Is the global economy headed towards a recession?

What policy instruments should be used to prevent the downturn from becoming severe?


Shahid Javed Burki July 26, 2022
The writer is a former caretaker finance minister and served as vice-president at the World Bank

Policymakers in both developed and developing countries have begun to worry about the possibility of a sharp slowdown in growth rate in various parts of the global economy. The Group of Seven (G7) met in late May 2022 to assess the global economic situation that was the result, among other factors, of the Russian invasion of Ukraine. The meeting was held in the Bavarian Alps in Germany. Summarising the discussion, the governor of the Bank of France, Francis Villery Gallau, said, “If I had to sum up: more uncertainty, more inflation, less growth.” The Central Bank governors and G7 finance ministers met separately from the heads of state.

After pumping billions of dollars into their economies to deal with the economic downturn caused by the Covid-19 pandemic, world economic leaders have had to deal with the threat of stagflation — slow or negative economic growth coupled with rising inflation. The slow down has already taken hold in Europe where the European Union grew by only 0.2% in the first quarter of this year. Some economies in the area even shrank. Italy, for example, saw a slight decline in national output in the first quarter of 2022. Russia’s economy was doing even worse. The White House said that it expected Russia’s gross domestic product to shrink by as much as 15% in 2022 because of sanctions imposed by the West. This was likely to happen despite the fact that energy prices had risen. Russia is one of the largest exporters of several fuels. Oil, gas, and coal price increases were helping the country face sanctions imposed by the West but the relief was not enough to prevent the severe economic slowdown.

According to some accounts provided by officials who went to the meetings, there was great worry about the building up of debt in the developing world. G7 leaders resolved in a joint statement to take action concerning Sri Lanka’s debt crisis. The country had defaulted on its foreign obligations and on July 8, the country’s President resigned from his job. He was pushed out of the presidential palace by a crowd that raided it. He and his family had been involved in massive corruption using government’s resources for enriching themselves. But Sri Lanka is not alone in suffering the impact of the shocks delivered first by the Covid-19 pandemic and then by the Russian invasion of Ukraine. Pakistan is also suffering from the rise in food and fuel prices, which could aggravate the political unrest the country currently faces. The leadership groups in Pakistan have also amassed large amounts of wealth and have sent it abroad. Pakistanis are some of the largest owners of property in London.

It was not revealed, however, whether G7 leaders discussed the possibility of increasing the amount of capital available with IMF, World Bank and regional banks for providing relief to their member states. They had done this some years ago when several developing countries were faced with debt crises.

During the G7 meetings, the Americans and the French were most vocal on the need to address the hunger crisis. More than 14 million people in Somalia, Ethiopia, and Kenya — half of them children — were on the verge of starvation, according to the International Rescue Committee. That number was projected to rise to 20 million by mid-2022 without substantial global action. These numbers didn’t include the developing situation in Afghanistan where food insecurity had already begun to take a heavy human toll. Most of those who were dying were children. Food shortages always lead to large movements of people, and the same will happen this time around. Hunger in Afghanistan will produce waves of migrants with hundreds of thousands of people heading towards Pakistan, Iran and Turkey. Some will attempt to cross the barriers to human movements erected in parts of Europe and find their way into the continent.

The G7 meetings had also hoped to discuss some initiatives before stakeholders got pre-occupied with the problem of what they saw as the coming global recession. One such initiative was to develop a universal tax that would be imposed on the rich — both on wealthy individuals as well as large corporations that had located their headquarters in countries with low levels of taxation.

If the world economy was indeed heading towards a recession, what policy instruments should be used to prevent the downturn from becoming severe? There is an oft-quoted pronouncement, initially made in 1955 by the then US Federal Reserve Chairman William McChesney, that the job of the Central Bank was to take away the punch bowl “just when the party was really warming up.” The new generation of central bankers no longer believe in the McChesney dictum. Taking away the punch bowl too early results in jobless recoveries in which the economy never reaches its full potential and workers never gain the leverage to bargain for a decent wage. Keeping the punch bowl in place was the approach adopted by Ben S. Bernanke when he left his job as Professor of Economics at Princeton University to take the chair at the US Federal Reserve. His book titled, ‘21st Century Monetary Policy: The Federal Reserve from the Great Inflation to Covid-19’ hit the book stands just as the current leadership of the Fed was struggling to define the approach it should adopt to deal with the coming recession. The book continues to favor the easy-money policy Bernanke followed at the Fed which included not only bringing the Bank’s interest rate to zero but flooding the market by an approach that was called monetary easing. This involved large purchases of bonds by the Central Bank, which put money in the coffers of commercial banks and finance houses.

In the book, the former Chairman of the Central Bank dodges the question on whether persisting with easy money approach leads to greater inequality. There is a legacy that Bernanke’s handling of the previous recession left behind. In the coming months the Federal Reserve will sharply increase interest rates, but will only gradually withdraw the bonds sold to increase money supply. This will produce a soft-landing without hurting the growth rate. But it will also put a lot of financial resources in the hands of those who play in the financial markets and liven up the currently depressed stock markets. However, wages will not increase thereby increasing the gap between the rich in society on the one side and that of all other classes on the other.

This is the approach the State Bank of Pakistan appears to be following. With the widening of income disparities, Pakistan’s political system is likely to become even more strained. Can Pakistan avoid a Sri Lankan type situation — with rapidly rising prices, persistent corruption at the highest levels of government, and increasing inequality and poverty? We will have an answer to this important question in the not too distant future.

Published in The Express Tribune, July 26th, 2022.

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