Three reasons expecting a soft landing for the global economy is just wishful thinking

The IMF’s latest global outlook projects a soft landing for the world economy despite the current challenges, but there are reasons to be sceptical
Headwinds include an increasingly sluggish Chinese economy, overlooked consequences of rising interest rates and inflation, and overly optimistic forecasts

Stephen Roach

Published: 1:30am, 27 Apr 2022

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The predictable downward revision cycle for the global economic outlook has officially begun. That is the message from the semi-annual World Economic Outlook just released by the International Monetary Fund, which reinforces earlier revisions from several prominent private forecasting teams.

The revision, largely in response to the war in Ukraine, is a big one. It calls for a sharp reduction in world economic growth to 3.6 per cent for 2022, fully 1.3 percentage points below the IMF’s global growth forecast of 4.9 per cent made just six months earlier.

To its credit, the IMF warned that this was coming with an interim downward revision of 0.5 percentage points in January. Even so, in looking back over the past 15 years, this is the third-largest cut in the IMF’s regular six-month revision cycle.

In April 2009, as the global financial crisis was unfolding, the IMF cut its global growth estimate for the year by 4.3 percentage points from 3 per cent growth to a 1.3 per cent contraction. As the Covid-19 pandemic erupted in early 2020, the IMF slashed its growth estimate for the year from a pre-pandemic projection of 3.4 per cent growth to a 3 per cent contraction.

In both of those earlier cases, the outsize forecast reductions foretold sharp global recessions. Yet neither the IMF nor most other forecasters believe the current shortfall in global growth will push the world into outright recession. The latest World Economic Outlook calls for a perfect soft landing for the global economy.

Following the recent downward revision, global growth is now expected to settle into a 3.6 per cent growth trajectory over 2022-23, which is fractionally above the 3.4 per cent average since 1980. Landings don’t get much smoother than that.

Global growth remains under threat, but there’s no need to be too bearish

But that could be wishful thinking, for several reasons. For starters, forecasters were overly optimistic in extrapolating the sugar high of 2021 into the future. The 6.1 per cent surge of global growth in 2021 was the sharpest rebound on record.

However, this followed the steepest plunge on record. Just as lockdowns brought the bulk of the global economy to a virtual standstill in early 2020, reopening and aggressive monetary and fiscal stimulus produced the mother of all snapbacks.

Forecasters and investors extrapolate current trends into the future, so it is important to look through the extraordinary volatility of 2020-21 to get a clean read on which trend to extrapolate.

During those two years, global GDP growth averaged just 1.5 per cent, well below the official global recession threshold. Needless to say, if world economic growth slows more towards that underlying trend than the soft-landing glide path, another global recession is hardly far-fetched.

A second reason to doubt buoyant forecasts is that the China cushion has been deflated. China’s economy is growing well below the pace recorded from 2010 to 2019.

The latest IMF outlook puts average Chinese growth in 2022-23 at 4.75 per cent, a little more than half the post-crisis trend when strong Chinese growth was the only thing preventing the world from relapsing into recession. As was the case back then, global resilience without a more vigorous Chinese economy is highly unlikely.

That is the risk today. China faces a trifecta of shocks with a new wave of Covid-19 lockdowns, the ongoing pressures of deleveraging – especially in its unstable property sector – and war-related collateral damage resulting from its ill-advised partnership with Russia, so the world economy can no longer rely on China as a source of resilience.

That cuts both ways. If China deepens its commitment to Russia, it will share in Russia’s isolation. For a Chinese economy that remains deeply reliant on the rest of the world, that could prove to be President Xi Jinping’s greatest challenge.

Third, the downshift in the global growth cycle is being accompanied by a major upswing in the global inflation and interest-rate cycles. The soft-landing crowd is dismissive of the consequences. As inflation surges, there is loose talk of “peak inflation” – the fanciful idea that it is so bad now that it can only get better from here.

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This argument misses the point. With the US consumer price index surging by 8.5 per cent in March, there is an excellent chance this key barometer of inflation will be considerably lower by the end of the year, but how much lower? Low enough to rescue the US Federal Reserve from its most irresponsible monetary policy gambit since the mid-1970s?

Don’t count on it. While the Fed is now talking tough, talk is cheap. Even if the Fed moves as expected and boosts the federal funds rate to 2.5 per cent by November, the nominal policy rate is likely to be well below the inflation rate.

That means the inflation-adjusted federal funds rate will remain in negative territory throughout the year, marking a 38-month period of negative real policy rates. Real interest rates matter in maintaining price stability and driving economic growth. When assessing risks to the global business cycle, the bottom line is that the upswing in real rates has much further to go.

All of this underscores the downside risks that are building in the global economy. As a recovering Wall Street forecaster, I empathise with the mindset of most forecasting teams who believe they have factored in most conceivable risks.

In this case, financial markets concur, convinced that an inflation-prone world with accommodative central banks is somehow gliding toward a soft landing for the ages. But is this already-rosy scenario really supposed to play out without China? Dream on.

Stephen S. Roach, a faculty member at Yale University, is the author of Unbalanced: The Codependency of America and China and the forthcoming Accidental Conflict: America, China, and the Clash of False Narratives. Copyright: Project Syndicate

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