April 25, 2024
World Economy

Global Economy Approaches Soft Landing, but Risks Remain

The clouds are beginning to part. The global economy begins the final
descent toward a soft landing, with inflation declining steadily and growth
holding up. But the pace of expansion remains slow, and turbulence may lie

Global activity proved resilient in the second half of last year, as demand
and supply factors supported major economies. On the demand side, stronger
private and government spending sustained activity, despite tight monetary
conditions. On the supply side, increased labor force participation, mended
supply chains and cheaper energy and commodity prices helped, despite
renewed geopolitical uncertainties.

This resilience will carry over. Global growth under our baseline forecast
will steady at 3.1 percent this year, a 0.2 percentage point upgrade from

October projections
, before edging up to 3.2 percent next year.

Important divergences remain. We expect slower growth in the United States,
where tight monetary policy is still working through the economy, and in
China, where weaker consumption and investment continue to weigh on
activity. In the euro area, meanwhile, activity is expected to rebound
slightly after a challenging 2023, when high energy prices and tight
monetary policy restricted demand. Many other economies continue to show
great resilience, with growth accelerating in Brazil, India, and Southeast
Asia’s major economies.

Inflation continues to ease. Excluding Argentina, global headline inflation
will decline to 4.9 percent this year, down 0.4 percentage point from our
October projection (also excluding Argentina). Core inflation, excluding volatile food and energy
prices, is also trending lower. For advanced economies, headline and core
inflation will average around 2.6 percent this year, close to central
banks’ inflation targets.

With the improved outlook, risks have moderated and are balanced. On the

  • Disinflation could happen faster than anticipated, especially if labor
    market tightness eases further and short-term inflation expectations
    continue to decline, allowing central banks to ease sooner.
  • Fiscal consolidation measures that governments have announced for
    2024-25 may be delayed as many countries face rising calls for increased
    public spending in what is the biggest global election year in history.
    This could boost economic activity, but also spur inflation and increase
    the prospect of disruption later.
  • Looking further ahead, rapid improvement in Artificial Intelligence
    could boost investment and spur rapid productivity growth, albeit one with

    significant challenges for workers

On the downside:

  • New commodity and supply disruptions could occur, following renewed
    geopolitical tensions, especially in the Middle East. Shipping costs
    between Asia and Europe have increased markedly, as Red Sea attacks reroute
    cargoes around Africa. While disruptions remain limited so far, the
    situation remains volatile.
  • Core inflation could prove more persistent. The price of goods remains
    historically elevated relative to that of services. The adjustment could
    take the form of more persistent services—and overall—inflation. Wage
    developments, particularly in the euro area, where negotiated wages are
    still on the rise, could add to price pressures.
  • Markets appear excessively optimistic about the prospects for early
    rate cuts. Should investors re-assess their view, long-term interest rates
    would increase, putting renewed pressure on governments to implement more
    rapid fiscal consolidation that could weigh on economic growth.

Policy challenges

With inflation receding and growth remaining steady,

it is now time to take stock and look ahead.

Our analysis
 shows that a substantial share of recent disinflation occurred via a decline
in commodity and energy prices, rather than through a contraction of
economic activity.

Since monetary tightening typically works by depressing
economic activity
, a relevant question is what role, if any, has
monetary policy played? The answer is that it worked through two additional
channels. First, the rapid pace of tightening helped convince people and
companies that high inflation would not be allowed to take hold. This
prevented inflation expectations from persistently rising, helped dampen
wage growth, and reduced the risk of a wage-price spiral. Second, the
unusually synchronized nature of the tightening lowered world energy
demand, directly reducing headline inflation.

But uncertainties remain and central banks now face two-sided risks. They
must avoid premature easing that would undo many hard-earned credibility
gains and lead to a rebound in inflation. But signs of strain are growing
in interest rate-sensitive sectors, such as construction, and loan activity
has declined markedly. It will be equally important to pivot toward
monetary normalization in time, as several emerging markets where inflation
is well on the way down have started doing so already. Not doing so would
jeopardize growth and risk inflation falling below target.

My sense is that the United States, where inflation appears more
demand-driven, needs to focus on risks in the first category, while the
euro area, where the surge in energy prices has played a disproportionate
role, needs to manage more the second risk. In both cases, staying on the
path toward a soft landing may not be easy.

The biggest challenge ahead of us is to tackle elevated fiscal risks. Most
countries came out of the pandemic and energy crisis with higher public
debt levels and borrowing costs. Bringing down public debt and deficits
will give space to deal with future shocks.

Remaining fiscal measures introduced to offset high energy prices should be
phased out right away, as the energy crisis is behind us. But more is
needed. The danger is two-fold. The most pressing risk is that countries do
too little. Fiscal fragilities will build up until the risk of a fiscal
crisis forces sudden and disruptive adjustments, at great cost. The other
risk, already relevant for some countries, is to do too much, too soon, in
the hope of convincing markets of ones’ fiscal rectitude. This could endanger growth prospects. It would also make it much harder to
address imminent fiscal challenges such as the climate transition.

What to do then? The answer is to implement a steady fiscal consolidation,
with a non-trivial first installment. Promises of future adjustment alone
will not do. This first installment should be combined with an improved and
well-enforced fiscal framework, so future consolidation efforts are both
sizable and credible. As monetary policy starts to ease and growth
resumes, it should become easier to do more. The opportunity should not be

Emerging markets have been very resilient, with stronger-than-expected
growth and stable external balances, partly due to improved monetary and
fiscal frameworks. Yet divergence in policy between countries may spur
capital outflows and currency volatility. This calls for stronger buffers,
in line with our

Integrated Policy Framework

Beyond fiscal consolidation, the focus should return to medium-term growth.
We project global growth of 3.2 percent next year, still well below the
historical average. A faster pace is needed to address the world’s many
structural challenges: the climate transition, sustainable development, and
raising living standards.

Reforms that ease the most binding constraints to economic activity, such
as governance, business regulation and external sector reform, can help
unleash latent productivity gains,

our research shows
. Stronger growth could also come from limiting geoeconomic fragmentation
by, for instance, removing the trade barriers that are impeding trade flows
between different geopolitical blocs, including in low-carbon
technology products that are crucially needed by emerging and developing

Instead, we should strive to keep our economies more interconnected. Only
by doing so can we work together on shared priorities. Multilateral
cooperation remains the best approach to address global challenges. Progress
toward that, such as the recent

50 percent increase
 of the Fund’s permanent resources, is welcome.


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