Inflation expectations still firmly anchored in the United States and the euro area?

The sharp rise in inflation in 2021 in many advanced economies was not anticipated to this extent by many households, professional economic analysts, or financial market participants. Whether this unexpected rise in inflation will translate into higher inflation rates in the coming years depends to a large extent on long-term inflation expectations. These have increased in the United States and the euro area, for example, in the course of 2021 and to some extent also following Russia’s invasion of Ukraine, but at least for the time being remain at levels that do not suggest any significant deviations from the two percent inflation targets in the United States and the euro area. In the U.S., for example, professional economic analysts’ expectations for annual inflation over the next ten years increased from 2.2% since the beginning of 2021 to 2.5% at the beginning of 2022 (figure), but did not indicate any significant increase in long-term inflation expectations; this is also reflected in the fact that between 2002 and 2021, the average of these expectations was 2.3%. It should be noted that here we are looking at the consumer price index published by the Bureau of Labor Statistics, which is more widely followed by the American public. For its average inflation target of two percent, the U.S. Federal Reserve prefers to observe the personal consumption expenditures index published by the Bureau of Economic Analysis, which usually indicates a lower inflation rate by about 0.3-0.6%.

Also, shortly before the start of the war in Ukraine, households surveyed in the University of Michigan’s consumer sentiment surveys still expected inflation to be 0.3 percentage point higher annually over the next five years than it was at the beginning of 2021. It should be noted that the inflation rates expected by households at the level usually overestimate actual inflation and in the past were also usually about half a percentage point higher than the expectations of professional economic analysts.

In addition to surveying professional economic analysts and households, another option is to look at securities-derived inflation expectations of financial market participants to identify changing long-term inflation expectations. One advantage of this approach is that these expectations respond without lags in each case and can be assumed to reflect the expectations of profit-oriented financial market participants. A significant drawback, however, is that in the past they have often turned out to be very volatile and usually somewhat too high compared with actual inflation, and they are also of limited use in identifying changes in inflation expectations among the population at large. It is noteworthy that in the U.S.A., inflation expected by financial markets increased only from 2.0% to 2.3% during 2021. Since Russia’s invasion of Ukraine, however, these expectations have become more volatile, fluctuating between 2.1 and 2.4%.

Similarly, for the euro area, it is possible to check whether long-term expectations are significantly above the European Central Bank’s two percent target. For example, according to the Survey of Monetary Analysts, inflation expectations are stable at two percent from2024 to 2028. In the Survey of Professional Forecasters, which is also conducted by the ECB, respondents also expect an average annual inflation rate of 2.0% until 2026. However, there is still a probability of around 20% that inflation will exceed 2.5% in this five-year period. By contrast, the probability that the inflation rate will be between 1.5% and 2.4% is estimated at just over 50%. After all, according to this survey, the probability of a long-term inflation rate of below 1.5% is just under 30%. On the financial markets, too, somewhat higher inflation rates are now expected for the euro area in the long term. In addition, surveys of households in Germany, for example, have revealed a slight increase in long-term inflation expectations since the end of 2021.

All in all, it can be seen that, although long-term inflation expectations have risen in the euro area as well, they are still within a range that is compatible with the inflation target. Although long-term inflation rates in the two major economic areas of the U.S. and the euro area are thus still within a largely unproblematic range, the increases since 2021, some of which have been noticeable, show that the expectations of the various economic players are nevertheless adapting to the current high inflation rates. For this reason, too, it seems crucial that central banks in advanced economies identify further inflation risks more clearly than they did last year, especially in view of the war in Ukraine and the sanctions against Russia.

Sources: University of Michigan, Consumer Sentiment Survey; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters; Federal Reserve Bank of St. Louis market-based inflation compensation using nominal and indexed Treasury securities.

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World economy shocked by the war in Ukraine

The global economy is being hit hard by Russia’s invasion of Ukraine and the resulting surge in energy prices. In the economies of Europe – particularly in Central and Eastern Europe – economic development is being particularly affected due to geographical proximity and high dependence on Russian natural gas. But the economic impact of the war is also being felt in other regions of the world. For example, the war and sanctions against Russia are increasing the already existing bottlenecks in global supply chains. Ukraine and Russia are major suppliers of various raw materials needed for key production steps. This is likely to lead to production delays around the world in the coming months and push inflation up further. Food prices will also remain significantly elevated due to fears of reduced exports of grains or raw materials for fertilizers from Ukraine and Russia.

