The central bankers at the Jackson Hole Economic Symposium were not deluded about inflation. They said that the threat of inflation persists and that its outlook has been complicated due to structural shifts within the global economy. The second argument is easy to dismiss, because officials are always complaining that their tenure in office has been marked by unusual uncertainties. However, in 2023 they will have a valid point. Five important shifts are happening right now in the global economic system.
First and foremost, a policy shift is needed from reducing inflation towards keeping it in check. In the US, the rate of inflation has been slowed dramatically, and in Europe it has moderated. However, Federal Reserve Chair Jay Powell and Christine Lagarde president of the European Central Bank were clear in saying that it was too early to celebrate. The strength of the US domestic demand is shocking everyone. This is likely to cause inflation to remain high, even though unemployment is at historic lows. The US economy has become too hot, and it needs to cool down. In Europe, the business outlook is grim , but wages and prices are still increasing rapidly. This raises the possibility of a prolonged stagflation.
Both economies will require time to adjust towards low inflation rates and sustainable growth rates. It will be necessary to maintain higher interest rates until the inflationary pressures have been eliminated.
The second major shift in global economics is the fact that the supply conditions are not stable.
The days of policymakers being able to understand inflationary pressures by simply constructing the best indicators of demand, and comparing them with a constant rate of sustainable annual growth are long gone. This analysis is no longer relevant due to the pandemics and energy crises of the last three years.
Economic analysis should instead include extreme shifts in supply, ranging from the lockdown of coronaviruses to fractures in global supply chain and energy supply conflicts after Russia’s invasion. The trends on the labour market are also difficult to predict.
In the US, there was a significant drop in prime-age labour force participation between 2021 and 2015 before a rapid and encouraging recovery. France has seen a large improvement in the availability and quality of labour. However, this is not universal. In the UK, there are still many people who refuse to work or cannot.
Bank of England faces the most difficult of trade-offs. It must deal with supply issues ranging from a persistent lack of business investment following the Brexit referendum in 2016, a sharp increase in long-term illness among employees, and an energy shortage. Bank of England cannot solve these issues with monetary policies, but must ensure that demand is reduced enough to push inflation higher. This will require some courage.
The BoE’s most pressing problem is the constrained supply. However, the third shift has to do with public finances. This applies more strongly on the other side. The Fed has to deal with US politics’ unwillingness to be restrained in their budget.
The Congressional Budget Office estimates that, ten months into the fiscal year, the federal deficit is double what it was the year before. Cash receipts have fallen by 10%, but nominal gross domestic products are up about 7% compared to the previous fiscal years. The US economy is now in a tighter fiscal and tighter money regime compared to a decade earlier. The same demographic, climate and defence challenges are faced by European nations. This makes a similar shift more likely to spread.
The fourth shift, if we look at a broader horizon is the need to pay greater attention to India’s prospects. China has dominated the global economy for years along with high-income nations because it produces more goods than anyone else and its economy grows at around 8 percent a year.
These days are over. China’s growth rate, when measured by purchasing power parity, is slower than India’s. India’s contribution to global economic growth will soon rival that of its neighbor and not just because China is experiencing a property crash. This could happen as early as the second half this year, and will likely be the norm in the 2030s.
New Delhi’s rise to the top of the global league table for growth contributions highlights the final economic shift. India is a lone outlier, with its rapid expansion. Other countries have seen a slowdown in productivity growth, and are building trade barriers, while promoting resilience rather than efficiency. Normal global growth is expected to slow in this world.
Prior to the financial crisis, global economic growth was sustainable at around 4 percent per year. In the 2010s, this figure dropped to around 3.5 percent. It seems that 3 percent is the new speed limit. Slower global growth won’t make it any easier to resolve geopolitical conflicts, even if the planet is healthy.