Global economy in uncharted waters

This was supposed to be the year of post-Covid normalization, labor-market healing, and a revival of economic growth. Yet it is turning out to be a fraught period of geopolitical realignments, persistent supply disruptions, and financial-market volatility, all of which are playing out in a context of surging inflationary pressures and limited policymaking space.

Owing to these developments, the latest update to the Brookings-Financial Times Tracking Indexes for the Global Economic Recovery (TIGER) shows an overall loss of growth momentum, with considerable unevenness across countries in their vulnerability to adverse domestic and international developments. The war in Ukraine, Covid-19’s resurgence in China, and the lack of macroeconomic policy options available to most governments will make 2022 a tough year for global growth. And although Covid-19’s disruptive effects seem contained in most parts of the world, the potential for new variants to emerge means that it will remain a wildcard.

The spike in geopolitical tensions has exacerbated global supply-chain disruptions. With prices already surging and demand holding up well in most major economies until recently, conditions are ripe for an escalation of inflationary pressures around the world. Worse, most governments and central banks will find it difficult to bolster demand if it shows signs of flagging in the face of mounting economic uncertainty and financial volatility. Consumer and business confidence have already taken a hit, and that bodes ill for consumer demand and especially for business investment.

The US economy continues to power along: headline employment and unemployment numbers have returned to their pre-pandemic levels; industrial output has been robust; and overall domestic demand remains strong, serving as a major engine of global growth. But the US Federal Reserve is at risk of losing control of the inflation narrative, which means that it could be forced to tighten monetary policy even more aggressively than it has signaled, raising the risk of a marked growth slowdown in 2023. High oil prices, a yield-curve inversion (when the yield on short-term debt is higher than on long-term debt), and a flailing stock market all point to – and feed – a widespread sense of impending difficulties.

Meanwhile, China’s determination to stick to its zero-Covid strategy has come to seem increasingly unviable. Consumer demand, investment, and production are all showing signs of weakening, which could have implications beyond China. On a more positive note, housing prices have leveled off, financial pressures have receded, and consumer price inflation remains relatively moderate. The Chinese government and central bank therefore have more room to maneuver than policymakers in other major economies do, and thus will probably enact more stimulus measures to counter weakening growth momentum. But the government’s commitment to keeping a lid on longer-term financial risks will remain a constraining factor.

For their part, eurozone economies are engaged in the difficult task of weaning themselves off Russian natural gas as quickly as possible. That could be immensely disruptive to some industries, though with a modest and short-lived overall hit to growth. If diminished energy supplies begin to exact a toll, the German economy’s strong recovery will become much shakier.

Eswar Prasad, Professor of Economics at the Dyson School at Cornell University, is a senior fellow at the Brookings Institution.