How central banks are risking a global recession

There’s a growing fear that historic, supersized interest rate adjustments simultaneously underway by global central banks will leave a devastating mark on the world economy.

Why it matters: Major economies are enacting a series of escalating rate increases, each trying to quash domestic inflation. But taken together, the risk is a global economic freeze.

• Moreover, it comes at a moment of tightening fiscal policy as well, as countries pull back their pandemic stimulus and emerging markets deal with heavy debt burdens.

Driving the news: A new paper from the World Bank finds that the global economy is in the midst of the “most intentionally synchronous episodes of monetary and fiscal policy tightening of the past five decades.”

• The authors find that further escalation of those policies could slow global growth to 0.5% next year — or a 0.4% contraction in per capita terms, meeting the definition of a global recession.

What they’re saying: “The present danger,” former International Monetary Fund chief economist Maurice Obstfeld wrote this week, “is not so much that current and planned moves will fail eventually to quell inflation. It is that they collectively go too far and drive the world economy into an unnecessarily harsh contraction.”

• The World Bank study by Justin-Damien Guénette, M. Ayhan Kose, and Naotaka Sugawara finds that the world’s war on inflation may result in steeper interest rate hikes than financial markets currently anticipate.
• “These types of events have permanent effects on output and it would be very damaging for the short term, as well as long-term for developing economies,” Kose tells Axios.

How it works: Countries are facing tighter financing conditions and the spillover effects of global monetary policy.

• The continued strength of the U.S. dollar — and, in turn, the weakness of other currencies — may help tame inflation domestically. But it creates a troubling dynamic overseas, especially for nations and companies that borrow in dollars and are seeing their debt get pricier as the dollar appreciates.

The bottom line: Interest rate hikes around the world may be happening at the same time, but they are not coordinated. It means, for now, decisions are primarily based on conditions in domestic economies. Persistent global weakness could change that.

• “In an environment when you have this type of synchronous increase in interest rates, central banks need to take into account what others are doing, even if you’re not coordinated,” Kose says.