Is the global economy headed for recession?

Now, more than two years after the initial cataclysm, policymakers are faced with the dilemma of how to untangle the global economy from the extraordinary range of fiscal and monetary policies that were in response to the the pandemic.

And any hope that normalisation could be achieved during a period of relatively benign market and economic conditions was destroyed by the Russian invasion of Ukraine.

What the pandemic and the war in Europe have in common, apart from the horrendous human cost, is that both are exogenous shocks, and supply-side shocks for the global economy. 

Exogenous shocks

An exogenous shock is an event that disrupts the functioning of the economy, despite not being an event that originated within the economy.

A supply-side economic shock is an event that removes the link between supply and demand in an economy, usually by disrupting supply and creating much higher inflation. 

As exogenous events originate outside of the economy, economic theory typically states that when the exogenous event disappears, the economy’s recovery should be rapid as the underlying economy is fine.

That is why when the initial supply shock dissipated with the ending of economic restrictions, which were the exogenous event, and inflation surged, policymakers globally were relatively relaxed. They believed the underlying economy had not been impacted and the inflation would prove 'transitory'. 

Until about three weeks ago, economies were quite resilient and were coping with the higher interest rates, but the economic data has started to turn.Gilles Moëc, Axa

Now, more than two years later, inflation expectations have been revised sharply upwards, and more trickily the inflation is coming from the supply side and so serves to dampen demand in the economy. 

This leaves policymakers trying to solve the inflation problem without triggering a recession as a consequence of the slowing demand.

Any hope of the inflation being transitory was then dented by the second exogenous shock as Russia invaded Ukraine, causing commodity prices to spike. 

Stewart Robertson, chief economist at Aviva Investors, says: “During Covid, economies were turbo charged by fiscal and monetary stimulus.

"That created an excess of demand over supply, which causes inflation. I hope inflation has peaked now, or is close to peaking.

"About half of the inflation rate in the developed world now, say 4 or 5 percentage points, is caused by the energy price spike. So even if energy prices just stabilise, inflation should halve over the next 12 months or so, and that could help the growth outlook.”