Inflation Battle Raising Risk of Recession, World Bank Warns

Inflation Battle Raising Risk of Recession, World Bank Warns


Central bankers all over the world are tightening financial conditions at the same time, and that’s raising the risk of a global recession in the near future, the World Bank said Thursday.

“The global economy is in the midst of one of the most internationally synchronous episodes of monetary and fiscal policy tightening of the past five decades,” analysts at the World Bank wrote. “These policy actions are necessary to contain inflationary pressures, but their mutually compounding effects could produce larger impacts than intended, both in tightening financial conditions and in steepening the growth slowdown.”

Modeling recent trends in the economy and the decisions of policymakers, World Bank analysts Justin-Damien Guenette, M. Ayhan Kose and Naotaka Sugawara laid out three possible scenarios for the next two years. In the baseline scenario, monetary policy unfolds as currently expected, with central bank rates rising to a range near 4%, enough to slow global economic growth – but not enough to bring inflation down to the desired target range. Inflation (as measured by a weighted global average) remains elevated, falling gradually from 4.6% in 2023 to 3.2% in 2024, still above the global target of 2.5%.

In the second scenario, inflation expectations drift upward and policymakers take stronger-than-expected steps to contain price increases, causing a “sharp downturn” that does not result in a global recession but also does not get inflation under control within the desired timeframe. Global growth recovers in 2024, but at a relatively anemic 2.7% rate, below the 3% rate economists would expect otherwise.

In the third scenario, interest rates move even higher, causing a re-pricing of risk in the markets while sparking a global recession in 2023. Inflation drops rapidly to 3% but starts creeping higher in 2024 in a sluggish recovery hampered by policymakers’ hesitation to deploy countercyclical measures.

A “difficult balancing act:” Policymakers must walk a narrow path to restore price stability while avoiding a global recession. The analysts concluded their study with recommendations for how to proceed along that path. Among other things, the analysts called on central bankers to be aware that their national policies could have spillover effects, producing more severe outcomes on a global level than intended.

In addition, policymakers need to help ease the constraints on the supply of goods, labor and energy that are contributing to inflationary pressure around the world – and that threaten to spark new conflicts. “One of the most pressing priorities in this context is the need to renew support for a rules-based international economic order, guarding against the threat of protectionism and fragmentation that could further disrupt trade networks,” the analysts said.