The legacies of a tumultuous 2022 are a long haul

Economies around the world were turbulent over the course of 2022. Few have yet to fathom just how deep in uncharted waters the global economy has drifted. Historians may look back at 2022 as a critical juncture in world affairs. Exploding geopolitical forces are likely to have path changing effects, from deglobalisation, green transition to geopolitical realignments. The weaponisation of interdependence wreaked havoc, with food riots from Sri Lanka to Egypt, whip-sawing commodities, rocketing US dollar and tantrums in financial markets. A series of harsh events and unprecedented macroeconomic policies combined to derail development.

Annus horribilis

Apart from the glorious ending in an epic World Cup final, 2022 can fairly be described as annus horribilis, a Latin phrase embellishing a horrible year with sarcastic humour, made famous in the early 1990s by Queen Elizabeth II, who departed in 2022 as did the King of Football!   

The Economist encapsulated 2022 as a year with "the biggest land war in Europe since 1945, the most serious risk of nuclear escalation since the Cuban missile crisis and the most far-reaching sanctions regime since the 1930s. Soaring food and energy costs have fueled the highest rates of inflation since the 1980s in many countries and the biggest macroeconomic challenge in the modern era of central banking." 

Inflation, high throughout most of 2021, accelerated globally. Prices increased ("runaway inflation"), net weight of products shrank ("shrinkflation") and their ingredients degraded ("skimpflation"). Demand pull from pent-up demand and excessive policy stimulus added, if not triggered, inflationary momentum.  Supply bottlenecks, energy crisis, labour shortages, and appreciation of the US dollar were dominant drivers unleashed most steadfastly by Russia's war against Ukraine with far-reaching global spillovers. Extreme weather caused "heatflation" from loss of harvest. 

The climate crisis respected no borders. It ranged from prolonged drought in the Middle East and North Africa, to erratic monsoons in South Asia, record-breaking heat waves in Europe and China, and, lately, the "blizzard of the century" in North America. The damage wrought by the extreme conditions overburdened places least able to respond. 

The risk of debt distress escalated for a growing number of developing countries. The UN Conference on Trade and Development warned in October that the debt servicing costs of a significant number of low- and middle-income countries rose above 20% of annual government revenues. Earlier in May, the IMF assessed 55% of the 69 low-income countries at high risk of debt distress, compared with 30% in 2015. Total public and private debt in developing countries increased 60 percentage points of GDP since 2010. In most, investment as a percentage of GDP declined. 

China's growth-crushing zero-Covid restrictions laid bare its outsized importance in the global supply chain. The restrictions were lifted abruptly in December in the wake of popular protests. A wave of Covid infections has swept China since reopening. Several countries are instating restrictions on travellers from China, fearing the spread of new variants. 

Tumult in the digital economy intensified after a rise on the back of the pandemic when stay-at-home orders boosted demand for tech products. The industry hit a rough patch in 2022 from the collapse of crypto to chaos at FTX, Twitter and Meta. Popularity of TikTok surged to levels making countries worry about safeguarding user data from the Chinese government. 

Cascading and interlinked crises impeded progress towards Sustainable Development Goals. Human development and infrastructure investment lost out in firefighting the virus and inflation, pushing the middle-income and poorest countries backward in education, health, food security, and capital flows.

Blind guided navigation

No one quite knows what to do. Policy plumbers are in unfamiliar territories in fixing the nuts and bolts bruised and displaced by the fallout. Inflation proved more persistent than major central banks anticipated. Their response to surging inflation was a centrepiece of policy discussions. The US Fed gained new prominence. The de facto central banker of central banks around the world walked into a credibility problem after spending the majority of 2021 downplaying the inflation risk. Hawks, drawing parallels to the problems facing the Fed in the early 1980s, when interest rates rose to 20%, urged the Fed to be as aggressive.  

Alan S. Blinder recently reminded "those who misremember the past may be led into error by misreading history." The differences between now and then are greater than the similarities. High inflation then had become deeply ingrained in popular psychology. This presumably is not yet the case as we enter 2023. The Fed came late to fight inflation this time. Yet tightening monetary policy can drive unemployment rate up to a modest 4.5% with the US economy in 2022 having 1.9 job openings per unemployed, a soft-landing prospect not in the realm of possibilities in the early 80s. 

The blind guided policy responses missed tools beyond interest rate hikes. Nobel Laureate Joe Stiglitz (December 2022) believes "well-directed fiscal policies and other, more finely tuned measures have a better chance of taming today's inflation than do blunt, potentially counterproductive monetary policies." Aggressively fighting inflation by raising rates high enough may help the poor when wages are lagging prices. But nothing is harder on workers than eroding income and bargaining power.  "This can happen if the central banks engineer a recession."

