A Mild Global Contraction Is Coming

NEW YORK – There are currently four scenarios for the global economic outlook. Three of these entail potentially serious risks with far-reaching implications for markets.

The most positive is a “soft landing,” where central banks in the advanced economies manage to bring inflation back down to their 2% targets without triggering a recession. There is also the possibility of a softish landing. Here the inflation target is achieved, but through a relatively mild (short and shallow) recession.

The third scenario is a hard landing, where returning to 2% inflation requires a protracted recession with potentially severe financial instability (such as more bank distress and highly leveraged agents suffering serious debt-servicing difficulties). If the effort to tame inflation triggers severe economic and financial instability, a fourth scenario becomes possible: central banks wimp out and decide to allow for above-target inflation, risking a de-anchoring of inflation expectations and a persistent wage-price spiral.

As matters stand, the eurozone is already in a technical recession, with GDP having fallen in the fourth quarter of 2022 and the first quarter of 2023, and with inflation still well above target (despite its recent decline). The United Kingdom is not yet in a recession, but growth has slowed sharply and inflation remains stubbornly high (above the OECD average). And the United States suffered a sharp slowdown in the first quarter even as core inflation (which excludes food and energy prices) remained high (though it is falling, it remains above 5%).

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© Project Syndicate

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