26 June 2022

BIS Annual Economic Report: No respite

While the after-tremors of the pandemic still reverberate, two new shocks hit home in the year under review: the unexpected resurgence of inflation and the tragic war in Ukraine. Last year's Annual Economic Report (AER) raised the prospect of a bumpy pandexit; bumps have turned out to be a one-two punch.

There is no respite for the global economy. Two years ago, it was shaken by the onset of the pandemic, as an overwhelming health crisis turned into an overwhelming economic crisis.

These tumultuous events are bound to have far-reaching consequences. Are we perhaps witnessing a regime change, from a low- to a high-inflation regime? Is the global economy flirting with stagflation? And are we seeing signs of an end to the post-World War II globalisation era? Meanwhile, the crypto universe is in turmoil, reminding us that there are important developments in the monetary system that we cannot neglect.

On the macro front, policy is facing daunting challenges. In some ways, they are not new; but in others, they are unique. As Mark Twain quipped, "History does not repeat itself, but it often rhymes." The world economy experienced stagflation in the 1970s, following a shift away from a low-inflation regime. The new element is that, against the backdrop of historically low interest rates, debt levels – private and public – have never been as high. This is far from inconsequential. Moreover, the monetary and financial system is in the throes of the digital revolution. This, too, albeit in a different way, is far from immaterial.

Our AER tackles these issues head-on. What happened in the year under review? What are the risks ahead? What can policy do? And where is the monetary system heading as the digital revolution proceeds? What vision should guide policy?

Never say never

Resilient but losing momentum and buffeted by non-economic forces: in a nutshell, this is how global growth evolved over the review period.

Growth proved resilient for much of 2021.

In fact, in 2021 as a whole, the world economy expanded at its fastest rate in almost 50 years. And the expansion was broad-based. This confirmed the unique nature of the Covid-19 recession. An artificial suppression of activity due to the health emergency gave way to a strong rebound once the containment measures were lifted. In addition, the outsize policy support, both monetary and fiscal, provided a major impulse. The scenario in which economic scars would have held back growth did not materialise.

Growth lost momentum as the review period progressed.

First was the spread of a new virus variant (Omicron) in late 2021, which prompted countries to put in place new containment measures. As it turned out, the impact was smaller than initially feared. The virus proved milder than expected and so did the necessary policy-induced restraint on activity. The main exception was China. The strict anti-Covid measures caused a major slowdown in growth, adding to the effect of regulatory measures designed to rein in the real estate sector.

Then was the outbreak of the Russia-Ukraine conflict in February 2022. Probably the most significant geopolitical event since the fall of the Iron Curtain, the war is first and foremost a humanitarian tragedy. But its near-term impact on economic activity is also substantial. The impact has not been felt so much through the sanctions-induced drop in Russia's GDP – although the imprint on world growth is material. Nor has it been felt, so far, through its direct financial consequences – although more may be in store (see below). Rather, it has operated mainly through soaring commodity prices – notably energy and food – as well as concerns about the war's broader ramifications.

This shock is inherently stagflationary. To be sure, its impact on growth is uneven across the world. Commodity exporters fare better than importers. But, for the world as a whole, the outcome is unambiguously contractionary. Since commodities are a key production input, an increase in their cost constrains output. At the same time, soaring commodity prices have boosted inflation everywhere, exacerbating a shift that was already well in train before the onset of the war....

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