PIIE projects modest economic growth with downside risks

The Peterson Institute for International Economics (PIIE) today announced its semiannual Global Economic Prospects, showing below-trend economic growth in the United States and Europe for 2023 and 2024. Demand and output have been more resilient than anticipated, and inflation—although seeming to have peaked in many countries—remains high. As a result, the Federal Reserve and many other central banks will continue to maintain tight financial conditions. In addition, the potential for further turmoil in the banking system increases negative tail risk for economic activity.

Karen Dynan, PIIE nonresident senior fellow, forecasts that global GDP will increase 2.9 percent in 2023 and 3.1 percent in 2024. US GDP in 2023 is projected to be about 1.3 percent above its 2022 level, and in 2024 is projected to rise 1.0 percent. Dynan, former assistant secretary for economy policy and chief economist at the US Treasury Department, also expects that core US personal consumption expenditure (PCE) inflation will moderate from a pace of 4.8 percent over the four quarters of 2022 to 3.9 percent over the four quarters of 2023 and 3.2 percent over the four quarters of 2024.

Tight financial conditions will constrain economic growth this year and next in many advanced economies. Still, the outlook for the euro area is brighter than a few months ago.

Among major emerging economies, China is rebounding because of its reopening from COVID-19 pandemic shutdowns, and in India progress on reforms will bolster activity. By contrast, in Brazil high interest rates and structural problems will remain a drag.

In the United States, incoming data have been stronger than expected, with consumers still having pent-up demand and (in the aggregate) the wherewithal to finance it. Labor markets have eased, but only slightly, and inflation remains well above the Federal Reserve's target. Although turmoil in the banking sector since the recent failures of two US regional banks has generated some further tightening of financial conditions, the Fed will probably still need to make a couple of further 25 basis point hikes to bring inflation down toward its target. A recession is not the most likely outcome, but risks tilt to the downside because of the possibility of further contagion from the situation in the banking sector and the intrinsic difficulties of achieving a soft landing.

Banking sector

Anna Gelpern, PIIE nonresident senior fellow, discussed recent volatility in the banking sector and its implications for financial regulation and supervision, observing in her presentation that "banking crisis" headlines obscure real differences among failed and stressed banks in the United States and Europe.

All banks are adjusting to higher interest rates, and many might reassess the balance between their banking and trading books. Nonetheless, the two US regional banks that failed recently, Silicon Valley Bank and Signature Bank, were outliers in many respects. There is no obvious reason to link their troubles to those of Credit Suisse, the global systemically important Swiss bank that was acquired by its rival UBS in a March 19 emergency deal brokered by the Swiss authorities. There are lessons to be learned from the way in which governments on both sides of the Atlantic have managed their respective crises.

Gelpern says it is disturbing to learn that the system was so fragile in the eyes of US policymakers that they decided to use extraordinary tools to safeguard US financial stability to manage the failure of two relatively niche institutions. By definition, the regime put in place after the last crisis to guard against systemic risk fell short. Regulatory relief legislation in 2018 and the measures that followed were part of a cyclical pattern. Risk management, regulation, and supervision all failed at basic tasks. On the other hand, she says it is comforting that, once they decided that the system was at risk, the authorities had no trouble invoking and adapting the emergency toolkit under the stringent Dodd-Frank Act standards. In sum, the response was broadly right, but damaging to the credibility of regulation and supervision going forward. There is no single magic loophole or blanket fix, and we will learn more from the behavior of banks and depositors over the next few weeks, she noted.

Credit Suisse has had many bespoke problems for a long time, and its demise was not shocking, Gelpern said. The way in which the authorities went about the deal, especially with the "wipe-out" of additional Tier 1 capital, could have broader ramifications. Their actions could well be in line with the underlying contracts, but this would not be a good answer if they upended investor expectations and shook confidence in loss-absorbent debt. Depending on the prevalence of this variant of loss-absorbent debt, it could take more than somber statements from regulators to maintain the viability of this instrument.

Euro area

Turning to the euro area, Jacob Funk Kirkegaard, PIIE nonresident senior fellow, contends in his analysis that the economies of the euro area and broader European Union have been surprisingly resilient, despite regional negative economic shock since Russia's invasion of and war on Ukraine. European labor markets remain at historically high labor utilization, corporate profits have recovered to their long-term trend, and headline inflation has peaked as energy prices have fallen dramatically and the fiscal costs of the crisis for national governments declined significantly.

Kirkegaard argues that with headline inflation declining rapidly, core inflation will soon peak too, while the European Central Bank will maintain a monetary policy intended to return inflation to its 2 percent target in a timely manner. A return to rising real wages will support household income and consumption, and high carbon prices and funding from the European Union's pandemic recovery fund will continue to spur green investments in the bloc. Defense spending, too, will permanently shift upwards, even if the war in Ukraine ends later in 2023. Recent financial market turbulence in the Swiss banking sector is unlikely to have a discernable macroeconomic effect on the euro area, nor affect near-term monetary policy decisions.

Media Contact

Michele Heller, PIIE director of strategic communications and media relations, [email protected]