The Inflation Challenge in 2024
The latest consumer price data in major advanced economies offer some encouraging news about headline inflation trends; but core inflation (excluding energy and food prices) remains uncomfortably above central banks’ targets. Among the many variables for forecasters to watch in the new year, three stand out.
Where Will the Global Economy Land in 2024?
Heading into 2024, most economists and market analysts have adopted a baseline scenario in which most major economies avoid both a recession and renewed inflation – the much-desired "soft landing." But the current encouraging consensus could still be derailed by any number of factors, not least geopolitics.
NEW YORK – Around this time a year ago, about 85% of economists and market analysts – including me – expected that the US and global economy would suffer a recession. Falling but still-sticky inflation suggested that monetary policy would grow tighter before rapidly easing once the recession hit; stock markets would fall, and bond yields would remain high.
Instead, the opposite mostly happened. Inflation fell more than expected, a recession was avoided, stock markets rose, and bond yields fell after going higher.
One therefore must approach any 2024 forecast with humility. Still, the basic task is the same: start with a baseline, an upside, and a downside scenario, and then assign time-varying probabilities to each.
The current baseline for many, though not all, economists and analysts is a soft landing: advanced economies – starting with the United States – avoid a recession, but growth is below potential and inflation continues to fall toward the 2% target by 2025, while central banks may start to cut policy rates in the first or second quarter of this year. This scenario would be the best one for equity and bond markets, which have already started to rally in expectation of it.
An upside scenario is one with “no landing”: growth – at least in the US – remains above potential, and inflation falls less than markets and the US Federal Reserve anticipate. Rate cuts would occur later and at a slower pace than what the Fed, other central banks, and markets are currently expecting. Paradoxically, a no-landing scenario would be bad for stock and bond markets despite surprisingly stronger growth, because it implies that interest rates will remain somewhat higher for longer.
A modest downside scenario is a bumpy landing with a short, shallow recession that pushes inflation lower, faster than central banks expect. Lower policy rates would come sooner, and rather than the three 25-basis-point cuts that the Fed has signaled, there could be the six that markets are currently pricing in.
Of course, there could also be a more severe recession, leading to a credit and debt crisis. But while this scenario looked quite probable last year – owing to the commodity-price spike following Russia’s invasion of Ukraine and some bank failures in the US and Europe – it seems unlikely today, given the weakness of aggregate demand. It would become a concern only if there were a new large stagflationary shock, such as a spike in energy prices stemming from the conflict in Gaza, especially if it escalates into a wider regional war involving Hezbollah and Iran that disrupts oil production and exports from the Gulf.
Other geopolitical shocks, like new tensions between the US and China, would probably be less stagflationary (lower growth and higher inflation) than contractionary (lower growth and lower inflation), unless trade is massively disrupted, or Taiwanese chip production and exports are impaired. Another major shock could come in November with the US presidential election. But that will bear more on the 2025 outlook, unless there is major domestic instability ahead of the vote. Again, though, US political turmoil would contribute to stagnation rather than stagflation.
With respect to the global economy, both a no-landing scenario and a hard-landing scenario currently look like low-probability tail risks, even if the probability of no landing is higher for the US than for other advanced economies. Whether there is a soft landing or a bumpy landing then depends on the country or region.
For example, the US and some other advanced economies look like they may well achieve a soft landing. Despite tighter monetary policy, growth in 2023 was above potential, and inflation still fell as the pandemic-era negative aggregate supply shocks subsided. By contrast, the eurozone and the United Kingdom had below-potential growth close to zero or negative for the last few quarters as inflation fell and may miss out on stronger performance in 2024 if the factors contributing to weak growth persist.
Whether most advanced economies will have a soft or bumpy landing depends on several factors. For starters, monetary-policy tightening, which operates on a lag, could have a greater impact in 2024 than it did in 2023. Moreover, debt refinancing could saddle many firms and households with substantially higher debt servicing costs this year and next. And if some geopolitical shock triggers another bout of inflation, central banks will be forced to postpone rate cuts. It would not take much escalation of the conflict in the Middle East to drive up energy prices and force central banks to reconsider their current outlook. And many stagflationary megathreats over the medium-term horizon could push growth lower and inflation higher.
