Washington—The Peterson Institute for International Economics (PIIE) today announced its semiannual Global Economic Prospects, significantly downgrading its outlook for the US and global economies relative to its forecast in April.
A recession in the United States now appears likely, after almost a year of slow economic growth has generated no appreciable decline in inflation. The Fed will probably need to raise its policy rate substantially higher. A soft landing is not the most likely outcome, but the forecast US downturn will probably be mild by historical standards.
PIIE Senior Fellow Karen Dynan forecasts that global economic growth will step down markedly, with the brisk gain of 5.8 percent in 2021 to be followed by increases of 2.9 percent in 2022 and 1.8 percent in 2023. US GDP in 2022 will be about 1.7 percent above its 2021 level, and, in 2023, is projected to be below its 2022 level. Cumulatively, the downward revisions to the forecast put the projected level of US GDP in 2023 more than 3 percentage points below the level projected in the PIIE Global Economic Prospects in April. Dynan, former assistant secretary for economic policy and chief economist at the US Treasury, also projects that core US personal consumption expenditures (PCE) inflation will moderate from a pace of 4.6 percent over the four quarters of 2022 to 3.6 percent over the four quarters of 2023—still well above the Fed’s target.
After marked rebounds in 2021 from pandemic-related weakness, most large economies are seeing a significant slowing of economic growth this year. Inflation has surged rapidly in many countries and, as a result, their central banks are tightening monetary policy sharply.
Together with supply disruptions from the war in Ukraine and other factors, tighter financial conditions will lead to economic contractions in 2023 in most of the large advanced economies. Elsewhere, China will continue to grapple with COVID shutdowns and a property slump, India’s recovery will be ended by monetary tightening and external headwinds, and Brazil’s economy will suffer from political gridlock.
In the United States, financial conditions are responding to Fed tightening. Volatility in financial markets will continue to be pronounced as market participants come to terms with a scale of increase in interest rates unseen in many years. Housing demand is dropping, and consumer demand has slackened a bit. Yet, labor markets remain very tight, and the scope for labor supply to expand looks limited. Therefore, the Fed will probably need to raise the policy rate more than it has officially recognized, and a soft landing is possible but is not the most likely outcome. Dynan puts the probability of the United States entering a recession in 2023 at two-thirds, and she projects the unemployment rate will peak next year at 5½ percent. As-yet solid household and business finances are likely to act as shock absorbers and produce a recession that is mild by historical standards.
Turning to the euro area, PIIE C. Fred Bergsten Senior Fellow Olivier Blanchard argues that while headline inflation rates are rather similar in the United States and Europe, their underlying dynamics differ. In the United States, headline inflation is likely to improve, but underlying core inflation is strong, reflecting overheating and strong second-round wage effects. In Europe, headline inflation may further deteriorate, reflecting rising natural gas prices; core inflation is weaker, without overheating demand and reflecting weaker second-round wage effects. In short, while the inflation situation in the United States may be worse than the headlines, the situation in Europe may be better than the headlines.
Blanchard argues that the dynamics of demand in the United States and Europe also differ sharply. Demand remains strong in the United States but is weaker in Europe, reflecting the loss of purchasing power from higher energy prices and limited gas supply, potentially leading to gas rationing. Such rationing may lead to lower manufacturing production, especially in Germany, with spillovers to the rest of Europe. If so, demand may weaken enough on its own that the European Central Bank does not need to (and should not) increase interest rates very much.
On fiscal issues, Blanchard emphasizes that the various packages put in place by European governments to protect households from the energy shock and limit price increases have a substantial fiscal cost and will lead to larger deficits. But, given the still largely negative real interest rates on government bonds, their debt dynamics are still favorable, and there is no issue of debt sustainability for the moment. Investors are willing to give a pass, so long as the deficits are used either for (temporary) income support or for investment. The UK crisis indicates, however, that they do not give an unconditional pass and that the content and credibility of policy matters. If gas and electricity prices remain high, the issue might arise and force a stronger fiscal adjustment in the near term.
PIIE Anthony M. Solomon Senior Fellow Mary Lovely observes that the Chinese slowdown was widely unanticipated at the start of the year, as seen by a comparison of current and past forecasts. She attributes the weakened domestic demand to the government’s response to COVID outbreaks and the ongoing crisis in the property sector.
Looking beyond the upcoming 20th Party Congress, Lovely argues that Chinese policymakers will seek an exit ramp from the zero-COVID policy but that this search will be complicated by difficulties obtaining effective vaccines and devising less restrictive border policies. She emphasizes the structural roots of the property crisis and the difficulties China faces in moving away from overreliance on investment-led growth. Additionally, Lovely highlights the challenges for Chinese growth in the context of a slowing global economy.
Michele Heller, PIIE director of strategic communications and media relations, [email protected]
The Peterson Institute for International Economics is an independent nonprofit, nonpartisan research organization dedicated to strengthening prosperity and human welfare in the global economy through expert analysis and practical policy solutions.