What will happen to the global economy in 2024?

Exactly one year ago, roughly 85 percent of economists and market analysts (myself included) expected the US and global economy to enter recession. Inflation did decline, but remained stubbornly high, suggesting that monetary policy will tighten rather than ease sharply once the recession begins; a stock market crash was expected, but also that bond yields would remain high.

However, in reality something completely opposite happened. Inflation fell more than expected, recession was averted, stock markets rose, and bond yields, after rising, fell.

That is why any forecast for 2024 must be approached with a grain of salt. The basic task remains the same though: start with a base, positive, and negative scenario, then assign time-varying probabilities to each.

The current baseline scenario for many (though not all) economists and analysts is a soft landing for the economy. Developed countries (starting with the US) are managing to avoid recession, but growth rates are below potential levels and inflation continues to decline towards the 2% target by 2025. Central banks may start reducing the discount rate in the first or second quarter of this year. This scenario would be the best for the stock and bond markets, which have already started to recover there.

In the positive scenario, there is no landing. Economic growth rates (at least in the US) remain above potential levels, and inflation is falling less than markets and the US Federal Reserve expect. Interest rate cuts are coming later and at a slower pace than the Fed, other central banks and markets currently expect. Paradoxically, a no-landing scenario would be bad for stock and bond markets, despite unexpectedly high rates of economic growth. The reason is that in this situation interest rates would remain at higher levels for a longer time.

The moderately negative scenario predicts a bumpy landing with a short, mild recession that would reduce inflation faster than central banks expect. The reduction of interest rates would start earlier, and instead of three reductions by 25 basis points, which the FED is hinting at, there could actually be six at which the markets are currently pricing.

Of course, there could also be a severe recession that would lead to a credit and debt crisis. But while this scenario looked quite likely last year - due to a spike in commodity prices following Russia's invasion of Ukraine and a series of bank failures in the US and Europe - today it seems unlikely due to weakness in aggregate demand. This scenario would only be possible if there was another major stagflationary shock, such as a spike in energy prices due to the conflict in Gaza, especially if it escalated into a wider regional war involving Hezbollah and Iran, which could lead to disruptions in oil production. and export from the Persian Gulf.

Other geopolitical shocks, such as renewed tensions between the US and China, would likely be less stagflationary (lower growth and higher inflation) and more contractionary (lower growth and lower inflation), unless there is a major disruption to trade or Taiwan's semiconductor manufacturing and exports . Another big shock could happen in November, with the presidential elections in the USA. But it will affect the prospects for 2025 more, unless there is instability in the country ahead of the vote. Then again, however, political turmoil in the US would contribute to stagnation, not stagflation.

In terms of the global economy, the "no-land" and "hard-land" scenarios look like low-probability risks today, although the probability of a "no-land" scenario is higher for the US than for other developed countries. The answer to the question of whether the economy will have a soft or unstable landing depends on the specific country or region.

For example, it looks like the US and some other advanced economies could achieve a soft landing. Despite tighter monetary policy, growth in 2023 was above potential and inflation continued to fall as negative aggregate supply shocks in the pandemic era subsided. In contrast, the Eurozone and the United Kingdom have seen growth below potential levels (close to zero or even negative in the last few quarters) as inflation has fallen. They may not perform better in 2024 if the factors that contributed to weakening growth rates persist.

There are several factors that determine whether the economic recovery in the most developed countries of the world will be soft or thorny. For starters, monetary policy tightening, which works with a lag, could have a bigger impact in 2024 than in 2023. In addition, debt refinancing could burden many firms and households with significantly higher debt service costs this year and next. And if geopolitical shocks trigger another rise in inflation, then central banks will have to delay interest rate cuts. Even a small escalation of the conflict in the Middle East would be enough to boost energy prices and force central banks to reconsider existing plans. A number of stagflationary megathreats looming over the medium-term horizon have the potential to push economic growth rates down and inflation rates up.

Finally, there is China, where the economy is already experiencing a decline. Without structural reforms (which do not seem to be forthcoming), its potential economic growth rate will be below 4% in the next three years, and by 2030 it will fall to around 3%. The Chinese authorities may find it unacceptable for the economic growth rate to be below 4% this year, but 5% growth is simply not achievable without massive macroeconomic stimulus, which would increase already high leverage ratios to dangerous levels.

China is likely to resort to modest stimulus, which will be enough to achieve growth just above 4% in 2024. Meanwhile, structural reasons for slowing economic growth (aging society, excessive debt, housing market upheaval, government intervention in the economy, lack of a strong network social protection) will not disappear. Finally, China could avoid a full-scale hard landing, with a severe debt and financial crisis; but it looks like it is facing a hard landing, with disappointing economic growth rates.

The best scenario for the prices of financial assets, stocks and bonds is a soft landing of the economy, although this scenario may already be partially factored into these prices. A no-landing scenario is good for the real economy, but bad for stock and bond markets because it would put the brakes on central banks cutting interest rates. A bumpy landing would be bad for stocks (at least until the market decides the short, mild recession has bottomed out) and good for bond prices because it would allow interest rates to fall earlier and at a faster pace. Finally, it is clear that a severe stagflationary scenario would be the worst for both the stock market and the bond market.

For now, the worst-case scenario seems least likely. There are, however, a number of factors, including those of a geopolitical nature, that can spoil any forecast for this year.

The author is professor emeritus of economics at New York University's Stern School of Business; was senior economist for international affairs at the White House Council of Economic Advisers during the Clinton administration; he worked for the IMF, the US Federal Reserve and the World Bank

Copyright: Project Syndicate, 2024. (translation: NR)