My forecast is based on the assumption that the war between Russia and Ukraine will continue for several weeks and months and that the sanctions will remain in place for the longer term. Political and economic developments in Russia and the region as a whole will remain a source of heightened uncertainty over the forecast period, dampening global economic development. Globally, inflation will remain high for the time being in view of the sharp rise in raw material prices. At least the Corona pandemic subsided, at least temporarily, in spring 2022. With the exception of China, measures to contain the pandemic have been largely lifted in most countries. However, the continuation of the recovery of the global economy from the effects of the pandemic is now being slowed by the Ukraine war and its economic consequences.

Final quarter of 2021 in Europe dominated by the corona pandemic

In the fourth quarter of 2021, economic activity in the advanced economies was heterogeneous. In the euro zone, economic activity cooled significantly as a result of a new wave of the pandemic, with the growth rate only o.3 percent compared with the previous quarter. The course of economic activity varied from country to country and was largely shaped by the timing and strength of corona waves and the measures taken to contain them in each case. However, the imposed or voluntary restrictions on social contact and economic activity were significantly lower than in previous pandemic waves. By contrast, overall economic output in the USA expanded strongly, with growth of 1.7% compared with the previous quarter. However, this significant growth was also due to a sharp increase in inventories. Following very low inventories in the summer, many companies apparently tried to replenish their stocks as best they could out of concern about continuing supply bottlenecks, but this is likely to have exacerbated existing supply chain problems in the short term. In Japan, too, GDP expanded by a strong 1.1% in the final quarter of 2021. The Japanese economy benefited above all from a return to significantly higher consumer spending and dynamic exports.

In many emerging countries, the economy grew only moderately in the fourth quarter of 2021. In various emerging countries, particularly Turkey, Brazil and – to a lesser extent – Russia, high inflation rates and economic policy measures to reduce them were the main factors slowing economic growth. In India, too, the economic recovery continued at a much slower pace. In China, the economy grew by 1.6 percent despite the smoldering debt problems in the real estate sector, even if the increase remained moderate compared with the pre-pandemic trend rates. Private consumption and exports in particular drove growth, while investment was unusually subdued for China.

Global trade in goods, which had recovered rapidly from the pandemic-related slump and had already exceeded pre-crisis levels by spring 2021, developed dynamically, rising by 2.5% in the fourth quarter compared with the previous quarter. year-on-year growth was 6.4%. The marked upturn in international merchandise trade was due not least to the fact that demand shifted from personal services, where consumption was reduced as a result of the pandemic, to tradable goods. The consumption structure is now expected to return to normal. Strong growth in world trade – driven in particular by strong demand in the United States – has contributed significantly to bottlenecks in international supply chains. The significant growth in demand meant that maritime transport capacity – be it ship capacity, container availability or handling capacity at ports -2021 was barely able to cope with additional volumes.

Exploding commodity prices and renewed supply bottlenecks lead to rising inflation

Russia’s invasion of Ukraine caused many prices for raw materials and agricultural products to explode. Brent crude oil rose in price from around $80 per barrel at the beginning of the year to over $120 at the beginning of March. European natural gas prices doubled in the same period, having already risen by a factor of four in the course of the previous year. Significant price increases were also seen for industrial raw materials and foodstuffs. Shortages of key raw materials and production losses in Ukraine are exacerbating the already existing problems in international supply chains. For example, further delays are expected in semiconductor production, leading to bottlenecks in the automotive industry in particular. While there were signs of a gradual easing of supply chain problems at the beginning of the year, Russia’s invasion of Ukraine is likely to exacerbate the bottlenecks again. Russia and Ukraine are also major grain growing countries. The war has significantly increased uncertainties as to whether farmers in the two countries will be able to regain the crop volumes of previous years and export them. As a result, grain prices have also skyrocketed. Concerns about food shortages have increased significantly, particularly in some emerging countries.

Against this background, producer prices in the manufacturing sector have once again increased significantly, having already risen sharply since spring 2021. In the USA and the euro zone they were around 9.8% and 11.7% higher respectively in January than a year earlier. Consumer price inflation also picked up again, having already risen sharply in many places during 2021. In the United States, inflation – which there was also fueled by noticeable fiscal stimulus in 2021 in addition to high raw material prices and price increases due to supply bottlenecks – climbed to 7.9% in February. Inflation in the euro zone also increased significantly to 5.8% most recently.