Then there is China, which is already experiencing a bumpy landing. Without structural reforms (which do not appear forthcoming), its growth potential will be below 4% in the next three years, falling closer to 3% by 2030. Chinese authorities may consider it unacceptable to have actual growth below 4% this year; but a growth rate of 5% simply is not achievable without a massive macro stimulus, which would increase already high leverage ratios to dangerous levels.
China will most likely implement a moderate stimulus that is sufficient to get growth slightly above 4% in 2024. Meanwhile, the structural drags on growth – societal aging, a debt and real-estate overhang, state meddling in the economy, the lack of a strong social safety net – will persist. Ultimately, China may avoid a full-scale hard landing with a severe debt and financial crisis; but it likely looks like a bumpy landing ahead, with disappointing growth.
The best scenario for asset prices, stocks, and bonds is a soft landing, though this may now partly be priced in. A no-landing scenario is good for the real economy but bad for equity and bond markets, because it will prevent central banks from following through with rate cuts. A bumpy landing would be bad for stocks – at least until the short, shallow recession looks like it has bottomed out – and good for bond prices, since it implies rate cuts sooner and faster. Finally, a more severe stagflationary scenario is obviously the worst for both stocks and bond yields.
For now, the worst-case scenarios appear to be the least likely. But any number of factors, not least geopolitical developments, could be this year’s forecast spoiler.
Don’t Extrapolate Last Year’s Trends for the Global Economy
The unexpected resilience of the global economy in 2023 has led many analysts to adopt an optimistic outlook for the upcoming year. But given the escalating crisis in the Middle East and persistent market volatility, the chances of a robust worldwide economic recovery appear slim.
CAMBRIDGE – Behavioral economists have popularized the term “recency bias” to describe our tendency to be disproportionately influenced by the latest events compared to earlier ones. Could this cognitive phenomenon explain why numerous analysts have a rather optimistic tilt for the world economy in 2024? Or are there really positive trends counterbalancing the obvious and mounting challenges to global growth?
A recent Financial Times editorial reflected the prevailing optimism, proclaiming that “after this year’s resilient showing, there is every chance that the reality next year will also be better than expected.” The trends that supported the global economy’s unexpected resilience in 2023 “also offer plenty of reasons to be optimistic for 2024.”
This upbeat mood has spread to financial markets. A growing number of commentators have predicted that stock markets will finish the year above the already elevated levels of 2023, which were buoyed by a remarkable year-end rally.
Today’s optimistic sentiment stands in stark contrast to the grim predictions that dominated the run-up to 2023, when Bloomberg Economics asserted that there was a 100% probability that the United States would fall into a recession. It is also at odds with a range of economic, financial, geopolitical, and political developments. Notably, it appears to be predominantly driven by a single factor: central banks aggressively cutting interest rates amid the softest of all soft landings for the US economy.
To be sure, central banks have enormous sway over financial-market sentiment. Since the 2008 global financial crisis, central bankers have acted as the world’s leading policymakers – flooring interest rates, flooding economies with liquidity, fueling huge gains across virtually all asset classes, and facilitating a notable shift in wealth distribution that overwhelmingly benefited the wealthiest. But this trend reversed in 2022 when central banks, led by the US Federal Reserve, belatedly responded to rising inflation by embarking on one of the most aggressive cycles of interest-rate hikes ever. The subsequent losses in both high-risk and low-risk assets seemed poised to continue into 2023 until the consensus forecast shifted toward significant rate cuts and renewed talk of a “Fed put.”
While central banks have had a significant effect on market confidence, their impact on actual economic outcomes has been limited. Their ultra-dovish policies during the 2010s helped keep the global economy afloat, yet overall growth remained disappointingly low, unequal, and still detached from climate realities. The 2022 shift to tighter monetary policies was expected to lead to higher unemployment and sluggish growth; instead, the US unemployment rate ended 2023 at a remarkably low 3.7%, and third-quarter annualized growth accelerated to 4.9%. Moreover, the extent to which aggressive interest-rate hikes contributed to reducing inflation has become the subject of debate among economists.
