What is happening to the world economy? War in Ukraine, inflation and the pandemic are slowing things down.
It’s not just the United States — the global economy is slowing.
Inflation in European countries has risen sharply as the war in Ukraine has pushed up the prices of basic necessities such as heating, gas and food. China’s “zero Covid” policy of strict lockdowns and mass testing continues to disrupt the production of goods. And around the world, central banks are raising interest rates to contain rising prices from weakening consumer demand.
The International Monetary Fund has lowered its growth outlook for 2023, forecasting that the global economy will grow 2.7 percent in 2023, compared to 3.2 percent this year. The IMF said in a report last month that the global economy faces “steep challenges” as pandemic-related supply chain disruptions, the war in Ukraine, China’s economic slowdown and rising interest rates weigh on growth.
“In short, the worst is yet to come, and for many people, 2023 will feel like a recession,” the organization said in the report.
In the United States, recession fears have grown and inflation remains stubbornly high. Some economists and investors have expressed concern about the US Federal Reserve’s aggressive rate hikes and how much they could weaken the world’s largest economy. By making borrowing more expensive, the central bank is attempting to curb consumer demand, which should result in slower price growth. But it could also trigger an economic downturn if companies significantly delay hiring or firing workers in response.
Still, some economists say the United States is actually in a better position than many other nations. European countries, for example, are experiencing a dramatic slump because their energy supply has been severely affected by the war in Ukraine. Many American households still have excess pandemic savings, and unemployment in the United States remains low.
“We’re raising interest rates quite aggressively and financial market conditions in the US have tightened,” said Ryan Sweet, chief US economist at Oxford Economics. “But so far the economy has weathered it reasonably well. Inflation is high in the US, but almost everywhere.”
Central banks around the world have been raising interest rates to stem rising prices. The European Central Bank started raising interest rates earlier this year, and officials recently signaled they weren’t done yet. The Bank of England has also raised interest rates several times this year.
There are several factors contributing to economic instability around the world, from the war in Ukraine to China’s tough Covid policies and the weakening of the real estate industry.
The War in Ukraine
The war in Ukraine has triggered an energy crisis in Europe, which has caused prices to rise. Countries that were more dependent on energy imports from Russia – such as Germany and Italy – have been particularly hard hit by the restricted supply of natural gas.
Euro-zone inflation rose 10.6 percent year-on-year in October, up from 9.9 percent in the previous month. Inflation in the UK has also skyrocketed due to skyrocketing energy bills. In October, consumer prices in the UK rose 11.1 percent year-on-year.
The war has also disrupted exports of foodstuffs such as wheat, sunflower oil and other products, straining the world’s food supply and further raising inflation.
These price hikes could result in a painful economic slowdown, as things like groceries and gasoline are usually necessary purchases for households. When European consumers spend more of their budget on these items, they have less money for other goods and services, said Raghuram Rajan, a professor at the University of Chicago Booth School and a former IMF chief economist.
“Energy and food are an essential part of your household budget,” Rajan said. “The more you spend on essentials, the less you have on essentials, so you need to cut that spending.”
Pierre Lafourcade, a global economist at UBS, said European households also haven’t accumulated as much excess savings as Americans. At the start of the pandemic, US lawmakers passed more stimulus measures and sent direct checks to consumers, resulting in more robust savings that have helped cushion household budgets.
“They had no equivalent in the eurozone,” Lafourcade said. “In the eurozone and in the UK, they never had excess savings to begin with.”
UBS economists have predicted that the global economy will grow 2.1 percent next year, the lowest rate since 1993. UBS expects 13 out of 32 economies to contract for at least two quarters, in what their economists say amounts to a global recession.
Although the war in Ukraine exacerbated global inflation, consumer prices around the world were already rising before the Russian invasion. Workers testing positive for Covid prompted plant closures, and increased demand for goods among American consumers pushed up the prices of many goods. The IMF forecast that global inflation will rise to 8.8 percent in 2022 from 4.7 percent in 2021, although the agency expects overall price increases to fall to 6.5 percent in 2023.
However, the main factors driving inflation in the United States differ from those in Europe.
Karen Dynan, an economics professor at Harvard University and a nonresident senior fellow at the Peterson Institute for International Economics, said inflation in the United States has impacted a broader range of goods and services relative to other countries, in part due to strong consumer demand. At the start of the pandemic, people stuck at home increased their spending on items like exercise bikes and home-work equipment. Supply chain disruptions also made it difficult to produce and transport goods around the world, leading to a rise in prices.
Inflation in Europe was mainly driven by rising energy and food costs as a result of the war in Ukraine, Dynan said. If energy and food costs fell, it would do a lot to mitigate rising prices in European countries, but it would have less of an impact on bringing headline inflation down in America, she said.
“In the United States, that’s not enough to solve our inflation problem because our inflation is broader,” Dynan said.
China’s economic slowdown
China is under “extreme pressure” due to its tough Covid policies and the weakening of the real estate industry, said Kenneth Rogoff, an economics professor at Harvard University and a former chief economist at the IMF.
China’s economy – the second largest in the world – has taken its toll as it attempts to stamp out Covid outbreaks through sweeping lockdowns and mass testing. Though economists expect China’s economy to grow again next year as restrictions may ease, the “zero-Covid” approach has already disrupted commodity production, weakened consumer spending and fueled growing anti-political protests.
The country’s real estate sector, which accounts for about a fifth of economic activity in China, has also weakened significantly. For years, China’s housing industry has recorded rising sales figures and real estate prices. But excessive borrowing by developers has caused construction delays and falling home prices over the past year, sparking anger among Chinese homeowners. The Chinese government issued several policies earlier this month to boost its real estate industry, but economists say the sector is unlikely to see a quick recovery.
Although Rogoff said the United States economy is in “significantly better shape” compared to European countries and China right now, he said a weaker global economy has many negative implications for American consumers. If consumers in other countries cannot afford to buy as many American goods, American companies and their exports can be harmed. If companies with large overseas operations make fewer profits in those countries, it could result in lower salaries for their workers in America, Rogoff said.
And while the US economy is currently holding up, the country could still experience a painful downturn in the coming months as the Fed continues to hike interest rates.
“If we tighten too much, we’re likely to underperform Asia,” Rogoff said. “Whether we do worse than Europe, that’s a low bar.”
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