Compared with the previous year, most of the price increase was due in particular to the dramatically higher oil price. However, core inflation (inflation excluding energy and food prices) was also noticeably higher in February, particularly in the USA. In the United States, it was 6.4% year-on-year in February; in the euro zone, 2.7%. Inflation is not expected to fall rapidly; in fact, it is likely to rise in the course of the spring before rates are expected to decline gradually in view of weakening raw material prices and weakening economic momentum. The current supply bottlenecks should also be gradually overcome in the course of the year.

Difficult balancing act for monetary and fiscal policy

In view of high inflation and the gloomy economic outlook, central banks are faced with a dilemma similar to that previously encountered in the wake of the two oil price shocks in 1973 and 1979. The economic outlook, which was still quite favorable at the beginning of the year before the war in Ukraine, led central banks in most advanced economies to hold out the prospect of gradually less expansionary monetary policy for the current year in view of higher inflation. Central banks in the United Kingdom and South Korea have already decided to raise key interest rates for the first time in 2021. Central banks in Norway and various countries in Central and Eastern Europe have also taken their first interest rate steps in 2021. The U.S. Federal Reserve has now raised its key interest rates by a quarter of a percentage point for the first time since December 2018, following the outbreak of war in March 2022, and has also announced that it intends to begin the process of gradually reducing its balance sheet from the summer. The European Central Bank has also already taken a slightly less expansionary course. It phased out its securities purchases under the emergency purchase program launched at the start of the pandemic in March. At the same time, it temporarily increased its general securities purchase program to EUR 40 billion per month, but is expected to phase this out next summer. An increase in key interest rates is expected towards the end of the current year. However, inflation in both the USA and the euro zone is not expected to fall gradually toward the central banks’ two percent target until 2023.

In Japan, inflationary pressures have also become somewhat higher, but they remain low compared with other advanced economies, so monetary policy is not expected to tighten until towards the end of the forecast period. In various emerging economies, such as Turkey, Brazil and Russia, inflation rates have skyrocketed, in some cases dramatically, and key interest rates have already been raised significantly.

After governments had mitigated the economic consequences of the pandemic and the measures taken to combat it by means of expansive fiscal policies in the advanced economies – and to a lesser extent also in many emerging economies – in 2020 and 2021 through extensive additional spending and tax deferrals, no new economic stimulus measures are expected in this respect in the current year. However, in view of the war and higher energy and food prices, measures are likely to be taken in various countries to mitigate the impact on low- and middle-income households, for example. Several countries are also likely to see higher defense spending and accelerated energy restructuring in the medium term, which should result in deficits remaining elevated in many advanced economies.

In emerging economies, budget deficits, which have risen sharply since the pandemic, are being reduced only slowly despite the gradual economic recovery, although longer-term spending programs have often been put in place, as in advanced economies, aimed primarily at strengthening infrastructure.

Outlook: Slowdown in recovery accompanied by high inflation

The war in Ukraine and the extensive sanctions against Russia have noticeably clouded the global economic outlook. While household purchasing power is being reduced by high energy prices, high geopolitical uncertainty is likely to reduce companies’ propensity to invest. In addition, continuing supply chain problems will repeatedly lead to production delays in industry. The economy will therefore only grow slightly or stagnate in many places in the first half of 2022.

By contrast, positive impetus will come from the recovery as a result of the lifting of pandemic-related restrictions on social life. Most existing restrictions will be lifted or replaced by less far-reaching requirements by the start of the second quarter. Individual behavioral adjustments to avoid infection will also be significantly lower. In emerging markets, where vaccination campaigns to date may have used less effective vaccines, somewhat slower success in pandemic control can be expected. But even there, the remaining restrictions are likely to only marginally limit economic activity. China, on the other hand, is likely to continue to adhere to a much stronger containment policy than other countries, which is likely to repeatedly lead to the sealing off of entire cities and closures of factories or port facilities. This will help keep problems with international supply chains high through at least the first half of 2022.

During 2022, the problems are likely to gradually dissipate. Energy and commodity prices are also expected to gradually decline again from the summer onward, reducing inflationary pressures. Against this background, I expect the global economy to grow by only around three percent this year. In 2023, economic output is then expected to grow more strongly again by slightly more than four percent.

