Last month, when world leaders convened in Davos for the annual World Economic Forum summit. To discuss the economy that was in bad shape.
The economists surveyed by the WEF for its Chief Economists Outlook report. A global recession in 2023—characterized by a decline in the global gross domestic product—is likely. The World Bank issued a warning that the world economy was “perilously close to entering a recession” in January as well.
Since then, the International Monetary Fund has offered a less dismal estimate in its end-January review. Indicating that the world economy may escape decline this year. Nevertheless, the IMF has forecast that the UK economy will contract. Whereas it has issued a warning that the US has a “narrow road” to avoiding a recession.
One major factor driving the economy towards a recession, as noted by the IMF, the World Bank. And many other experts, is the recent significant increase in interest rates by central banks to control skyrocketing inflation.
Price stability is the main objective of central banks. In fact, the majority of central banks in industrialised nations try to maintain consumer price inflation below 2 percent. However to do so by controlling the quantity of credit and money accessible in the market.
Their most crucial instrument is the interest rate at which they lend to other banks. Low interest rates enable people and businesses to borrow more from banks. This then stimulates economic activity.
As a result of lockdowns and supply chain snags brought on by the COVID-19 epidemic. Which crippled the international economy, central banks around the world lowered interest rates to boost demand—a strategy known as loose monetary policy.
The US Federal Reserve has raised interest rates by 4.5 percentage points since early last year. Due to the most recent increase occurring on February 1. The European Central Bank raised rates by 2.5 percentage points during the same time period.
The increase in interest rates has been far more pronounced in some nations, such as Brazil. Where it has increased by 11.75 percentage points. Since March 2021 and by 10 percentage points in Sri Lanka.
The goal is to reduce consumer demand in the anticipation. That individuals will put off making large purchases like car purchases or vacation bookings.
The strategy seems to be effective as inflation levels are starting to decline in several nations. For instance, in the US, while inflation peaked in June 2022 at 9.1% percent. It has since dropped drastically to 6.5 percent in December, a four-decade low. Consumer price inflation in Brazil has decreased from a peak of 12.1% in April of last year to 5.8% in December.
Increased interest rates, though, also have additional effects on the economy.
Because they typically have little bargaining leverage in salary negotiations and have insufficient reserves to deal with the growing cost of living, the poorest people are frequently the ones that suffer the most as a result of this spiral.
But if central banks raise interest rates to restrain demand, a downturn in the economy and, in some cases, a recession, are the inevitable results. And experts anticipate that central banks will keep raising interest rates, at least in the near term.
However, the IMF’s latest, upbeat prediction that the world economy would expand in 2023 shows that a recession isn’t a certain conclusion of the struggle against inflation.
Central banks require assistance from their nations’ governments through other policies to sustain price stability while averting recession, according to Manuela of Moschella
Financial services company Nomura’s managing director and top economist for India and Asia (outside of Japan), Sonal Varma, claimed that as borrowing prices rise, businesses tend to scale back on investments or start laying off employees.
The IMF cited Europe’s “better-than-expected adaptation to the energy crisis” as a major reason why the world might avoid a recession. Europe is already setting an example that appears to be working.
Many European nations have tried to implement tax incentives, cap power prices for vulnerable demographic groups, or subsidise excessive energy expenses.
Overall, the IMF has stated that government assistance of 1.2 percent of the European Union GDP to people. And businesses affected by the energy crisis is a contributing factor in the “resilience” displayed by Europe in terms of its economic performance. EU nations had allocated 600 billion euros ($654 billion currently) for these initiatives by November of last year.
These actions have enabled the European Central Bank to raise interest rates at a slower pace. Than other developed economies, such as the US, by helping to reduce inflation. Additionally, despite predictions that it would contract in the fourth quarter of 2022. Europe’s GDP actually expanded by a meagre 0.1 percent.
Before the COVID-19 epidemic, the most developed nations, including the USA and the Eurozone, experienced a decade of deflation. During which time inflation remained low and they struggled to resurrect economic activity, she said. Inflation first appeared to be a passing fad. “Central banks have to hit the acceleration button pretty hard.” Moschella said, adding that they are now playing catch-up.
In addition to 1975 and 1982, the world economy has experienced recessions in 1991, 2009, and 2020 over the past 50 years.
Economists predict that a severe economic downturn will harm millions of working people worldwide. Even if the globe is able to avoid a recession in 2023. European nations’ actions will only lessen the damage for their population, not totally protect them.
