Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate.
December 24, 2022 — Economists spent most of 2022 convincing themselves that the global economy was about to fall into recession, if it wasn’t already in one. With the year over, the global recession has now been postponed to 2023.
- Tour d’horizon
In the US, reports that a recession had begun in the first half of the year clearly were premature, especially given how tight the labor market was. It still is. The chances of a downturn in the coming year are well below 100%, despite the confidence with which many say it is certain. It is foolish to think we can predict a recession with certainty. But the chances are indeed far above the usual 15 %. The odds are perhaps 50-50 in 2023 and 75% at some point during the next two years. The main reason is the rapid raising of interest rates by the Fed (and other central banks), which in turn is attributable to high inflation.
Europe, hard-hit by higher energy prices, has worse prospects. A recession is highly likely, for example as defined by the criterion of two consecutive quarters of negative growth.
China looks to be in still worse shape. It has the same problems as Europe, plus also the recent collapse of the property sector and the return of Covid-19 due to re-opening without adequate vaccination. Growth will be far less than what the Chinese had become accustomed to. But it almost never turns negative. Even an 8-percentage-point decrease in GDP growth at the time of the Global Financial Crisis, from 14% in 2007 to 6% at the height of the Great Recession in 2009, was not enough to cause Chinese output to shrink in absolute terms. This is one of many illustrations of the drawbacks of defining recession by an automatic rule based on negative GDP growth.
- Policy mistakes
In many countries, current woes are substantially self-inflicted. Governments have made mistakes with consequences that are turning out to be as huge as they were predictable.
Europe over the decade 2011-2021 needlessly made itself dependent on Russian energy, especially natural gas. Russia’s invasion of Ukraine on February 24, 2022, was a still greater blunder. China’s zero-Covid lock-down policy came at high economic costs in 2022, while the absence of a plan for the end-game meant that the mortality costs were only postponed, as the current re-opening is demonstrating. Other governments where recent policy-making has been poor include Brazil, India, Mexico, Turkey, and South Africa, among others.
The US, for its part, has made many mistakes. High on the list is its willful abandonment of leadership of the rules-based liberal international order. This includes ignoring the WTO and the trade rules that its members had negotiated over many years. Donald Trump’s tariffs were bad, but Joseph Biden has done little to reverse them, while the “buy American” attributes of the otherwise-laudable Inflation Reduction Act of 2022 went further to flout the agreed rules.
- Financial markets in 2022
Although the effects of higher interest rates have hardly begun to show up in slower growth, and still less in labor markets, they have shown up in financial markets over the course of the last year.
American stock prices peaked in January 2022 and trended strongly downward subsequently. Bonds, real estate, and Emerging Market assets are all down for the year as well. This looks like a long-anticipated bursting of the “everything bubble.”
In July 2021, I gave 9/10 odds that there would be a general bursting of asset bubbles. How could one tell, at the time, that bubbles characterized the climate in financial markets? Historically high valuations of equity prices — relative to dividends, earnings, or income — were an obvious indication. But to be fair, real interest rates, and even nominal interest rates, were less than or equal to zero, this time last year. A low discount rate meant that virtually any level of asset prices could be rationalized as the present discounted value of future income.
Four other kinds of assets entered 2022 more audibly screaming, “I am a bubble!”: (1) Meme stocks, like Gamestop; (2) Crypto currencies, like Bitcoin and hundreds of others; (3) NFTs (Non–Fungible Tokens); and (4) SPACs (Special Purpose Acquisition Companies). Each of these assets was innovative, but not necessarily in a good way. Each of them all but collapsed during the year.
Should the savvy investor “buy on the dip”? Stock prices are not yet back down to where they were three years ago, on the eve of the 2020 pandemic. They may have further to fall before they could be judged in line with economic fundamentals. The same might be said cryptocurrencies, if one assesses their fundamental value at zero.
- Global recession?
So, will there be a global recession in 2023? We need first to define “global recession”. Again, the rule of two consecutive quarters of negative growth won’t work, because this criterion is too exclusive: Global growth in the post-war period has seldom fallen below zero, even for a single quarter, let alone two. Not even the severe oil-shock-induced downturns of 1974 and 1981 qualified. The explanation is that even in times of apparent recession, negative growth among Advanced Economies is usually outweighed by still-positive growth among Emerging Market and Developing Economies. Two exceptions were the 2008 Global Financial Crisis and the 2020 Covid recession.
The IMF projects global GDP slowing, from 6.0 % in 2021, to 3.2 % in 2022 and 2.7% in 2023 [World Economic Outlook, October 2022]. The OECD forecasts 2.2 % for 2023 [November 2022]. That is a momentous slowdown. But it still leaves the world economy unlikely to meet a negative-growth threshold. Even by laxer criteria such as growth below a 2 ½ % threshold, or flat GDP per capita, global recession in 2023 is far from a certainty.
This post written by Jeffrey Frankel.