Risks

The greatest uncertainty factor for the economy lies in the further course of the war in Ukraine. For example, there could be a further escalation of the conflict, resulting in further sanctions or restrictions on oil and gas supplies from Russia. Economic development in the world and in Europe in particular would be further affected by this. However, an easing of the conflict – for example in the form of a ceasefire – is also conceivable, which would probably lead to an upturn in global economic development. However, the risk of geopolitical crises or even armed conflicts is also heightened in other regions of the world. In Asia, for example, geopolitical crises continue to smolder around Taiwan and the Korean peninsula.

With vaccination progress and the now dominant Omicron virus variant, which is usually associated with milder disease courses than other variants, the downside risks related to new pandemic waves have recently been reduced. However, new virus variants could lead to further waves of infection and, in particular, require the reintroduction of infection control measures if existing vaccines lose their effectiveness. Another negative risk for the economy is the longer than assumed persistence of problems in international supply chains, which would slow down the economic recovery and further increase inflation risks. Above all, there is the risk in this context of even more numerous than assumed factory or port closures in China in the course of pandemic control measures.  In addition, it is possible that the smoldering real estate crisis in China could worsen and spill over to the rest of the Chinese economy and other countries. Since Chinese real estate companies are highly leveraged and have high foreign borrowings, an increase in U.S. policy rates, for example, could worsen the situation. A real estate and financial crisis in China, given its relatively low financial linkages with the rest of the world, would probably not turn into a global financial crisis, but given the size of the Chinese economy, it would have a significant impact on the rest of the world through its goods markets. Other emerging and developing economies also face the risk that an increase in interest rates in the U.S. will lead to capital outflows. In the context of China, it is also important to mention the high level of political tension with the United States. The American need to limit China’s economic expansion and the associated increase in its international political influence has continued under the new American administration. In this environment, the risk of a renewed flare-up of the trade and economic conflict between the two great powers remains high, especially against the background of Western sanctions against Russia, which the Chinese government has so far not supported.

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Further wave of pandemic delays recovery of the global economy

The global economy lost momentum at the end of last year. In the euro zone in particular, a renewed wave of pandemic and bottlenecks in international supply chains caused the economy to slow down in the final quarter of 2021; the growth rate in the euro zone was just 0.3 percent compared with the previous quarter, following a strong 2.3 percent in the third quarter. In other major economies – particularly the United States – the economy still grew at higher rates in the fourth quarter. In the USA, however, the significant growth of 1.7 percent was also due to a sharp increase in inventories. After very low inventories in the summer, many companies apparently tried to replenish their stocks as best they could out of concern about continuing supply bottlenecks. In the emerging markets, too, the economy probably developed somewhat less dynamically in the fourth quarter of 2021, but in many places it was still solid. In China, for example, the economy grew by 1.6 percent despite the smoldering debt problems in the real estate sector. Growth was driven primarily by private consumption and exports, while investment was subdued, which is unusual for China. In India, too, the economy probably continued its recovery process in the fourth quarter of 2021. However, in other emerging markets – particularly Turkey and Brazil – growing inflation rates and economic policy measures to reduce them in particular are likely to have significantly dampened economic growth.

Against the backdrop of the omicron wave and continuing problems with international supply chains, the global economy lost further momentum at the beginning of the year. In addition, particularly in Europe, economic activity is being weighed down by the high level of uncertainty surrounding the further course of the Russia-Ukraine conflict. In the advanced economies, the pandemic in January probably dampened private consumption significantly through restrictions or voluntary behavioral adjustments. In February, however, there are now signs of a gradual easing of the pandemic situation in several countries. However, economic development is being hampered above all by the numerous work stoppages caused by isolation or quarantine, which could lead to interruptions in production or the transport of goods. Against this background, gross domestic product in many advanced countries is likely to increase only slightly in the first months of this year.

But in China, too, the economy continues to be severely impacted by the pandemic. The Chinese government is still taking particularly rigorous measures – such as sealing off entire cities – to contain the corona pandemic. One of the consequences of this is that temporary closures of production facilities or ports, for example, are repeatedly occurring, which is also delaying a normalization of international supply chains. Other countries are differently well prepared for the omicron wave. In India, Russia and Mexico, for example, only slightly more than half of the population has been vaccinated against the coronavirus. Vaccination rates in Central Eastern European countries are also mostly below those of other European countries. In addition, booster vaccinations are often less advanced in Central Eastern Europe.