What do we know more now about the policy elephants in the room than we did at the dawn of 2022?

Tightening tougher than easing 

A significant part of the blind sight owes to total lack of history on the undoing of liquidity through monetary policy action. Larry Summers in 2021 concluded "…the beginning of wisdom is seeing that the quantitative easing prescription makes little sense today".  In 2022, by not renewing bonds on its balance sheet reaching maturity or selling them, the Fed started Quantitative Tightening. How this process unfolds is of global interest.

The QT has raised liquidity concerns in the bond markets. The financial sector does not quickly shrink the claims it has issued on liquidity even as the central bank takes back reserves. This "liquidity dependence" has made the system vulnerable to an "accident waiting to happen", caution Raghuram Rajan et al (September 2022).  They observe that deposits with shorter maturity in commercial banks and their outstanding lines of credit to corporations increased when the Fed's balance sheet expanded via large-scale asset purchases. There was no commensurate shrinkage of these claims on liquidity when they reversed it in 2017. 

"If the past repeats, the shrinkage of the central bank balance sheet is not likely to be an entirely benign process..." If banks do not reduce the claims written on liquidity commensurately with QT, the system could become more prone to liquidity stress necessitating even greater central bank balance sheet support in the future. Monetary policy tightening can trigger feedback loops through financial institutions and markets that intensify the downturn everywhere.

This poses a dilemma. Rates need to increase to reduce inflation. If the Fed must simultaneously supply liquidity to stabilise US government bond markets, the message on policy stance is blurred in addition to making the Fed a direct financier of the government. Providing liquidity on a sustained, large-scale basis is very different from making liquidity available to transit from secular stagnation. 

Global public goods in short supply

Global institutions are still not ready to deliver nearly enough global public goods. The cascading effects from the overlapping crises worsened an already fragmenting international system. Cooperation was Missing in Action in rate hikes, vaccination, climate change, migration, and protectionism, not to speak of peace and security. 

Policy coordination slipped from the international agenda. Go it alone pivots in fiscal, monetary, and financial regulatory policies of advanced economies has challenged development as we enter 2023. Monetary tightening in advanced economies caused huge capital outflows from developing countries causing currency depreciation and inflationary expectations. Global finance lost appetite for investment in developing countries. 

The defunct idea that "if each country pursues its own national interests, then the world will do as well as possible" rose from the ashes. Meghnad Desai lamented in September 2022: "There is obviously a serious global paralysis here. We know the danger. We know how to avoid the danger. We promise to do so. But we never do." 

Multilateral frameworks under the liberal international order have struggled to enforce known durable solutions to recognised global challenges. A surge in authoritarian and nationalist expression has come in tandem with an evolving set of societal values placing greater primacy on diversity, equity, inclusion, and ecological sustainability. The acute polarising effect of these narratives has fed global paralysis.

Uncertainties are endemic  

Uncertainty remains the dominant theme entering 2023. With continued expectation of further policy tightening in the advanced economies, the World Bank President David Malpass thinks the chances of a global recession in 2023 are 50/50, a quantitative euphemism for "your guess is as good as mine". 

Central banks have made clear they do not intend to stop hiking until inflation normalises around levels such as the average 3.8% per annum globally during 2001-2020. Global recession is therefore a possibility with growth expected to slip to 2.7% after a sharp slowdown in 2022 (IMF, October 2022). Excluding the global financial crisis and the worst stage of the pandemic, that would make it the weakest year for the world economy since 2001. 

Two recent polls by Bloomberg place the probability of recession in the US and the Eurozone in the next 12 months at 50% and 80% respectively. Asia is generally at lower risk of a recession, but the broader global slowdown will spillover to Asian economies.  China's prospects today look far less stable than they did at the outset of 2022. The reopening of the world's factory could spur growth. But it also carries risks. Recent experience shows that significant setbacks normally occur when healthcare systems are overwhelmed.

The medium-term inflation outlook is high-for-long. Inflation has started to drop in the US and Europe as energy prices pull back and higher interest rates feed through the economy. However, recurrent bouts of price increases over the next decade are likely because of near or friend-shoring and disorderly green transition. The potential jump in demand for energy from China as its economy ramps up is another wild card. 

Critical unknowns include the duration of the Russian war in Ukraine, the diversity of climate change's impact, virus mutations, and the ability of countries to cope with repeated shocks.  It is perhaps safe to conclude that the problem in 2023 will be a cocktail of uncertainty featured, among others, in the path of food and energy prices as well as rapid increase in the cost of money.

Dr Zahid Hussain is the former lead economist of The World Bank, Dhaka Office.