These developments suggest that central-bank policies alone – investors currently expect the Fed to cut interest rates by around 1.5 percentage points – may not be enough to generate the necessary growth momentum to withstand the headwinds facing the global economy.
In fact, one would be hard-pressed to find a systemically significant economy poised for breakout growth in 2024. As China remains saddled with an economic model that yields diminishing returns, the authorities have acknowledged that its growth rate is constrained by domestic inefficiencies, pockets of excessive debt, increased global fragmentation, and the West’s weaponization of trade and investment. Europe, for its part, is unlikely to replicate last year’s unexpectedly strong performance, given especially the sluggishness of global manufacturing and Germany’s economic stagnation.
Once again, commentators seem to be placing their hopes on US economic exceptionalism. But things have evolved over the past year. Lower pandemic-era household savings and higher debt act as headwinds to America’s remarkably agile and resilient economy. Moreover, recent interest rate increases are likely to continue to constrain new household mortgages, companies navigating the mountain of corporate debt expected to mature in 2025, and highly leveraged non-bank institutions dealing with their losses.
The current geopolitical climate also is not conducive to robust growth. The devastating aftermath of Hamas’s brutal October 7 attack against Israel, in which Israel has destroyed much of Gaza and is reported to have killed more than 23,000 Palestinians – mostly civilians, including thousands of women and children – has challenged hopes of containing the crisis. Israel and the Iran-backed Lebanese militia Hezbollah appear headed toward greater hostilities, and attacks against commercial vessels in the Red Sea by the Yemeni Houthis are already disrupting global trade in a manner that renews stagflationary pressures on the global economy.
Beyond the Middle East, Western democracies and many developing countries face important elections in 2024.
Given these circumstances, the chances of robust global growth in 2024 appear tenuous. Nevertheless, there are two ways to mitigate the threats posed by an increasingly fragile economic and geopolitical environment. First, policymakers need to launch major economic-policy overhauls, focusing on structural reforms aimed at cultivating the growth and productivity engines of tomorrow. Second, the international community needs to do better to end the atrocities in the Middle East before that conflict spreads even further across the region and fuels geopolitical turmoil beyond it. Without these interventions, today’s optimists will be sorely disappointed by year’s end.
The Global Economy Is Not Out of the Woods
As geopolitical tensions spike and interest rates remain elevated, 2024 is poised to be yet another tumultuous year for the world economy. This is especially true for emerging markets, which managed to avert a crisis in 2023 but could struggle to do so again if global growth fails to meet expectations.
CAMBRIDGE – The global economy was full of surprises in 2023. Despite the sharp rise in interest rates, the United States successfully avoided a recession, and major emerging markets did not spiral into a debt crisis. Even Japan’s geriatric economy exhibited stunning vitality. By contrast, the European Union fell behind, as its German growth engine sputtered after China’s four-decade era of hypergrowth abruptly ended.
Looking ahead to 2024, several questions loom large. What will happen to long-term inflation-adjusted interest rates? Can China avoid a more dramatic slowdown, given the turmoil in its real-estate sector and high levels of local-government debt? Having maintained near-zero interest rates for two decades, can the Bank of Japan (BOJ) normalize rates without triggering systemic financial and debt crises? Will the delayed effects of the Federal Reserve’s interest-rate hikes eventually push the US into a recession? Can emerging markets maintain stability for another year? Lastly, what will be the next major source of geopolitical instability? Will it be a Chinese blockade of Taiwan, former President Donald Trump winning November’s US presidential election, or an unforeseen event?
The answers to these questions are interconnected. A recession in the US could lead to a significant decrease in global interest rates, but this may provide only temporary relief. After all, several factors, including extraordinarily high debt levels, creeping deglobalization, rising populism, the need to increase defense spending, and the green transition, will likely keep long-term rates well above the ultra-low levels of 2012-21 for the next decade.