Economic recovery continues in spring

With the onset of spring, the global economic recovery will gain more momentum. This forecast is based on the assumption that the ongoing pandemic wave in most advanced economies will gradually subside in the course of the spring and that the immunization of the population acquired through vaccination or surviving illness will prevent a strong resurgence of the pandemic. Most existing restrictions on social life will be lifted or replaced by less far-reaching requirements by the beginning of the second quarter. Individual behavioral adjustments to avoid infection will also be much lower, which will spur private consumption In less advanced economies, where vaccination campaigns to date may have used less effective vaccines, somewhat slower success in pandemic control is expected. This forecast also assumes that China will adhere to a much stronger containment policy than other countries. This will contribute to only a gradual reduction in international supply chain problems over the course of the first half of 2022.

Against this background, gross domestic product in the advanced economies will start to grow again at slightly higher rates from the second quarter. In the United States, however, the stimulus effect of the fiscal stimulus adopted in December 2020 and March 2021 is slowly running out, which will dampen private consumption and goods imports. In addition, high inflation – averaging 4.7 percent in 2021 – is reducing household purchasing power. In view of the rise in inflation, the U.S. Federal Reserve announced that it would phase out its securities purchase program in March and raise its key interest rates. Further hikes are likely to follow later this year. However, inflation will also gradually decline as fiscal stimulus is phased out and global supply chains gradually normalize. But inflation will still be somewhat higher in 2023 than in the years before the pandemic. The days of very low inflation are likely to be over, at least for the time being. The economies of Japan and the United Kingdom will also start to grow more strongly again from the second quarter. In Japan, further fiscal stimulus measures were adopted in November, providing an additional boost to domestic demand. In the United Kingdom, the further recovery is still being hampered by the consequences of Brexit and unresolved issues relating to the status of Northern Ireland.

Further recovery also in the euro area

Likewise, a noticeable economic recovery is foreseeable in the euro zone from the second quarter. Catch-up effects and the good situation on the labor market in many countries will support private consumption. In many euro area countries, for example, consumer confidence has declined only moderately despite the omicron wave. In addition, tourism will pick up noticeably again toward the summer, generating revenue for various European vacation destinations. The extensive reconstruction aid provided under the European Reconstruction and Resilience Facility will probably have only a minor effect on the economy in the short term, but will probably boost investment noticeably in the medium term. In addition, it currently looks as if the European Central Bank will continue to pursue its loose monetary policy and only gradually make it less expansive. Although it will probably phase out its securities purchases under the emergency purchase program launched at the start of the pandemic in March, it will probably temporarily increase its general securities purchase program at the same time and then gradually reduce it over the course of the year. An increase in key interest rates is not yet expected in 2022. Inflation in the euro zone, which rose to 5.1 percent in January in the face of higher energy prices – it averaged 2.7 percent in 2021 – will probably ease gradually in the course of this year; however, a rapid decline to the central bank’s two percent target is not expected for the time being.

In Central and Eastern Europe, too, economic momentum will pick up again in the spring. In the manufacturing sector, order books are well filled and purchasing managers’ indices were well above the expansion threshold at the beginning of January 2022, so as the pandemic subsides and the supply problem gradually resolves, production in the region should pick up significantly. Fiscal stimulus could also come from allocations from the European Recovery Fund over the forecast period.

In the emerging markets, the omicron wave is likely to dampen further economic recovery for somewhat longer than in the advanced economies. In China, further economic momentum will also be held back by country-specific factors. Above all, piled-up debts, especially in the real estate sector, are a drag on the Chinese economy. At least the government seems to have succeeded so far in preventing a major crisis, which would probably also have a major impact on the financial sector and the rest of the economy. In addition to the pandemic, various other emerging markets such as Turkey and Brazil are also struggling with a significant rise in inflation, which is severely dampening people’s purchasing power and growth prospects. Uncertainties regarding the further course of the Russia-Ukraine conflict and possible Western sanctions are weighing on the Russian economy. For example, the ruble has depreciated further against the US dollar and the euro, especially since the beginning of 2022. At least export revenues have increased due to the rise in oil prices and are easing the burden on the federal budget.

From the fourth quarter of 2022, the global economic upswing will lose some momentum and most advanced economies will gradually regain or exceed their long-term growth path. Economic output will also continue to grow solidly in China and most other emerging economies; however, in China in particular, growth rates are likely to be significantly lower than in the decade before the pandemic in view of the simmering problems in the real estate sector and a labor force that is no longer growing.

