Staring at a new crisis

Inflation remains the greatest challenge in 2023. If not reduced soon, the world economy could see a deeper decline in growth rate

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The global average consumer price index was up by 8.8 percent in 2022, according to estimates by the International Monetary Fund. Last year, the global inflation rate increased significantly compared with the growth rate in 2021, reaching the highest level since the beginning of the 21st century.

Inflation rates of the world's major economies have increased significantly, with China being an exception. The annual average growth rate of the consumer price index was about 8.1 percent in the United States, the highest in 40 years, and about 8.3 percent in the eurozone, the highest level since the Treaty on European Union was signed in 1992. The average CPI growth rate in all developed economies reached 7.2 percent. Even Japan, which has the most stable prices among developed economies, saw its CPI rising to 3.7 percent in October.

The annual average CPI growth rate of the emerging economies in Europe was as high as 27.8 percent last year and about 14 percent in Africa, Latin America and the Middle East. The emerging economies in Asia saw an average CPI growth rate of 4.1 percent last year, compared with 2.2 percent in 2021.

The Ukraine crisis played a major role in fueling this round of global inflation. As Russia is a major exporter of oil and natural gas, and Russia and Ukraine are major food exporters, the crisis pushed up international energy and food prices.

The competition among major powers, especially that between China and the US, is another factor. The US has weaponized supply chains from emphasizing efficiency to prioritizing security and politics, raising the cost of supply and driving up prices.

The pandemic has also led to a shrinking labor force in many countries and supply shortages in the labor market, bringing about wage increases and further pushing up inflation. For example, in the US, there was a labor shortage of up to 3.5 million people in 2022, of which 2 million people retired ahead of schedule due to pandemic-related factors. In the third quarter of 2022, the wage index of domestic workers in the US was up by 5.1 percent year-on-year, the highest increase this century.

Surging demand is another factor. Different countries have loosened their COVID-19 response policies since 2021 and demand has gradually begun to recover. However, the recovery of supply is slower. In 2022, demand recovered further, giving rise to global inflation.

The large-scale expansionary fiscal and monetary policies put in place by various countries have also driven up demand. When inflation is fueled by surging demand, unemployment falls, especially in developed economies. For example, the jobless rate in the US in November was 3.7 percent, down by 0.5 percentage points year-on-year, marking the lowest level since the 1960s.

Global inflation is also a source of instability in the global economy. The response measures put in place by various countries have resulted in a decline in growth of the real economy, shrinking financial wealth, depreciation of currencies other than the US dollar, and foreign debt crises in some countries.

The greatest harm is that inflation leads to a decline in the real income and living standards of people, especially the low-income group. It could even fuel public protests and social unrest. In fact, in 2022, people in Europe, Africa, Latin America, and Southeast Asia hit the streets to protest against high prices. Therefore, dealing with rising inflation was the top priority of macroeconomic policies last year. The US Federal Reserve has raised interest rates seven times in a row since March, raising the target level of the federal funds rate from the range of 0 to 0.25 percent to the range of 4.25 to 4.5 percent. The sharp rise in interest rates has resulted in fresh global economic turmoil.

Cost-driven inflation would exert downward pressure on economic growth, and raising interest rates to curb consumption and investment demand would result in more economic downturn. The IMF lowered the world economic growth forecast four times in a row last year. In October, it estimated that the annual growth rate of the world GDP in 2022 would be 3.2 percent, a sharp drop of 2.8 percentage points compared with 2021. Last year, the GDP growth rate of the US dropped to 1.6 percent from 5.7 percent in 2021. The growth of the eurozone from 5.2 percent to 3.1 percent, and the average growth rate of all developed economies from 5.2 percent to 2.4 percent.

Emerging markets and developing economies saw their average growth rate drop from 6.6 percent in 2021 to 3.7 percent last year.

Rising interest rates and economic slowdowns have negative impacts on financial markets. The prosperity of the global financial market and the high price of financial assets have long been built on the basis of zero or even negative interest rates in major developed economies. Since 2022, with the shrinking of assets under negative interest rates globally, the environment for negative interest rates and zero interest rates has gradually shifted to a high interest rate. This, coupled with fears of an economic downturn and recessions, has triggered large fluctuations in the global financial market. Last year the US stock market lost $15 trillion in value compared with the beginning of 2022. Most other developed and emerging economies were also hit by declines of varying degrees.

The most distinct feature of the forex market in 2022 is the sharp rise of the dollar, and the sharp depreciation of other currencies.

As of mid-December, the dollar index had risen by 9.3 percent compared with the beginning of the year. That was due to the consecutive interest rate hikes by the Fed to increase the yield of dollar assets, which led to capital inflows to the US, and because other countries are facing more serious inflation than the US, leading to the weakening of other currencies. The Argentine peso depreciated by 40.5 percent against the dollar, and the Turkish lira by 30.3 percent. Such sharp depreciation has further heightened the pressure for imported inflation on these emerging economies, leading to hyperinflation. It would also make it more difficult to repay international debts denominated in US dollar, bringing about a foreign debt crisis such as that of Sri Lanka.

In 2023, the governance of inflation remains the most important challenge for the world economy. If not reduced significantly soon, it would become even more difficult to tame inflation. A more sustained high interest rate level would be required to effectively curb inflation. The world economy will then see a deeper decline in growth rate or even a recession at a higher level of interest rate, and further turbulence could emerge in the financial and foreign exchange markets. The world may not be too far away from a new economic crisis.

The author is a research fellow of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences and a research fellow of the National Institute for Global Strategy at the CASS. 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