The Upcoming Recession

Written By: Rassiq Aziz Kabir, Zara Mustafa, and Saldana Rahaman Safa

The financial status quo of the world is indicating a possible recession. With skyrocketing inflation, slow economic growth, and the Russia-Ukraine war – the global economy’s facing significant downturns, and most economists are predicting that it will undergo a large-scale recession whose consequences could be even grimmer compared to 2008’s Global Financial Crisis. Policy interventions are likely to bolster stagflation in the short-run, but are still the most crucial. 

Recession Indicators

Copper price fall evoked the fear of the upcoming recession. Prices dropped by almost 20% in the second quarter of 2022 (Mining, 2022). Copper, a historically reliable indicator for economic health, continues to be under pressure from a problematic demand forecast — resulting from the Covid-19 lockdown of China and tightening monetary policy. This is causing recession fears because of the trade-off between inflation and growth. When Covid-19 expanded globally in the first quarter of 2020, copper plummeted by 19.8% (Reuters, 2022). With declines between 20 and 40 percent, other industrial metals are also on track for their greatest quarterly drop in several years, and since 2011 there has been no other drastic quarterly plunge.

The slowdown of economic activity clearly indicates the dramatic rise in the probability of a recession. Of the various indicators of forecasting a recession, the drop in the stock market is one of them. During recessions, stock prices are primarily impacted by declining corporate earnings. Stock markets from all over the world are tumbling from the last quarter of 2021. 

According to Wall Street, stocks twice reached bear market territory in the first few months of the year, resulting in losses of more than 20% for investors, as well as the S&P 500 index decreasing by 2% in the first hours of trading (Cassidy,2022). In the last quarter of 2021, many investors purchased securities to sell during the bull market. But the second quarter of 2022 is ongoing, and still, the market is on the decline. 

The sluggish economy is not just one country’s phenomenon; the same problem exists in Europe, but additional challenges make solving them difficult. In this context, Germany’s DAX index ( a stock market index consisting of the 40 major German blue chip companies trading on the Frankfurt Stock Exchange) dropped by 3%, while France’s CAC dropped by 2.8% (Aenlle,2022). Moreover, If this situation continues in the long run, companies may face problems in routinely distributing dividends and buybacks to shareholders. 

The boost of inflation and reduction of global GDP is nothing but a “hefty price” that people from all over the world are paying because of the Ukraine-Russia war. For this war, the prolonged effect of global supply-chain disruption can not measure the surging prices of food and energy, especially for low-income countries. Due to its economies’ struggles to wean themselves off on Russian fuel, Europe is one of the regions most in danger. The 1.5% of additional inflation in 2022 because of the Ukraine invasion by Russia is also a compelling reason to sense the upcoming recession (Horobin,2022). 

Current Economic Scenario 

Globally, inflation is becoming a serious concern for economists. The inflation is the result of very high levels of demand (pent-up demand) caused by the relative normalization of the Covid-19 crisis. The prices of goods have soared as a result, and evidently, demand-pull inflation has been a phenomenon globally. 

The inflation has mostly been driven by exceedingly high food and energy costs, where, other than the coronavirus pandemic, the Russian invasion of Ukraine played a significant role. Inflation in the United States is the highest in the last 40 years as measured by the Consumer Price Index (CPI)  (Inflation: Why Is It Rising across the World and Will It Stay That Way? | World Economic Forum, 2022). As per a Pew Research finding concerning 44 advanced economies, all of them had a significant increase in consumer prices, compared to their pre-pandemic state (Desilver, 2022) . 

As per the data of March 2022, the annual consumer price inflation in the USA is 8.5%. It is 7% in the United Kingdom, 7.5 percent in the Eurozone, and 16.7 percent in Russia. Argentina and Turkey had a huge rise in their price levels, which are chronologically 52.3 and 61.1 percent. It is 6.22 percent in Bangladesh and 7 percent in India. (Mahmood, 2022)

The significant downturns due to the coronavirus made the case for a recession inevitable. With Wall Street recording one of its worst trades in history and the consumer savings rate at its worst state since the 2008 global financial crisis, the case for a recession is becoming even stronger, along with the slow growth of the global economy, which has been prevalent ever since the beginning of the pandemic.

