The five global economic shifts happening now

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in jackson hole economic seminar Last week, central bankers were disenchanted with inflation. Its threat remains, they say, and its outlook is complicated by structural changes in the global economy. Typically, the latter argument is easily dismissed as officials complain that their tenures are fraught with unusual uncertainty. Come 2023, however, their point makes sense. Five important shifts are currently taking place in the global economy.

The first and most direct is the necessary policy adjustment, from reducing inflation to controlling inflation. The pace of price increases has slowed sharply in the U.S., and so has Europe, but Fed Chair Jay Powell and ECB President Christine Lagarde made it clear that central bankers are now taking a triumphant step It’s too early.

CPI annual percent change line chart shows inflation has slowed, but remains contained

The strength of domestic demand in the United States has surprised everyone, and if it persists when unemployment is near record lows, it will likely lead to excessive inflation. While the Atlanta Fed’s current forecast that third-quarter growth is on track to reach 6% annualized growth is almost certainly wrong, the U.S. economy is running too hot and needs to cool down. In Europe, business is sluggish, but prices (especially in resorts) and wages are still rising rapidly, raising the prospect of prolonged stagflation.

Both economies will need time to adjust to low inflation and sustainable growth rates. This will require raising interest rates for a longer period of time until inflationary pressures have fully passed.

But it is now more difficult to judge exactly when inflation risks have abated, because the second important shift in the global economy is that supply conditions are far from shaky.

Gone are the days when policymakers could understand inflationary pressures simply by constructing the best available demand indicator and comparing it to a constant sustainable growth rate. The pandemic and energy crisis of the past three years have made this analysis redundant.

Instead, economic analysis must cover extreme supply shifts, from coronavirus lockdowns and disruptions in global supply chains to energy supply conflicts following Russia’s invasion of Ukraine. Even in the labor market, trends are difficult to assess.

In 2021, the U.S. prime-age labor force participation rate has seen a decline in inflation, but there has been an encouragingly rapid recovery recently. France has also made huge improvements in labor supply, but these improvements are far from widespread, and the unwillingness or inability to work is still evident in the UK.

The BoE is facing its most difficult trade-off yet, having to grapple with supply issues including a persistent shortfall in business investment since the 2016 Brexit referendum, a sharp rise in chronic illness among staff and an energy crisis. Central banks cannot correct these problems through monetary policy, but need to ensure that demand is cut enough to further curb inflation. It takes some courage.

If the most pressing issue facing the BoE is supply constraints, a third shift concerns public finances and applies most forcefully across the Atlantic. In short, the Fed must contend with the reluctance of US politicians to show any restraint on its budget.

Ten months into the most recent fiscal year, the Congressional Budget Office calculates that the federal budget deficit is more than double what it was a year earlier. Cash receipts fell 10%, while nominal gross domestic product was about 7% higher than in the previous fiscal year. Compared with a decade ago, the U.S. economy has shifted from relatively tight fiscal policy and loose monetary policy to loose fiscal policy and tight monetary policy. European countries face the same defense, demographic and climate challenges, making similar shifts likely to spread.

Looking at it more broadly, the fourth shift calls for greater focus on India’s economic prospects. For years, China has dominated the global economy along with high-income countries because it produces more goods and services than any other country and its economy grows about 8% a year.

Those days are coming to an end. Although China’s economy is more than twice the size of India’s in purchasing power parity exchange rates, its underlying growth rate is slowing rapidly. You don’t have to predict China’s impending housing crisis to think that India will soon rival its neighbors, not only in terms of population but also in terms of contribution to global growth. This could even happen in the second half of this year and could become the norm by the 2030s.

New Delhi tops the list of global growth contributors, underscoring an eventual shift in the global economy. India is a rapidly expanding outlier. Elsewhere, productivity growth is slowing and countries are erecting trade barriers and increasing resilience rather than efficiency. In this world, normal global growth will slow.

Before the financial crisis, the global economy was growing at about 4% per year on a sustainable basis. This figure dropped to around 3.5% in the 2010s. Now it seems that 3% is the speed limit. Slower improvements in living standards will reduce carbon emissions, given the health of the planet, but slowing global economic growth will certainly not make it easier to resolve geopolitical tensions.

chris.giles@ft.com

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