ADB economists Matteo Lanzafame, Irfan Qureshi, Arief Ramayandi and Marcel Schroder answer questions about the possibility of a global recession and how it could affect Asia.
Global demand has consistently weakened this year, for multiple reasons, and the risk of recession is rising. If advanced economies were to fall into recession, developing countries in Asia would not be immune to the fallout. Policymakers in the region will need to monitor and carefully navigate a challenging economic environment to keep inflation in check and sustain growth.
Although a global recession has no clear-cut definition, the term can be broadly referred to as a synchronized GDP (or per-capita GDP) contraction across many economies in the world, accompanied by a broad decline in various other measures of global economic activity. The world economy has rarely registered an annual contraction. In the post-war period, it happened only during the Global Financial Crisis in 2009 and the COVID-19 pandemic in 2020.
Advanced economies are not in a recession, but their growth prospects have deteriorated. The US economy expanded again in the third quarter of this year, after contracting for two consecutive quarters—which is usually taken as the technical definition of a recession. Even with negative or slower growth, job growth has remained relatively strong, and unemployment is low. Nevertheless, growth in the US will remain sluggish going forward as continued rapid monetary tightening by the Fed and weaker global demand will slow economic activity.
Apart from the US, other advanced economies are also decelerating substantially and the risk they will fall into recession in 2023 is significant. Much of Europe, in particular, is expected to experience negative growth in the fourth quarter of this year. This is primarily because the Russian invasion of Ukraine has resulted in elevated energy prices, particularly for natural gas, which are continuing to fuel inflationary pressures. The European Central Bank has aggressively hiked interest rates to tame rising inflation, which will further dampen growth.
The main reasons are the global monetary tightening cycle and possible escalation of the fallout from the invasion.
Central banks in advanced and emerging economies are facing increasing inflation and responding by repeatedly hiking interest rates. Containing inflationary pressures is necessary, but synchronized rate hiking across the world means a global monetary tightening cycle. This increases the negative effects on global liquidity, as simultaneous policy rate hikes in different economies reinforce each other’s tightening impact on global financial conditions. There is a risk that central banks may overdo it, underestimating the impact of their actions on inflation and the contractionary effects on the real economy.
At the same time, risks of an escalation of the economic fallout from the Russian invasion of Ukraine cannot be ruled out. Indeed, the gas leaks discovered on subsea Russian pipelines to Europe in late September and the missiles hitting Poland’s territory in mid-November indicate these risks are substantial. Global oil and, particularly, gas prices are likely to remain elevated—and they may even spike again, which worsens the global inflation outlook.
A recession in the US and the euro area would affect Asia mainly through trade. These two economies absorbed about 29% of the region’s merchandise exports in 2021.
The effects are likely to be layered. First, lower consumer spending in the US and euro area would dampen Asia’s export prospects. More open economies—such as the People’s Republic of China, the Republic of Korea, and Singapore—would suffer a larger impact. Next, slower growth in the People’s Republic of China—which exports about 30% of its merchandise to the US and Europe—would decrease further the demand for imports from the rest of Asia and create distortions to production chains in the region.
Some developing Asian economies could also be affected via reversals of financial flows. During periods of heightened global uncertainty, investors often look for safe-haven assets, and this can result in substantial capital outflows and currency depreciation in emerging economies. Such a development could fuel imported inflation, stifle consumer and business confidence, and give rise to balance-of-payments and debt-servicing difficulties in economies with weaker macro-fundamentals.
Rising interest rates hurt the poor the most. If central banks in the region hike rates in response to monetary policy tightening in the US, domestic liquidity will be squeezed, and growth will slow. On the other hand, rapid increases in the US interest rates may lead to capital flow reversals, currency depreciations, and possibly an inflationary spike that would likewise damage growth prospects. Either way, general economic conditions will get worse—and, unfortunately, when that happens, people in poverty bear the brunt.
There is no one-size-fits-all response. In each economy, the right policy mix will need to strike a balance between the objectives of price and exchange rate stability, and continued economic recovery.
Policymakers in Asia should carefully weigh their options in aiming to achieve these objectives. In the context of rising inflation, conducting the right assessment of how much the pandemic has affected the productive capacity becomes key. In economies where the current level of economic activity is higher than its post-COVID-19 productive capacity, monetary policy tightening should be given more weight.
But where the current level of economic activity remains short of the economy’s production capacity, aggressive monetary tightening can be costly and counterproductive. In either case, the conduct of monetary policy should be coordinated with prudent practices of fiscal policy, which provide comprehensive social protection to the most vulnerable groups and invest in areas with high development returns.
Greater coordination among monetary authorities across the world, as well as clearer communication of their planned tightening path to tame inflation, would make it easier for policymakers to choose the right policy mix.
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