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worldyou Might be so Global monetary policy is expected to tighten most rapidly in 40 years to deal a heavy blow to the global economy. In 2023, however, it appears to be ignoring the impact of rising interest rates. Not only is inflation stubbornly high, but economic activity appears to be accelerating. Rapid growth may sound like a good thing, but it is a headache for policymakers trying to achieve a controlled slowdown. And that could mean the recession will be more painful when it finally hits.
At the end of last year, business surveys showed that manufacturing and service output were contracting around the world. Today, manufacturing output is flat, but services are picking up. American consumers are consuming freely. Both wages and prices continue to grow rapidly, even where they have been stagnant for a long time. Japan seems to be planning a big wage hike in the spring. In the Eurozone, the monthly rate of ‘core’ inflation, excluding food and energy prices, broke his record in February. The labor market is extremely tight. As we reported this week, OECDa group of mostly wealthy countries, where employment rates have reached record highs.
From equities to credit, financial markets are pricing in above-trend global economic growth. Not long ago, investors debated whether the global economy would face a “hard landing” with a recession or a “soft landing” with inflation overcome without a recession. Today they are asking if the global economy is really on land.
There are several reasons for the apparent acceleration. The mini boom that took hold in the market in late 2022 has inspired animal spirits. China’s coronavirus-free restart led to a rapid economic recovery, filling up orders in emerging markets. Falling energy prices in Europe have loosened the twist in its economy. But above all, consumers and businesses in most large nations are in surprisingly good financial shape. Many households are still maintaining savings accumulated during the covid-19 pandemic. Businesses have managed to keep interest rates low for a long period of time and have yet to suffer from rising borrowing costs. Only in the most rate-sensitive sectors of the global economy, such as real estate, will the impact of higher interest rates be clearly visible. The economy is doing very well in America, and even housing may be recovering slightly.
Acceleration means a recession is not imminent. But it also means the central bank will need to raise interest rates further if it is to succeed in pushing inflation back to his 2% target. On March 7th, Federal Reserve Chairman Jerome Powell hinted at something similar, sending the stock market down. Policymakers currently face two difficult decisions.
The first is that monetary tightening so far has not yet had sufficient effect. Economists often talk about a “long and fluctuating lag” in which interest rates work, but research suggests policy today may be working faster. If last year’s tightening has already worn off, more tightening may be needed. The second judgment concerns the persistence of factors that seem to have kept much of the economy safe from higher interest rates. Eventually, consumers will run out of cash reserves and businesses will feel the pinch of rising borrowing costs. Economies are suffering in countries like Sweden, where rising interest rates quickly trickle down household budgets.
One thing is clear: the ideal path for inflation to fall without slowing growth too much looks narrower than it did a month ago. Instead, central banks will likely have to choose between allowing inflation to rise or hitting the brakes hard for the second year in a row. ■
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