Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
What is happening to the global economy? As difficult as the present situation is in the UK, we are not unique in facing challenges.
The world economy looks set to slow over the next year. This has led to an easing of inflation expectations globally, with commodity prices falling from their recent highs. In particular, oil prices are down about a quarter from their spring peak. For many countries across the globe, such an easing in oil prices will be a welcome development – acting as a self-correcting mechanism – helping offset some of the economic weakness.
Worryingly though for the UK and western Europe, gas prices have continued to surge to new highs because of the war in Ukraine. This has perpetuated near-term economic challenges, squeezing spending by firms and people alike.
The pandemic triggered a deep global recession in 2020. Post-pandemic, the pace of recoveries across the globe has varied but was driven largely by rebounds as life returned to normal and by reflationary policies reflecting the scale of monetary and fiscal easing.
Even at the beginning of this year the expectation across financial markets was that global growth would slow through this year and into next as rebounds lost momentum and as reflationary policies wore off. Since then, expectations have deteriorated further, largely as higher inflation hit, which led a host of central banks globally to tighten monetary policy.
One of the most cited measures of the world economy are the International Monetary Fund’s (IMF) forecasts. Although not always correct, they usually reflect the consensus. Its latest forecasts in June 2022, called ‘Gloomy and more uncertain’, caught the mood of the moment. The IMF lowered its forecasts from those made just two months earlier, reflecting the deteriorating global landscape.
Sometimes in the UK it is remarked that next year we will see the weakest growth among the G7. This is misleading, as the reality is that the major countries in western Europe are in a similar position, with France, Germany and Italy facing challenges. Where the UK is unique, though, is that it’s the only G7 country tightening fiscal policy.
The IMF’s figures showed that ahead of the pandemic the world economy slowed from 3.6 per cent growth in 2018 to only 2.9 per cent in 2019. Any figure around three per cent or less is seen as very weak, by global standards. The world economy was thus already looking fragile when the pandemic hit. In 2020, growth slumped by 3.1 per cent. The global rebound in 2021 was 6.1 per cen,t and this year the IMF expects global growth of 3.2 per cent followed by 2.9 per cent next. These forecasts may prove optimistic. Part of the challenge is that the world’s major economies are stalling.
The major exception during the pandemic was China. It continued to grow, and its monetary policy remained prudent. Furthermore, measures were taken to curb excesses in areas like the property sector. Following the trade dispute with the US under Donald Trump, China focused on increasing its self-sufficiency in areas of fuel, food and technology. This formed part of its “dual circulation policy”, and it felt vindicated in its stance during the pandemic.
This year, however, China’s economy has weakened reflecting its zero-Covid policy and deepening worries in its property sector. Importantly, China has ample room for monetary and fiscal manoeuvre to ease policy to stabilise economic activity this year and next. Perhaps one of the lessons is that, while the trend for the Chinese economy is up, one should expect increased volatility along that upward path.
The US has shrunk in each of the first two quarters of this year. Technically, this signals a recession. The recent weakness of confidence is also consistent with that. Yet the US economy grew strongly in the last few months of last year and, as here, is witnessing a strong labour market.
High inflation, which has in turn led the US Federal Reserve to raise interest rates, is at the heart of this slowdown. It has been a global problem.
This coming week, central bankers from across the globe gather at the annual Jackson Hole conference in Wyoming. Since the 2008 global financial crisis we have witnessed unconventional monetary policy globally, with cheap money. Indeed, ahead of the pandemic the central banks were convinced that they had beaten inflation and in turn policy rates would remain low.
How wrong they were. Now, they lack credibility and are talking tough – led by the US Federal Reserve.
How central banks are responding though gives a good insight into how economic conditions vary across the world.
The US is tightening to keep inflation in check. Financial markets expect US rates to peak by spring and to fall next year, as the US economy starts to slow. But it is by no means clear that the US Federal Reserve is prepared to cut rates. After all, even though interest rates have risen, inflation is still high.
China, the world’s number two, has cut interest rates recently. Likewise, Japan, the word’s number three, is keeping policy accommodative with interest rates low and unchanged.
Meanwhile, and to much domestic shock in the world’s fourth largest economy, Germany, inflationary pressures look set to persist. While the annual rate of inflation has eased from a recent high of 7.9 per cent in May to 7.5 per cent in July, pressures persist with data last week showing producer prices rising by an annual rate of 37.2 per cent.
The problem in the euro area is that when it comes to monetary policy one size does not fit all. While data in Germany may support the case for higher interest rates, the risk is that if they rise too far this could trigger a sovereign debt crisis for Italy and others.
The period since 2008 has been characterised by cheap money policy across western economies. This has raised the question as to whether low rates and cheap money have prevented economies from seeking to address structural underlying problems. Indeed, before the pandemic hit, one fear was that western economies were set to return to secular stagnation, with weak growth.
The problem is most acute for western Europe, and not just because of the region’s inept energy policies that have left countries exposed to the present crisis.
While there is still uncertainty as to how the outlook will change because of Covid, two of the pre-pandemic trends are likely to reassert themselves: namely, the digital and data revolution, where the US has a lead, and the shift in the balance of power to the Indo Pacific – stretching from India in the west to the US in the east. Hence the UK’s welcome desire to reposition itself as part of the Pacific trade group, the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP).
Despite near-term challenges, I remain optimistic about the longer-term outlook. At the turn of this century, the world economy was $32 trillion in size. This year, despite all the problems we have seen so far this century, the world economy continues to growth and the IMF sees the size of the world economy exceeding £100 trillion this year.
Yet the world is not only changing economically. The war in Ukraine has led, in my view, to the emergence of a G3 world comprising the US, China, and a new non-aligned group compromising a swathe of countries which do not want, or have become unable, to take sides in the hope of retaining good relations with the world’s two largest economies. How we reposition ourselves in this changing global economy will be key for our outlook.