Downside risks dominate

Overall, I expect the global economy to grow by 4.3 percent this year. Next year, the global economy is expected to grow by 3.5 percent. As vaccination progresses, the downside risks relating to new pandemic waves have recently diminished, but remain elevated. For other reasons, too, the forecast as a whole remains predominantly subject to negative risks. In particular, there is a further risk that problems in international supply chains will persist longer than assumed, which would slow down the economic recovery and increase inflation risks. In particular, there is the risk of prolonged factory or port closures in China, and it is possible that the smoldering real estate crisis in China could worsen and spill over to the rest of the Chinese economy and other countries. Since Chinese real estate companies are highly leveraged and have high foreign borrowings, an increase in U.S. policy rates, for example, could worsen the situation. In other emerging and developing economies, there is a risk that pandemic-related economic dislocations and increases in private or public debt could lead to debt crises. In addition, the risk of geopolitical crises or even armed conflict has increased in some regions of the world. In particular, there is a possibility that Russia will attempt to annex parts of Ukraine, which would probably result in greater geopolitical tensions and, not least, a rise in oil and gas prices. In Asia, geopolitical crises continue to simmer around Taiwan and the Korean peninsula.

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One year of Joe Biden as US President: U.S. economy at least one step ahead of euro area

One year has now passed since Joe Biden was inaugurated as US President. He has been able to achieve some of his economic policy goals during this time – such as passing the major aid and stimulus package in March 2021 or getting Congress to approve infrastructure renewal in November. But recently, Joe Biden has also had to take a lot of economic criticism – some blame his expansionary fiscal policy for higher inflation, for example.

Yet there are also positive sides to the strong fiscal stimulus. For example, in contrast to the euro area, the U.S. economy has already returned to the pre-crisis level of economic output seen at the end of 2019 by early summer 2021. One important reason for this is probably the extremely expansionary fiscal policy during the pandemic. In total, three fiscal packages amounting to about 15 percent of U.S. gross domestic product were passed in 2020 and 2021 under Presidents Trump and Biden. These fiscal packages have stimulated private consumption, which already returned to pre-crisis levels by early 2021. But investment has also developed much better in the USA than in the euro area. The subdued investment trend in the euro area is likely to put the brakes on further recovery, especially as companies were already investing more cautiously than in the United States before the pandemic. At least there is reason to hope that the “Next Generation EU” fund will boost investment in the euro area in the coming years.

On the US labor market, these developments have been reflected in significant and rapid improvements. Admittedly, there are still far fewer jobs than before the pandemic because, for example, many people have to look after their children or relatives in need of care at home and have not yet returned to the labor market. But overall, the situation has nevertheless improved much faster than many had expected even as recently as spring 2021. Wages also grew more strongly than in the 2010s.

However, higher inflation has recently eaten up the nominal wage increases again. Although inflation – at an annual rate of 7.0 percent in December – is now expected to ease gradually, also in view of the expiry of the fiscal stimulus, it is likely to remain high this year. For example, the price-driving problems in international supply chains will not disappear any time soon in view of the omicron wave.

In principle, there is no need to fear somewhat higher inflation than in the years before the pandemic. It can be a positive sign of a dynamic economy in which low- and middle-income people also participate via higher wage increases. Nevertheless, there is a risk that inflation will remain long and well above the Fed’s average two percent target and can only be controlled with strong monetary tightening.

The comparatively favorable development of the U.S. economy despite continuing problems is not an isolated case. It has already proved resilient in the past and, for example, grew more strongly than in the euro area after the financial crisis until the start of the pandemic. In the United States, the economy grew by more than a quarter in real terms from 2009 to 2019, compared with only around 15 percent in the euro area. Even Donald Trump’s unpredictable and confrontational leadership has not led to the economic crash that has occasionally been predicted.

To be sure, it is quite possible that the euro area economy will grow more strongly than the U.S. economy in 2022. But this is mainly due to the fact that the US economy is at least one step ahead of the euro area in recovering from the pandemic. For the coming years, the United States has a good chance of leaving many economies in the euro area behind, despite the ongoing domestic political polarization.

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U.S. economy: Lower but still solid growth and higher inflation

The U.S. economy probably grew by a significant annualized 5 to 7 percent in the fourth quarter of 2021 compared with the previous quarter (we will have the exact figures at the end of January). The economic recovery after the pandemic-related slump in the first half of 2020 thus continued. By the summer of 2021, U.S. economic output had already returned to the level of the final quarter of 2019 before the pandemic. In the fourth quarter of 2021, private consumption in particular is likely to have increased at a solid rate, but corporate investment activity is also likely to have picked up. In the wake of strong domestic demand, imports have probably increased at a faster rate than exports, as was the case throughout last year; the trade deficit has therefore probably widened. Many infection control measures in the states had already been relaxed in the summer of 2021. This probably benefited personal services in particular.

