Central banks around the world have a tall task ahead of them: get the economy running not too hot, not too cold, but just right—or risk plunging the world into a historic recession.
That’s the message the World Bank is sending in a report documenting the risks presented by the most dramatic and widespread tightening of monetary policy since the 1980s.
Why it matters: Inflation hurts, but a worldwide recession would be no picnic either—the World Bank estimates it would set the global economy back around 6 years, with GDP not reaching the pre-COVID 2024 forecast until the end of the decade.
- “If the ongoing global slowdown turns into a recession, the global economy could end up experiencing even larger permanent output losses relative to its pre-pandemic trend,” the report finds.
Why it’s happening: Nearly every central bank on the planet is tightening monetary policy (by raising interest rates and ending quantitative easing) at the same time.
- Meanwhile, governments are cutting back on spending which shot up during the pandemic.
- The goal of tightening both monetary and fiscal policy is to bring inflation back down to a 2% target, but that comes with slowing growth and more unemployment.
The big risk is that these tightening effects are amplified because they are happening nearly everywhere at the same time in a mostly uncoordinated way, leading policymakers to overshoot the mark.
- “Just as central banks [...] misread the factors driving inflation when it was rising in 2021, they may also be underestimating the speed with which inflation could fall as their economies slow,” writes Peterson Institute fellow Maurice Obstfeld.
Bottom line: Central banks will have to calibrate their policy very carefully to avoid a damaging slowdown that would quickly supplant inflation as the biggest challenge facing our economy.