Unknown unknowns

It is in the interests of all the major economies to strengthen their economic cooperation

The top event for the world economy this year has undoubtedly been the interest rate hiking by the US Federal Reserve. The Fed was originally highly dovish over the inflation issue, but after November 2021, it pivoted to being super hawkish. The Fed has conducted seven interest rate hikes so far this year, and the federal funds rate has risen substantially.

The direction and intensity of monetary policy should be based on judgments over the nature of inflation. If inflation is caused by excessive demand, there is no doubt that a contractionary monetary policy should be put in place. However, if inflation is caused by supply shocks, such as the disruptions to supply chains caused by the COVID-19 pandemic, the surge in energy prices caused by the Russia-Ukraine conflict, or geopolitical conflicts followed by tariff wars, it will be difficult to use interest rate hikes to curb inflation. Instead, such a move is more likely to increase the costs of enterprises, which will shift the rising costs to the users and consumers of products. The rising costs of production will, to a large extent, negate the effect of contractionary fiscal and monetary policies on curbing rising prices. With supply shocks and backlashes in globalization, the rush to maintain inflation at around 2 percent, a target set 20 years ago, is likely to result in stagflation.

The extremely expansionary fiscal policy put in place by the US government in 2020 and 2021, and the extremely expansionary monetary policy adopted by the Fed since 2020 to prevent a stock market crash are key reasons for the rapidly deteriorating inflation situation in the United States starting from March. Even so, the inflation in the US so far has largely resulted from supply shocks.

The inflation rate in the US has fallen for four consecutive months. The US' GDP contracted for two consecutive quarters in the first half of this year. Although the US economy grew by 2.6 percent year-on-year in the third quarter, a surge in exports contributed 2.7 percentage points to this growth, while domestic demand continued to shrink. It is extremely rare for the US economic growth to mainly come from exports, and thus it is doubtful whether this economic growth can be sustained.

The economic performance of Europe in 2023 could be even more difficult than that of the US, with a higher possibility of stagflation. The Japanese economy could also slip into recession next year. The situation in developing countries might be better. India, in particular, may achieve relatively high economic growth in 2023.

The Chinese government set a GDP growth target of around 5.5 percent at the beginning of this year, and then carried out expansionary fiscal and monetary policies. This growth target was reasonable and within reach at the beginning of the year. The macroeconomic policies adopted by the government are generally correct. However, due to well-known factors, social and economic activities were greatly affected, and it was difficult for these expansionary macroeconomic policies to be implemented in full. China's economic growth in the first three quarters was lower than expected. Although the current inflation rate in China is lower than 2 percent, it may rise significantly sometime in the future.

The primary challenge that China needs to tackle is to stabilize and accelerate economic growth. We cannot give up eating for fear of choking, and we cannot turn to austerity policies as soon as the risk of inflation arises. There are no easy short-term solutions in macro policies. In order to maintain a proper economic growth rate, China may need to endure a relatively high inflation rate within a certain period of time.

The year 2023 could be difficult for economies across the world. It is extremely important to strengthen economic cooperation and policy coordination among countries and regions, and to avoid beggar-thy-neighbor approaches. For example, the frictions in trade, the tariffs and the technology suppression instigated by the US targeting China not only hurt both economies but also the global economy as a whole. China and the US, although competitors, are in the same boat. Neither side should rock the boat.

China and Europe need to strengthen cooperation. When Europe imports manufactured products from China, it is actually conducting energy imports. Also, China can purchase EU bonds in order to diversify its foreign exchange reserves and respond to the bloc's Next Generation EU plan, which would be a win-win choice. The two sides should find a suitable way to renew talks on the China-EU Comprehensive Agreement on Investment as soon as possible.

China and India are the world's two most populous countries. As neighboring countries, China will benefit from India's rapid growth, and India's development also needs China. India should join the Regional Comprehensive Economic Partnership and strengthen cooperation with neighboring countries, including China, with an open attitude.

China and East Asian countries are close neighbors and key links in the global industry chains. Despite changing times and geopolitical landscapes, there is still a firm economic foundation for the Association of Southeast Asian Nations Plus China, Japan and the Republic of Korea to achieve regional economic integration. In the face of new realities in geopolitics, East Asian countries should adopt a longer-term perspective and strive to deepen, instead of abandoning, the regional financial cooperation that began 25 years ago to attain greater regional prosperity.

As long as we abandon prejudice and strengthen cooperation, countries in the world will be able to overcome the difficulties in the global economy next year and achieve prosperity and development.

The author is an academician of the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.