At the beginning of the current year, the U.S. economy is now likely to grow less dynamically. The Omicron mutation has led to an enormous number of corona cases. Although hospital admissions and deaths have risen much less sharply than in previous corona waves, the U.S. healthcare system is nevertheless being strained. Pandemic containment measures have been stepped up again regionally. As in previous waves, personal services are suffering the most economically as a result. Although strict containment measures are unlikely as they were last winter, economic recovery will nevertheless be dampened by the spread of the omicron variant.

In addition, the stimulating effect of the fiscal packages adopted in December 2020 and March 2021, which boosted private consumption in particular via cash payments to households and a temporary increase in unemployment benefits, is now gradually coming to an end. Given the high level of savings accumulated during the pandemic, consumer demand is nevertheless likely to be the main growth driver of the U.S. economy in the coming quarters. In the course of 2022 and 2023, however, growth in private consumer spending will gradually weaken. Against this background, business investment will also increase noticeably over the forecast period. Although corporate financing conditions will become somewhat less favorable than recently, they will continue to support the propensity of companies to invest.

The dynamic recovery of the U.S. economy has also steadily improved the situation on the labor market. The unemployment rate was only 3.9 percent in December, down from 6.0 percent in March 2021 and as high as 14.7 percent in April 2020. However, many people have withdrawn from the labor market, at least temporarily. The labor force participation rate in December was still 1.5 percentage points lower than before the pandemic in February 2020, so the official unemployment rate probably underestimates the true extent of unemployment by 1 to 1 ½ percentage points. The labor market situation will continue to improve over the forecast period. In 2022 and 2023, however, the decline in the unemployment rate is likely to be much smaller than recently. In view of increasing labor market shortages, wages are likely to increase noticeably more than before the pandemic.

Inflation has picked up significantly in 2021, reaching a temporary high of an annual 7.0 percent in December 2021. Monetary policy will gradually become less expansionary in the face of this higher inflation and continued economic recovery. Inflation is also expected to be well above three percent this year. The personal consumption expenditures index published by the Bureau of Economic Analysis, which the U.S. Federal Reserve primarily uses for its monetary policy decisions, will also increase by more than three percent in 2022 before price increases might approach the central bank’s average inflation target of two percent in 2023. While much of the higher inflation at the beginning of 2021 was still attributable to temporary factors such as higher oil prices as well as supply bottlenecks and associated price increases for various goods – such as semiconductors and raw materials – a somewhat higher price increase is now visible for a broader number of goods. Against this backdrop, the U.S. Federal Reserve began gradually reducing its securities purchases as early as November 2021 and phasing them out by March 2022. The first increase in key interest rates is expected in March 2022. Two to three further interest rate steps are likely to be added in the current year. In addition, the central bank will probably announce its plans to gradually reduce its balance sheet – i.e. sell U.S. government bonds and mortgage securities – in the coming months. I expect it to start shrinking its balance sheet before the summer. All in all, the U.S. economy will probably grow by 3.8 percent this year. In 2023, the growth rate should be 2.6 percent.

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What caught my eye: Global supply chain pressures, monetary policy operations, U.S. exports, and much more…

The World Bank Economic Outlook: “Slowing Growth, Rising Risks”:

https://www.worldbank.org/en/publication/global-economic-prospects

Macro Musings with David Beckworth: Lorie Logan on “Monetary Policy Operations, the Fed’s New Standing Repo Facility, and the Future of the Fed’s Balance Sheet”:

https://macromusings.libsyn.com/

“A New Barometer of Global Supply Chain Pressures” (by the Federal Reserve Bank of New York) by Gianluca Benigno, Julian di Giovanni, Jan J. J. Groen, and Adam I. Noble:

“Historical Parallels to Today’s Inflationary Episode” by Chair Cecilia Rouse, Jeffery Zhang, and Ernie Tedeschi:

https://www.whitehouse.gov/cea/written-materials/2021/07/06/historical-parallels-to-todays-inflationary-episode/

“U.S.-China technology competition” A Brookings Global China Interview by Ryan Hass, Patricia M. Kim, Emilie Kimball, Jessica Brandt, David Dollar, Cameron F. Kerry, Aaron Klein, Joshua P. Meltzer, Chris Meserole, Amy J. Nelson, Pavneet Singh, Melanie W. Sisson, and Thomas Wright:

“When Will U.S. Exports Take Off?” by Ruth Cesar Heymann and Julian di Giovanni:

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Quote of the week – Elinor Ostrom

“Scientific knowledge is as much an understanding of the diversity of situations for which a theory or its models are relevant as an understanding of its limits.”