Meanwhile, Chinese leaders’ significant efforts to restore 5% annual economic growth face several daunting challenges. For starters, it is hard to see how Chinese tech firms can remain competitive when the government continues to stifle entrepreneurship. And China’s debt-to-GDP ratio, which surged to 83% in 2023, compared to 40% in 2014, constrains the government’s ability to provide open-ended bailouts.
Given that government support is crucial to addressing the high local-government debt and the over-leveraged property sector, China’s emerging plan appears to be to spread the pain. This entails allocating national funds to provinces, then compelling banks to extend loans to insolvent firms at below-market interest rates, and finally, curbing new borrowing by local governments.
But it will be hard to keep the Chinese economy firing on all cylinders while simultaneously imposing restrictions on new lending. Although China is already shifting away from real estate to green energy and electric vehicles (to the dismay of German and Japanese carmakers), real estate and infrastructure still account for more than 30% of Chinese GDP, as Yuanchen Yang and I recently showed, underscoring these sectors’ direct and indirect impact.
While Japan has maintained robust economic growth over the past year, the International Monetary Fund expects its economy to slow in 2024. But Japan’s ability to achieve a smooth landing largely hinges on how the BOJ handles the inevitable yet risky transition away from its ultra-low interest-rate policy.
Given that the yen has remained almost 40% lower than the dollar since early 2021, even as US inflation has surged, the BOJ cannot afford to delay this shift any longer. While Japanese policymakers may prefer to sit on their hands and hope a decline in global interest rates will boost the yen and solve their problems, that is not a sustainable long-term strategy. It is more likely that the BOJ will need to hike interest rates, or long-dormant inflation will start to rise, putting severe pressure on the financial system and the Japanese government, which currently maintains a debt-to-GDP ratio exceeding 250%.
Although the US economy, contrary to most analysts’ expectations, did not slip into a recession in 2023, the likelihood of one is still probably around 30%, compared to 15% in normal years. Despite the unpredictable long-term effects of interest-rate fluctuations, President Joe Biden’s administration continues to pursue an expansive fiscal policy. As a share of GDP, the deficit is currently at 6% – or 7%, if we include Biden’s student-loan forgiveness program – despite the economy operating at full employment. Even a divided Congress is unlikely to cut spending significantly in an election year. The high cumulative inflation of the past three years amounted to a de facto 10% default on government debt – a one-off event that cannot soon be repeated without severe consequences.
Amid an extraordinary confluence of economic and political shocks, emerging markets managed to avert a crisis in 2023. While this is largely due to policymakers’ embrace of relatively orthodox macroeconomic strategies, some countries have capitalized on escalating geopolitical tensions. India, for example, has leveraged the war in Ukraine to secure massive quantities of cut-rate Russian oil, while Turkey has emerged as a key channel for transporting sanctioned European goods to Russia.
As geopolitical tensions spike and polls suggest that Trump currently is the favorite to win the US presidential election, 2024 is poised to be yet another tumultuous year for the global economy. This is especially true for emerging markets, but don’t be surprised if 2024 turns out to be the rocky year for everyone.
The Global Economy Has Yet to Turn the Corner
The World Bank’s latest forecast finds that most economies will grow much more slowly in 2024 and 2025 than they did in the decade before COVID-19, implying that progress toward many development goals will be at risk. Fortunately, with the right policies, there is still time to turn the tide.
WASHINGTON, DC – As 2024 begins, the outlook for the global economy seems to be improving. Major economies are emerging mostly unscathed from the fastest rise in interest rates in 40 years, without the usual scars of financial crashes or high unemployment. Countries rarely succeed in taming steep inflation rates without triggering a recession. Yet a “soft landing” is now becoming more likely. Not surprisingly, financial markets are in a celebratory mood.
