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As Global Economy seems to crumble, Policy makers needs consistency.

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One-third of the global economy will likely decrease this year or next as real wages fall and prices rise.

The global economy is still facing significant hurdles, including the Russian invasion of Ukraine, a cost-of-living crisis driven by persistent and increasing inflationary pressures, and China’s downturn.

Our global growth forecast for this year remains steady at 3.2 percent, while our forecast for next year has been reduced to 2.7 percent, 0.2 percentage points lower than in July. The slowdown in 2023 will be widespread, with countries accounting for roughly one-third of the global economy expected to contract this year or next. The world’s three major economies, the United States, China, and the eurozone, will remain stalled. Overall, the shocks of this year will reopen economic scars that were only partially healed during the pandemic. In summary, the worst is yet to come, and 2023 will seem like a recession for many people.

The tightening of monetary and financial conditions in the United States will limit growth to 1% next year. We have reduced China’s growth prediction for next year to 4.4 percent due to a worsening property industry and ongoing lockdowns.

The slowdown is especially noticeable in the eurozone, where the war’s energy crisis will continue to take a significant toll, cutting growth to 0.5 percent in 2023.

Almost everywhere, fast-rising food and energy prices are generating considerable hardship for people, particularly the poor.

Despite the economic slump, inflationary pressures are proving to be more widespread and persistent than expected. Global inflation is now predicted to peak this year at 9.5 percent before slowing to 4.1 percent by 2024. Inflation is spreading far beyond food and energy. Global core inflation increased from 4.2 percent on an annualized monthly basis at the end of 2021 to 6.7 percent in July for the median country.

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The outlook’s downside risks remain strong, while policy trade-offs to solve the cost-of-living crisis have gotten more difficult. Among those mentioned in our report:

With high uncertainty and increased fragility, the danger of monetary, fiscal, or financial policy miscalibration has risen substantially.

Should financial market instability emerge, driving investors to safe assets, global financial conditions might worsen and the dollar appreciates more. This would exacerbate inflationary pressures and financial fragilities in the rest of the world, particularly in emerging markets and developing economies.

Inflation could become more persistent, particularly if labor markets remain highly tight.

Finally, the conflict in Ukraine continues, and further escalation could deepen the energy problem.
Our most recent outlook also examines the risks associated with our baseline projections. We believe that there is a one-in-four chance that global growth will slip below the historically low level of 2% next year. If several of the risks materialize, global growth would fall to 1.1 percent in 2023, with near-stagnant income per capita. According to our calculations, the likelihood of such a negative consequence, or worse, is 10% to 15%.

Living-cost crisis

Increasing pricing pressures, which squeeze real earnings and undermine macroeconomic stability, constitute the most direct threat to current and future prosperity. Central banks are now laser-focused on restoring price stability, and the rate of tightening has picked up significantly.

Both under- and over-tightening pose dangers. Under tightening would exacerbate inflation, damage central banks’ credibility, and destabilize inflation expectations. As history has shown, doing so would merely raise the overall cost of bringing inflation under control.

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Excessive tightening risks cause the world economy to into an unnecessarily deep recession. Financial markets may potentially be affected by excessively rapid tightening. However, the costs of these policy errors are not symmetric. Central banks’ hard-won credibility could be jeopardized if they underestimate the dogged endurance of inflation once more. This would be far more damaging to future macroeconomic stability. The financial policy should be used to keep markets stable when necessary. Central banks, on the other hand, must maintain a steady hand with monetary policy firmly focused on managing inflation.

Developing an acceptable budgetary answer to the cost-of-living crisis has proven to be a significant challenge. Let me highlight a few essential principles.

First, fiscal policy should not contradict monetary authorities’ efforts to reduce inflation. As recent events have demonstrated, doing so will simply prolong inflation and risk causing severe financial instability.

Second, the energy issue, particularly in Europe, is not a passing fad. The geopolitical rearrangement of energy sources in the aftermath of the conflict is extensive and long-term. Winter 2022 will be difficult, but winter 2023 will very certainly be worse. Price signals will be critical in reducing energy demand and stimulating supply. Price controls, untargeted subsidies, and export prohibitions are fiscally inefficient, resulting in excess demand, undersupply, misallocation, and rationing. They almost never work. Instead, fiscal policy should try to safeguard the most vulnerable people through targeted and temporary payments.

Third, fiscal policy may assist economies in adapting to a more volatile environment by investing in productive capacities, such as human capital, digitization, green energy, and supply chain diversification. By expanding these, economies can become more resilient to future crises. Unfortunately, these critical concepts are not always influencing policy at the moment.

The consequences of a strong dollar

The strength of the dollar is a key challenge for many emerging markets. The dollar is presently at its highest level since the early 2000s, while the gains are most noticeable against advanced-economy currencies. So far, basic issues such as tighter US monetary policy and the oil crisis appear to be driving the surge.

Most rising and developing countries should calibrate monetary policy to maintain price stability while allowing exchange rates to adjust, preserving valuable foreign exchange reserves for when financial conditions truly deteriorate.

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As the global economy enters turbulent waters, developing market governments must batten down the hatches.

Eligible nations with good policies should consider increasing their liquidity buffers as soon as possible, including by requesting access to the Fund’s precautionary instruments. Countries should also try to reduce the effect of future financial turbulence by implementing a combination of proactive macroprudential and capital flow policies, when appropriate, in accordance with our Integrated Policy Framework.

Too many low-income countries are on the verge of default. Progress toward orderly debt restructurings through the Group of Twenty’s Common Framework for the Most Affected is critical if a wave of a sovereign financial crisis is to be avoided. Time is running out.

The energy and food problems, combined with severe summer temperatures, serve as sharp reminders of the consequences of an unmanaged climate transition. Development on climate policies, as well as debt resolution and other targeted multilateral concerns, will demonstrate that focused multilateralism can produce progress for all while overcoming geoeconomic fragmentation forces.

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