In what is an unprecedented occurrence, the global economy is tottering towards the precipice, the second instance over the past two years. Even before most developing countries had fully recovered from the Covid-shock, a combination of economic and political occurrences undermined their fledgling recovery.
Russia’s invasion of Ukraine in February caused an upheaval in the energy market with the fuel price index of the International Monetary Fund (IMF) increasing by 28% within a month. These price shocks came on the back of a 53% increase in energy price index since mid-2021, fuelled by expectations of a sustained global economic recovery. These expectations were hardly surprising in view of the strong rebound in economic growth in most economies, resulting in an expansion of world output by 6% in 2021. This growth was buoyed by a 5.7% expansion of the US economy, the highest since 1984.
Moreover, the IMF’s assessment at the beginning of the year was that the global economy would grow by 4% or more during 2022–23. If realised, this would have been the first time since 2004–07 that growth of this magnitude was realised for three consecutive years.
But this seemingly happy augury soon ran into the risk of inflationary pressures that threatened to undermine the economic fundamentals. In the US, the consumer price index rapidly increased to scale levels that the country had not witnessed for the past four decades.
In March 2022, the Chairman of the US Federal Reserve, Jerome Powell, raised its benchmark rate from 0.25% to 0.5%, the first time it had done so since 2018, as US inflation spiralled to 8.5%. With inflation remaining stubbornly high, Powell announced four additional hikes in the interest rate, pegging it at 3.25% in September 2022. Markets expect US interest rates to be nearly 4.5% by the end of the year.
Thus, within a year of it registering the highest economic growth in four decades, Powell had its sights set on drastically slowing down the US economy in an attempt to arrest inflation. Powell’s actions are reminiscent of the “Volcker moment”, the series of interest rate hikes that the then Chairman of the Federal Reserve Paul Volcker had undertaken to douse the double-digit inflation recorded in 1979–80. As a consequence, the US economy slipped into a recession. In the aftermath of the “Volcker moment” of 2022, the US economy declined by 1.6% and 0.6% in the first two quarters of the year, which is expected to dampen world output.
The spike in US interest rates has caused a domino effect around the world. Most emerging economies, including India, have been witnessing withdrawal of foreign investment as investors have opted for the “safest haven”, which is now more attractive due to the higher interest rates. For instance, foreign portfolio investors have pulled out nearly $24 billion from India during this calendar year (up to October 20), whereas in the two previous years, they had invested $21 billion. A strong dollar has also impacted India’s current account. Since a large share of India’s imports is in the form of essentials like energy resources and intermediate products processed by several critical sectors like pharmaceuticals, a strong dollar could push the import bill towards unsustainable levels.
Further, when the US dollar is pushing higher, so would India’s external debt since over 53% of India’s external debt was denominated in the greenback as of March 2022. Finally, as India is affected by inflationary pressures, caused, among other things, by higher prices of imported commodities, the RBI is subjecting the economy to its own “Volcker moment”, which could adversely affect the country’s growth prospects.
What is clear from the above is the economic uncertainties being experienced the world over have been triggered by the growth-inflation spiral that the US has experienced over the past two years. But what caused this growth-inflation spiral, and more importantly, can it be prevented?
The exceptional rate of expansion of the US economy was the result of the massive economic stimulus totalling almost $5 trillion that the Trump and the Biden administrations had provided. The former administration obtained authorisation from the Congress to provide four stimulus packages in 2020, including $2.3 trillion through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and $900 billion through the Consolidated Appropriations Act.
The latter administration piloted the American Rescue Plan Act (ARPA) in 2021. The CARES Act and CAA injected $847 billion through direct payments to individuals and unemployment benefits. On the other hand, ARPA authorised issuance of economic impact payments (EIPs), one-time payments of $1,400 to eligible individual beneficiaries as well as unemployment benefits totalling $606 billion.
Thus, the two stimulus packages put over $1.4 trillion in the hands of the individuals for reviving consumer spending, which could, in turn, boost the economy. These packages had their desired effects as recovery of the US economy was the quickest among the major economies.
However, it was soon clear that the stimuli had excessively propped up consumer demand at a juncture when supplies were running low as lockdowns had adversely impacted production networks. China’s
zero-Covid policy made the situation worse.
It seems obvious that Washington had acted in an overzealous manner to revive the American economy, and ended up overheating it. But it is the global community that has to bear the adverse consequences of its policies.
The far-reaching implications of US’ stimulus policies make it imperative for collective thinking on an agreed set of guidelines on the use of interventions by the governments of advanced economies in times of economic crisis, since their actions can threaten the global economy as is being experienced now. The irony is that while the IMF has been closely monitoring developing countries to ensure that their governments do not run up huge fiscal deficits through excessive spending, similar disciplines are unheard of for the advanced countries.
Therefore, feasibility of framing a consistent set of disciplines on government spending needs to be explored by the G-20 at the earliest; India, as the next G-20 president, must provide the leadership for
Professor, Centre for Economic Studies and Planning, School of Social Sciences, JNU