But caution is in order. The World Bank’s latest Global Economic Prospects indicates that most economies – developed as well as developing – will grow much more slowly in 2024 and 2025 than they did in the decade before COVID-19. Global growth is expected to decelerate for a third year in a row – to 2.4% – before ticking up to 2.7% in 2025. Per capita investment growth in 2023 and 2024 is expected to average just 3.7%, barely half the average of the previous two decades.
The 2020s are shaping up to be an era of wasted opportunity. The end of 2024 will mark the halfway point of what was supposed to be a transformative decade for development – when extreme poverty was to be eliminated, major communicable diseases eradicated, and greenhouse-gas emissions nearly halved. What looms instead is a wretched milestone: the weakest global growth performance of any half-decade since 1990, with average per capita incomes in a quarter of all developing countries set to be lower at the end of 2024 than they were on the eve of COVID-19 pandemic.
Feeble economic growth threatens to undercut many global imperatives and make it harder for developing economies to generate the investment needed to tackle climate change, improve health and education, and achieve other key priorities. It would leave the poorest economies stuck with paralyzing debt burdens. It would prolong the misery of the nearly one in three people in developing countries who suffer food insecurity. And it would amount to a historic failure: a lost decade not just for a few countries, but for the world.
It is still possible to turn the tide. Our analysis suggests that most developing economies’ performance in the second half of the 2020s can be at least no worse than in the pre-COVID decade if they do two things. First, they must focus their policies on generating a broadly beneficial investment boom – one that drives productivity growth, rising incomes, a reduction in poverty, higher revenues, and many other good things. Second, they must avoid the kinds of fiscal policies that often derail economic progress and contribute to instability.
The evidence from advanced and developing economies since World War II shows that the right mix of policies can increase investment even when the global economy is not strong. Countries around the world have managed to generate nearly 200 windfall-producing investment booms, defined as episodes in which per capita investment growth accelerated to 4% or more and stayed there for more than six years. Both public and private investment jumped during these episodes. The secret sauce was a comprehensive policy package that consolidated government finances, expanded trade and financial flows, strengthened fiscal and financial institutions, and improved the investment climate for private enterprise.
If each developing economy that engineered such an investment boom in the 2000s and 2010s repeated the feat in the 2020s, developing economies would move one-third of the way closer to their full economic potential. And if all developing economies repeated their best ten-year performance in improving health, education, and labor-force participation, that would close most of the remaining gap. Developing economies’ potential growth in the 2020s would be closer to what it was during the 2010s.
There is also an additional option available to the two-thirds of developing economies that rely on commodity exports. They can do better simply by applying the Hippocratic principle to fiscal policy: First, do no harm. These economies are already prone to debilitating boom-and-bust cycles (because commodity prices can rise or fall suddenly), and their fiscal policies usually make matters worse.
When commodity-price increases boost growth by one percentage point, for example, governments increase spending in ways that boost growth by an additional 0.2 percentage points. In general, in good times, fiscal policy tends to overheat the economy. In bad times, it deepens the slump. This “pro-cyclicality” is 30% stronger in commodity-exporting developing economies than it is in other developing economies. Fiscal policies also tend to be 40% more volatile in these economies than in other developing economies.
The result is a chronic drag on their growth prospects. This drag can be reduced by – among other things – establishing fiscal frameworks to discipline government spending, adopting flexible exchange-rate systems, and avoiding restrictions on international movements of capital. If these policy measures were instituted as a package, commodity-exporting developing economies would achieve an increase in per capita GDP growth of one percentage point every 4-5 years.
So far, the 2020s have been a period of broken promises. Governments have fallen short of the “unprecedented” goals they promised to meet by 2030: “to end poverty and hunger everywhere; to combat inequalities within and among countries; … and to ensure the lasting protection of the planet and its natural resources.” But 2030 is still over a half-decade away. That is long enough for emerging markets and developing economies to regain lost ground. Governments acting immediately to implement the necessary policieswould create cause for everyone to celebrate.
Confronting Our Four Biggest Economic Challenges
At the start of a new year, it is increasingly obvious that new, creative thinking is needed to address climate change, socioeconomic malaise, faltering development strategies, and the breakdown of globalization as we know it. To remain relevant, economists must adapt to new realities and new demands.