The current state of the global economy, where a recession is looming along with exceedingly high levels of inflation, is very much reminiscent of a stagflation, or recession-inflation, which is also evident as per the level of global unemployment at this moment, which is higher than the pre-pandemic state. This rare occurrence of stagflation was last seen in 1970, and it has returned again in the current year due to the severity of the current situation. 

Stagflation poses a serious dilemma when it comes to monetary policy. When it comes to recession, an expansionary monetary policy is normally undertaken, and vice versa is done in the case of hyperinflation. But in stagflation, as both these phenomena occur along with high levels of unemployment, the standard macroeconomic measures are ineffective in overcoming such a situation. Eminent economists like Frederich Hayek, Paul Krugman, and others have varying views about tackling stagflation, and as the global economy is heading towards that direction, the economists will have to make their choice.

Central Bank’s Top Focus

While the central banks have various macroeconomic objectives, their principal one stands the stability of prices because price volatility complicates interpretation of information and decision making by economic agents leading to massive market inefficiencies and wage-price spirals.

In order to avoid this, central banks fix a target rate of inflation and ensure that the actual rates hover as closely as possible around the targeted rates, maintaining stability as well as their own credibility. The targeted inflation rate for major economies such as the US, UK, Canada, the Eurozone and South Korea is 2%, while for China 3% and India 2%-6%. Currently, the actual inflation rates are concerning way over the targeted rates as mentioned (Central Bank News: Inflation Targets, n.d.).

Tightening of the Monetary Policy 

Globally, the central banks have resorted to the traditional approach of taming inflation with interest rate hikes that increases the cost of borrowing and the incentives to save. Therefore, they aim to curtail the money supply and cool down the aggregate demand, thus, the price level in the economy. 

Federal banks increased their rate by 0.75% in June and is expected to increase further in the upcoming quarters amidst soaring inflation (Smialek, 2022). The Bank of Canada too is increasing its rate by 0.75% by this July. The President of the European Central Bank too announced to increase its interest rate by 0.25% for the Eurozone by this July, the highest in over a decade, and anticipates a greater percentage increase in the upcoming quarters depending on the data and expectations of inflation (Smith, 2022). 

According to a recent report by the World Economic Forum, initial weakening of the demand growth has already emerged in sectors elastic to interest rate changes (Can the World Avoid Stagflation? An Economist Explains | World Economic Forum, 2022). 

By-product of the Policy 

However, this interest hiking approach is definitely not expected to be without an opportunity cost, as it entails further knocking down of the economic growth rates across the globe. This is because interest hikes also discourage investments in new capital stocks to replenish the depleted ones – hampering the capital accumulation and growth and employment in the economies. According to the IMF, the possibility of a global recession in the later part of 2022 and 2023 is alarmingly high (Global Recession Risk Rising as Economic Outlook ‘Darkens Significantly’, IMF Says | Global Economy | The Guardian, 2022). Considering the reality, they have been downsizing the predicted global growth rates considerably.  In the current scenario, the President of the World Bank, David Malpass posited that the slowdown in the global growth from 2021 to 2024 is likely to be twice as much as it had been in the entirety of 4 years during the last global stagflation of the 1970s (Global Economic Prospects June 2022, 2022).   

Consequence of US rate hikes on other nations:

The global outlook, considering the interest rate hikes in the US, is deeply concerning. US rate hikes have been a contributing factor in the depreciation of currencies of other countries. For the first time in two decades, the Euro and Dollar have hit parity ( €1 =$1) (1 Euro Equals 1 US Dollar: For the First Time in 20 Years, Euro Hits Dollar Parity – World News, 2022). Currently, Asian countries like Bangladesh, India, China, Philippines and South Korea are all facing a plunge of around 5% to 6% in their currency value. The ramification of this fall is the exacerbation of inflation in these economies-through the import channels, as imports became more expensive in terms of dollars with the weakening of their own currencies. Specifically, it is a severe issue for heavily import dependent Asian countries like Bangladesh that rely on dollars for trade settlement. (Weijia, 2022)

Conclusion: 

Currently, policy-makers need to trade off economic growth for taming inflation as the latter poses more severe and long lasting ramifications for economies. While the economic future is grim, the world deeply covets the end of the Russia-Ukraine conflict and the stabilization of the markets. 

Featured Image Courtesy: Small Business Trends

References:

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