The global economic recovery is complete and world GDP is expected to converge on the pre-pandemic trend within a few months. How long the cyclical momentum lasts depends on how rapidly firms and households spend the excess savings built up during the recession, and how long the rise in inflation lasts. The speed of this recovery contrasts to that of the Global Financial Crisis (GFC); GDP has still not yet recovered to the pre-GFC trend and probably never will.
The longer-term trend in growth is likely to be subdued, especially in developed economies, in part thanks to deteriorating demographics. The rate of increase in the number of participants in the US labour market has gradually slowed, contributing reducing rates of growth to US annual GDP. Similar trends are in place across most advanced and many emerging economies, including China. With working-age populations in decline and dependency ratios increasing, the future is likely to hold much weaker growth than in previous decades.
Deteriorating demographics are to be expected in developed economies where the average standard of living is already high. They could prove more problematic in emerging economies like China — but, unfortunately, the same trends are in place there, as the chart below illustrates. If current trends persist, as seems likely, China will get old before it gets rich. And it is not just demographics that present a headwind for China. The evidence suggests that relative lack of political freedom is a long-term constraint on growth. It would be a global first if China were to succeed in breaking the trend towards slower growth without changing its political settlement.
There are other scenarios to consider. The deciding factor in how long the cyclical momentum will last is inflation: will the current increase in inflation prove to be transitory or will it require a significant policy tightening, or (explicit or implicit) accommodation of higher inflation in steady state? Fathom’s forecast central case sees inflation as transitory, but with 50% weight to scenarios in which inflation will be much stickier.
The risk of persistently higher inflation arises in part from the labour market. Since the pandemic, the US has experienced a higher level of unemployment for any given level of vacancies: the Beveridge curve has shifted out to the right. That shift reflects an increase in labour mark ‘rigidities’, probably, in this case, deriving from a mismatch between the type or location of vacancies that have arisen and the labour force available to fill those opportunities: a laid-off barista in a coffee shop in Detroit cannot readily take up a position as a software engineer in San Francisco, for example. The greater the labour market mismatch, the higher is the structural rate of unemployment, and the greater the potential impact on inflation arising from running the economy hot. It remains to be seen, of course, whether the Beveridge curve will shift back to the left, which is what Fathom assumes in central case — a great deal hinges on that question.
Another factor that would lead to persistent inflation would be a change in inflation expectations. Inflation, simply stated, equals expected inflation plus surprise inflation. If expectations are not anchored, it could encourage the Fed (and other central banks) to try, opportunistically, to shift the anchor of the inflation target upwards. They would need to get a couple of years of higher inflation under their belt first, so to speak, but at that point a move to a higher inflation target would be supported by many macroeconomists, including Fathom Consulting. In that scenario, inflation remains anchored but at a higher level in steady state. We would attach around a 40% weight to a scenario in which inflation stays higher through 2022 and potentially beyond. The remaining scenario is where inflation expectations are elevated, so above-target price rises stick, but central banks respond by tightening monetary policy, leading to a sharp slowdown in growth and a big fall in asset prices.
This is a summary of Fathom’s latest Global Economic and Markets Outlook – 2021 Q4. For more on Fathom’s take on the current outlook, and for more topics such as climate economics and the Centrality Tracker (a model of the three hubs of the global economy with their respective spokes), please contact email@example.com.
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