CAMBRIDGE – Another tumultuous year has confirmed that the global economy is at a turning point. We face four big challenges: the climate transition, the good-jobs problem, an economic-development crisis, and the search for a newer, healthier form of globalization. To address each, we must leave behind established modes of thinking and seek creative workable solutions, while recognizing that these efforts will be necessarily uncoordinated and experimental.
Climate change is the most daunting challenge, and the one that has been overlooked the longest – at great cost. If we are to avoid condemning humanity to a dystopian future, we must act fast to decarbonize the global economy. We have long known that we must wean ourselves from fossil fuels, develop green alternatives, and shore up our defenses against the lasting environmental damage that past inaction has already caused. However, it has become clear that little of this is likely to be achieved through global cooperation or economists’ favored policies.
Instead, individual countries will forge ahead with their own green agendas, implementing policies that best account for their specific political constraints, as the United States, China, and the European Union have already been doing. The result will be a hodge-podge of emission caps, tax incentives, research and development support, and green industrial policies with little global coherence and occasional costs for other countries. Messy though it may be, an uncoordinated push for climate action may be the best we can realistically hope for.
But our physical environment is not the only threat we face. Inequality, the erosion of the middle class, and labor-market polarization have caused equally significant damage to our social environment. The consequences are now widely evident. Economic, regional, and cultural gaps within countries are widening, and liberal democracy (and the values that support it) appears to be in decline, reflecting rising support for xenophobic, authoritarian populists and the growing backlash against scientific and technical expertise.
Social transfers and the welfare state can help, but what is most needed is an increase in the supply of good jobs for the less-educated workers who have lost access to them. We need more productive, well-remunerated employment opportunities that can provide dignity and social recognition for those without a college degree. Expanding the supply of such jobs will require not only more investment in education and more robust defense of workers’ rights, but also a new brand of industrial policies for services, where the bulk of future employment will be created.
The disappearance of manufacturing jobs over time reflects both greater automation and stronger global competition. Developing countries have not been immune to either factor. Many have experienced “premature de-industrialization”: their absorption of workers into formal, productive manufacturing firms is now very limited, which means they are precluded from pursuing the kind of export-oriented development strategy that has been so effective in East Asia and a few other countries. Together with the climate challenge, this crisis of growth strategies in low-income countries calls for an entirely new development model.
As in the advanced economies, services will be low- and middle-income countries’ main source of employment creation. But most services in these economies are dominated by very small, informal enterprises – often sole proprietorships – and there are essentially no ready-made models of service-led development to emulate. Governments will have to experiment, combining investment in the green transition with productivity enhancements in labor-absorbing services.
Finally, globalization itself must be reinvented. The post-1990 hyper-globalization model has been overtaken by the rise of US-China geopolitical competition, and by the higher priority placed on domestic social, economic, public-health, and environmental concerns. No longer fit for purpose, globalization as we know it will have to be replaced by a new understanding that rebalances national needs and the requirements of a healthy global economy that facilitates international trade and long-term foreign investment.
Most likely, the new globalization model will be less intrusive, acknowledging the needs of all countries (not just major powers) that want greater policy flexibility to address domestic challenges and national-security imperatives. One possibility is that the US or China will take an overly expansive view of its security needs, seeking global primacy (in the US case) or regional domination (China). The result would be a “weaponization” of economic interdependence and significant economic decoupling, with trade and investment treated as a zero-sum game.
But there could also be a more favorable scenario in which both powers keep their geopolitical ambitions in check, recognizing that their competing economic goals are better served through accommodation and cooperation. This scenario might serve the global economy well, even if – or perhaps because – it falls short of hyper-globalization. As the Bretton Woods era showed, a significant expansion of global trade and investment is compatible with a thin model of globalization, wherein countries retain considerable policy autonomy with which to foster social cohesion and economic growth at home. The biggest gift major powers can give to the world economy is to manage their own domestic economies well.
