Spanish Flu Era.
When the Spanish flu pandemic struck in 1918, World War 1 was not over. Upwards of fifty million people died worldwide from the flu. Post-war recessions hit hard in 1919 and again in 1920, driving unemployment up. Unrest and violence were roiling the world.
The depression of 1920-21 was a sharp deflationary recession in the United States, United Kingdom and many other countries, beginning 14 months after the end of World War 1. It lasted from January 1920 to July 1921. The extent of the deflation was not only large but large relative to the accompanying decline in the real domestic product.
There was an 18-month post-World War 1 recession immediately following the end of the war, complicating the absorption of millions of veterans into the economy. The economy started to grow but it had not yet completed all the adjustments in shifting from a wartime to a peacetime economy.
Covid-19 Era.
Compounding the damage from the Covid-19 pandemic, the Russian invasion of Ukraine has magnified the slowdown in the global economy, which is entering what could become a protracted period of feeble growth and elevated inflation. This raises the risk of stagflation, with potentially harmful consequences for middle-income and low-income economies alike.
Global growth is expected to slump from 5.7 percent in 2021 to 2.9 percent in 2022 – significantly lower than 4.1 percent that was anticipated in January. It is expected to hover around that pace over 2023-24, as the war in Ukraine disrupts activity, investment and trade in the near term, pent-up demand fades and fiscal and monetary policy accommodation is withdrawn. As a result of the damage from the pandemic and the war, the level of per capita income in developing economies this year will be nearly 5 percent below its pre-pandemic trend.
The war in Ukraine, lockdowns in China, supply-chain disruptions and the risk of stagflation are hammering growth. For many countries, recession will be hard to avoid. Changes in fiscal, monetary, climate and debt policy are needed to counter capital misallocation and inequality.
The June Global Economic Prospects report offers the first systematic assessment of how current global economic conditions compare with the stagflation of the 1970s – with a particular emphasis on how stagflation could affect emerging market and developing economies. The recovery from the stagflation of the 1970s required steep increases in interest rates in major advanced economies, which played a prominent role in triggering a string of financial crises in emerging market and developing economies.
Developing economies will have to balance the need to ensure fiscal sustainability with the need to mitigate the effects of today’s overlapping crises on their poorest citizens. Communicating monetary policy decisions clearly, leveraging credible monetary policy frameworks and protecting central bank independence can effectively anchor inflation expectations and reduce the amount of policy tightening required to achieve the desired effects on inflation and economic activity.
The current juncture resembles the 1970s in three key aspects: persistent supply-side disturbances fueling inflation, preceded by a protracted period of highly accommodative monetary policy in major advanced economies, prospects for weakening growth and vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.
However, the ongoing episode also differs from the 1970s in multiple dimensions: the dollar is strong, a sharp contrast with its severe weakness in the 1970s; the percentage increases in commodity prices are smaller and the balance sheets of major financial institutions are generally strong. More importantly, unlike the 1970s, central banks in advanced economies and many developing economies now have clear mandates for price stability and over the past three decades, they have established a credible track record of achieving their inflation targets.
Global inflation is expected to moderate next year but it will likely remain above inflation targets in many economies. The report notes that if inflation remains elevated, a repeat of the resolution of the earlier stagflation episode could translate into a sharp global downturn along with financial crises in some emerging market and developing economies.
The report also offers fresh insights on how the war’s effects on energy markets are clouding the global growth outlook. The war in Ukraine has led to a surge in prices across a wide range of energy-related commodities. Higher energy prices will lower real incomes, raise production costs, tighten financial conditions and constrain macroeconomic policy especially in energy-importing countries.
Growth in advanced economies is projected to sharply decelerate from 5.1 percent in 2021 to 2.6 percent in 2022. Growth is expected to further moderate to 2.2 percent in 2023, largely reflecting the further unwinding of the fiscal and monetary policy support provided during the pandemic.
Among emerging market and developing economies, growth is also projected to fall from 6.6 percent in 2021 to 3.4 percent in 2022 – well below the annual average of 4.8 percent over 2011-19. The negative spillovers from the war will more than offset any near-term boost to some commodity exporters from higher energy prices. Forecasts for 2022 growth have been revised downwards in commodity importing countries as well as four-fifths of the low-income countries.
The report highlights the need for decisive global and national policy action to avert the worst consequences of the war in Ukraine for the global economy. This will involve global efforts to limit the harm to those affected by the war, to cushion the blow from surging oil and food prices, to speed up debt relief and to expand vaccinations in low-income countries. It will also involve vigorous supply responses at the national level while keeping global commodity markets functioning well.
Policymakers, moreover, should refrain from distortionary policies such as price controls, subsidies and export bans, which could worsen the recent increase in commodity prices. Against the challenging backdrop of higher inflation, weaker growth, tighter financial conditions and limited fiscal policy space, governments will need to reprioritize spending toward targeted relief for the vulnerable population.
It is always helpful to go back and review recession outcomes so that we can manage our expectations. While every recession varies in terms of length, severity and consequences, we tend to see more layoffs and an uptick in unemployment during an economic downturn. Accessing the market for credit may also become harder and banks could be slower to lend because they are worried about default rates. During a recession, as interest rates go up and inflation cools, prices of goods and services fall. The economic outlook will also drag the stock market lower.
The general consensus is that the recession in 2023-24 may be short and will be widespread and significant.
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