short and long end of the yield curve.
But that easy-money environment is gone. The negative supply shocks of the pandemic, together with stimulus policies in response to it, led to a surge of inflation starting in 2021. Central banks then reacted (eventually) by hiking both nominal and real rates. But with private and public debt ratios so high, central banks will find it difficult to reduce inflation to their 2% target. They are caught in a ‘debt trap,’ facing not only a dilemma—how to achieve 2% inflation without causing an economic hard landing—but a trilemma: how to achieve price stability while also avoiding a recession and a financial crisis.
Developments since the publication of Megathreats have confirmed that this trilemma is a serious issue. If central banks continue increasing policy rates to pull inflation down to 2%, a recession and debt distress among highly leveraged private and public borrowers become more likely. But if policymakers blink and give up on their price-stability goal, inflation and inflation expectations could get de-anchored, triggering a wage-price spiral.
So far, central banks have not blinked. But if inflation remains above target—as seems likely, given high wage growth and still-high commodity prices—they eventually may bend to avoid causing an economic downturn and a financial crash. The fact that they have already paused rate hikes despite too-high core inflation (which excludes volatile food and energy prices) suggests that they may be preparing to accept above-target inflation.
To be concluded. ©20203/project syndicate
