Countries with sufficient fiscal and monetary space can respond to these actions, but countries without this space have more difficulties adjusting. Moreover, the current manner of monetary tightening is in no way steering towards an equitable (world)society with healthy ecological conditions. This is because the only way for tightening to slow the economy is through rising unemployment and muted wage growth, which means inequality will be amplified.  

Advanced economies

After the recent turmoil, central bankers in advanced economies are again fully focused on their fight against inflation. More policy interest rate hikes are thus likely, and rates will be kept higher for longer. So far, economic activity in advanced economies has remained surprisingly robust, largely because of ongoing fiscal expansion. The effects of such an extended period of fiscal support will take time to wane off and will delay the effects of monetary tightening.

We therefore expect a relatively gradual slowdown of the global economy in the coming months. Combined with the major central banks likely ending their rate hike cycles in Q3, this should extend the favourable environment for risk assets. However, tightened credit standards and high interest rates will increasingly start to affect corporate debt costs. This, in turn, will hamper business investment and ultimately result in a mild US recession starting early 2024.

The near-term fiscal-induced global growth robustness and rapid monetary tightening are not for free. Most of the fiscal measures since the COVID-pandemic do not have any sustainable earmarks, being designed purely to support aggregate demand and keep companies afloat. This means the current growth robustness comes at the expense of the future, as this is a lost opportunity to steer towards a more sustainable economic system.

Emerging markets

In the first half of 2023, emerging markets continued to show growth momentum and generally a remarkable economic resilience. Emerging markets had already started hiking rates in 2021 in anticipation of monetary tightening in advanced economies and many have paused their rate hikes following a substantial drop in headline inflation. And although the recent financial stress in the US did not expand to emerging market banks, efforts to fight inflation in advanced economies through sharp rate hikes have resulted in a slowdown of capital inflows to some emerging economies. One of the consequences of this is a delay in financial development.

This raises the question how financial systems can develop soundly, when external monetary cycles, particularly decisions made by the Fed, influence global credit growth and the prices of financial investments around the world, while risk management still needs to catch up. There is no silver bullet, but financial systems must put clients first, with the help of strong supervision and regulation. And for the poorer countries’ small financial institutions, the synergy of financial inclusion and fintech can contribute to better access and affordability.

We do not expect a new episode of global financial stress in the near-term, but it is becoming more urgent to expand the existing toolkit from multilateral institutions and central banks to safeguard financial stability of emerging economies affected by monetary policy decisions in advanced economies. Financial crises in many emerging economies may not have systemic impact but they do have significant distributional effects, exacerbating inequality. In an integrated global economy this will eventually become a problem for us all.