Consecutive rise in interest rates could lead to global recession in 2023: World Bank

More than a dozen countries rushed to raise interest rates in the last few months, but World Bank experts now worry that this could mean a looming global recession.

While consecutive interest rate hikes have helped control inflation, a recent report by the World Bank showed that such a series of rate hikes could push the world into a recession in 2023, largely because of the degree of synchronicity not seen over the past five decades.

Higher interest rates have been a traditional tool to tame inflation – a balancing act that makes borrowing more expensive, curbs consumer demand and weighs on business expansions. This helps cool down a heated economy by reducing the purchasing power of households.

But such synchronized efforts by most central banks could have a domino effect on developing economies.

The World Bank experts said that emerging markets and developing countries could see a series of financial crises, leading to long-term damage to the global economy.

According to Ayhan Kose, the World Bank’s acting vice president for Equitable Growth, Finance, and Institutions, tightening monetary and fiscal policies will help reduce inflation. “But because they are highly synchronous across countries, they could be mutually compounding in tightening financial conditions and steepening the global growth slowdown,” he said in the report.

The World Bank experts warn that central banks in advanced nations need to remain aware that their monetary tightening (when taming domestic inflation) can have cross-border spillover effects, especially in emerging and developing economies.

The report uses past global recessions (1975, 1982, 1991, 2009, and 2020) to illustrate the impact of central banks’ policy responses on developing economies.

The study showed that the policies adopted during the 1975 and 1982 global recessions are particularly relevant to the current times.

For example, the 1982 global recession coincided with the second lowest growth rate in developing economies over the past five decades—second only to 2020. This sparked more than 40 debt crises in many developing countries, followed by a decade of lost growth in these economies.

If previous global recessions are a guide, then the World Bank experts say there are two big concerns.

First, given the current weak growth outlook, even a moderate negative shock could push the global economy into a recession. Based on the finding, every global recession since 1970 was preceded by a year of relatively weak global growth. This has also resulted in declining consumer confidence in the past. Growth projections for 2022 and 2023 have also been downgraded for most countries—90 per cent for advanced economies and 80 per cent for emerging economies and developing countries.

Second, the recent slowdown in global GDP growth reflects pronounced declines in growth in several major economies such as the U.S., where growth has slowed at 0.9 per cent in the second consecutive quarter of 2022. Additionally, all previous global recessions coincided with sharp slowdowns in the U.S. The report showed a high probability of a major global slowdown, if the U.S., the world’s largest economy, falls into recession.

In June this year. U.S. President Joe Biden shrugged off any signs of the country falling into a recession. But the report said that the increased cost of borrowing and a sharp slowdown in the U.S. and other major economies could “trigger an acute financial stress” in emerging economies and developing nations.

World Bank experts believe global coordination with clear communication from central banks on their policies can help ensure global growth. While inflation may be cooling off in some countries including Canada, supply disruption remains a huge concern.

Food supply continues to be disrupted by multiple factors, ranging from extreme weather and higher input costs to Russia’s invasion of Ukraine. The World Bank report showed that unless these supply disruptions and labour-market pressures do not subside, the interest rate hikes could leave the global core inflation at 5 per cent—doubling the five-year average before the pandemic.

Strong steps were needed to ease labour market constraints, boost the supply of commodities and alleviate global supply bottlenecks and this can be done through global coordination, according to the report.

“To achieve low inflation rates, currency stability, and faster growth, policymakers could shift their focus from reducing consumption to boosting production. Policies should seek to generate additional investment and improve productivity and capital allocation, which are critical for growth and poverty reduction,” David Malpass, president of the World Bank, said in the report.