Last week, the world’s finance ministers and central bank governors assembled in Washington to discuss the global economy. With the pandemic and its effects receding, there was good news on inflation and growth. Yet as the International Monetary Fund’s briefings show, economic risks aren’t subsiding — and, not least in the US, political dysfunction is making things worse.
Efforts to curb inflation following the pandemic’s shocks to supply have broadly succeeded. Global inflation, which peaked at nearly 10% in 2022, is expected to fall to less than 4% by the end of next year, slightly below the pre-pandemic average. Given the severity of the initial upheaval, compounded by Russia’s war on Ukraine, disinflation caused smaller losses than once seemed likely, and moderate, steady growth has mostly resumed. The bad news is that economic and geopolitical risks are increasingly at odds with the apparent calm in financial markets.
History shows that heightened uncertainty over policy doesn’t always lead to downturns. Yet when it coincides with bad economic news, the damage can be especially severe. The risk is greater still if governments can’t respond forcefully, because excessive public debt restricts their options. With this in mind, efforts to rebuild confidence and restore so-called fiscal space should be priorities everywhere.
In its annual financial stability report, the IMF this year draws attention to the gaps between indexes that track market volatility and those that monitor geopolitical risk and economic uncertainty. At the moment, volatility is low and risk is high, and the difference is big by historical standards. Despite war in Europe, renewed instability in the Middle East, worsening trade relations and growing fiscal demands on governments (for defense, the energy transition and aging populations), investors are pricing in further interest-rate cuts and ambitious asset valuations. In fact, they seem decidedly optimistic — often a precursor of surging financial stress.
When the next downturn arrives, governments will need various stimulus measures to cushion the blow. Most central banks would currently have room to cut rates, despite some lingering concerns over entrenched inflation. But monetary policy can only do so much, and governments have much less fiscal flexibility than they would plausibly need. Thanks to the Covid-19 pandemic and its aftermath, ratios of debt to output have climbed alarmingly.
The US case is especially striking. Before the pandemic, its ratio of public debt to gross domestic product was roughly 80%. The figure now stands at just under 100%. On a current-policy basis (which assumes no significant setbacks), it will climb to more than 120% in 10 years and keep on rising. Yet far from discussing how to get public borrowing back under control, both candidates in the approaching presidential election have proposed policies that will push debt higher still.
Governments everywhere — and in the US, first and foremost — must take care not to snatch defeat from the jaws of victory. Costly as it was, the pandemic was a smaller catastrophe than it might’ve been. Undue optimism, fiscal recklessness and a refusal to grapple with mounting policy challenges could well squander this achievement. As the IMF has made clear, policymakers can either confront those challenges now or when another crisis forces them to.
Credit: Bloomberg
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