All these challenges call for new ideas and frameworks. We do not need to throw conventional economics out the window. But to remain relevant, economists must learn to apply the tools of their trade to the objectives and constraints of the day. They will have to be open to experimentation, and sympathetic if governments engage in actions that do not conform to the playbooks of the past.
LONDON – As 2023 draws to a close, there are many known unknowns – especially on the geopolitical front – and presumably as many unknown unknowns lurking on the horizon. Producing any forecast for the global economy is thus more difficult than usual. For their part, investment houses seem to be expecting a further slowdown in 2024, with many flummoxed by the fact that we haven’t had a major slump already.
The inflation outlook poses an even bigger challenge. The past few years have shown that inflation can be heavily affected – at least on a headline basis – by uncertainty and unknown unknowns that make themselves known. A heated debate about the inflation outlook is ongoing, with some highly respected and very experienced businesspeople expressing doubts that central banks have got the problem under control. The latest consumer price data for the eurozone, the United States, and the United Kingdom offer some encouraging news about headline inflation trends; but core inflation (excluding volatile energy and food prices) remains uncomfortably above central banks’ target rates.
Of course, the world’s second largest economy, China, does not seem to have this problem. On the contrary, its most recent consumer-price data show that it is experiencing deflation, with its core consumer price index falling by 0.5% (on an annual basis) in November. There once was a time when many analysts suspected that China was transmitting deflationary pressures to the rest of the world, primarily through its low-cost manufacturing export and their increased market share in foreign markets. If we were still in that era, some of the current inflationary fears might be lessened. But those days are gone, it seems.
The scale of China’s domestic economic challenges – deflation included – is a massive question deserving of its own commentary. Given the issues facing its property market, judging by similar experiences in other countries, one can assume that its difficulties will be prolonged. But a less pessimistic view is that Chinese policymakers are fully aware of those issues, owing precisely to those previous cases, as well as the warnings that various commentators have been issuing for quite some time.
In addition to Chinese domestic factors, one also must consider the trends for global commodity prices, over which Chinese demand will remain a big influence. Here, the news toward the end of 2023 has been more encouraging than many would have expected, and suggests that headline inflation in many countries could fall further in the coming months. Despite the chaos in the Middle East and the war in Ukraine, crude oil prices remain soft, surprising many analysts – including some who should know that this market is nothing if not unpredictable.
Beyond these factors, three others stand out for me. First, monetary growth has weakened sharply in many economies, which is quite reassuring when combined with current commodity-price trends. While it has been a long time since anyone other than the most ardent monetarists claimed that money supply always bears directly on inflation, the past few years have shown that if monetary growth accelerates radically (as it did in late 2020 and early 2021 in the US), inflation can rise.
Second, and perhaps in line with the commodity and monetary trends, recent measures of inflation expectations in key countries have been reassuring. In particular, the latest University of Michigan survey of consumers’ five-year outlook showed a sharp drop, to 2.8%, from 3.2% the previous month, indicating, at a minimum, that no sustained increase or “un-anchoring” of long-term inflation expectations is taking place.
The final, and perhaps trickiest, question is how central banks will respond. In its latest forward guidance to markets, the US Federal Reserve Board suggested that interest rates would be cut by 75 basis points in 2024. Other central banks however, especially in Europe, are pushing back on financial markets’ bet that interest rates will be cut next year, but markets do not seem to have gotten the memo. With core inflation still above target, real (inflation-adjusted) wages growing, and strong evidence of productivity growth nowhere to be seen, central bankers will be loath to cut rates soon. But as they continue to try to influence markets with their guidance and public statements, they will have to accept that markets – in their collective wisdom – may see something that they themselves do not. If the data take a sharp favorable turn, they will probably change their tune.
Wage growth remains a crucial variable. In some countries, especially the UK, it is finally outpacing consumer-price growth. Policymakers instinctively will worry that this trend will trigger a textbook wage-price spiral. But wouldn’t it be nice if recent real wage growth turned out to be justified by a rebalancing of financial returns and the long-awaited return of positive productivity growth? With a new year comes a new hope.