Elinor Ostrom

The last quotes were from David Hume, Hannah Arendt, Janet Yellen, Niccolò Machiavelli, Joseph Schumpeter, Piero Sraffa, Winston Churchill, Christina Romer, Esther Duflo, Peter Drucker, Frank Knight, Joan Robinson, Robert Mundell, Alfred Marschall, Janet Yellen, Ludwig von Mises, Thorstein Veblen, Deirdre N. McCloskey, Paul Samuelson, Elinor Ostrom, Robert Solow, Joan Robinson, and Friedrich A. Hayek.

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The Italian Economy: Solid economic growth but bumpy road ahead

Italy has been in a difficult economic situation for many years. The pandemic made the economic and social Italy has been in a difficult economic situation for many years. Initially, the pandemic made the economic and social problems even worse. After a solid economic recovery in 2021, I am cautiously optimistic for Italy and the Italian economy. Despite various remaining problems, there is hope for new dynamism after the pandemic. After an economic contraction of 9 percent in 2020, economic expansion may have amounted to 6.5 percent in 2021 followed by a growth rate of 4.7 percent in 2022 and an expansion of around 2.4 percent in 2023. Inflation will likely exceed two percent in 2022 before averaging approximately two percent in 2023.

In 2020, the coronavirus pandemic caused a health crisis and a severe recession in Italy leading to a decrease in economic output of nine percent. Economic recovery has been solid so far. My cautious optimism regarding the Italian economy has been confirmed so far. In 2021, the economy probably expanded by well above six percent. The availability of vaccines greatly helped improve the situation. However, it has remained always obvious that virus mutations could make the situation worse again. The so-called omicron mutation currently shows us that some or all the available vaccines might not be fully effective against new mutations. Increased uncertainty and new restrictions to curb the rapid spread of omicron will weigh on economic activity in the first quarter of 2022. Private consumption expenditures – particularly related to personal services – will probably stagnate. Some modest growth rates can be expected, however, for private investment and public spending.

Expansionary fiscal and monetary policies will support the gradual recovery of the economy and the labor market. But the situation will continue to be difficult for a considerable number of people. Monetary policy of the European Central Bank will continue to be expansionary, although the scale of the quantitative easing programs will be gradually reduced in 2022. Inflation will be well above two percent inflation target in 2022. Interest rate increases are generally not expected for 2022. However, I think that a first interest rate increase might be adopted in this year, because my expectations for inflation are somewhat higher than the consensus forecast (I still expect that inflation pressures will be lower in 2023 than in 2022, but price increasing will remain somewhat higher than in the pre-pandemic period).

Importantly, Italy will receive financial support from the recovery fund of the European Union (probably more than 200 billion euros). Many effects of these public expenditures will be relevant for the medium term, but there might also be some smaller short-run impacts. These funds are planned to be used, among others, for infrastructure projects such as high-speed trains, “green” energy, and projects surrounding the “digital economy”. One may expect that the recovery fund will lift the gross domestic product of Italy by around 4 percent in the coming years. In the years to come, the further accumulation of public debt might be a burden and the government should aim at gradually achieving a balanced budget to bring the debt-to-GDP ratio gradually down again in the medium term. The new prime minister, Mario Draghi (the former ECB president), is trying to implement sensible measures to reform the Italian economy. One should not expect miracles, but I am cautiously optimistic for the Italian economy. It has a lot of potential such as a lot of productive small and medium-sized firms and skilled people.

I expect a solid growth rate in 2022. For the whole year 2022, my current forecast is 4.7 percent. The recovery will then slow down to more “usual” rates in 2023. Currently, I expect a growth rate of 2.4 percent. Inflation will be above two percent (the target of the ECB) in 2022 and average around two percent in 2023. The situation on the labor market will also gradually improve, but remain difficult for a considerable number of people. As mentioned above, my expectations for inflation are somewhat higher than the consensus forecast but I still expect that inflation pressures will be lower in 2023 than in 2022. However, price increasing will remain somewhat higher than in the pre-pandemic period. This does not have to be a bad thing. In my view, it will reflect somewhat higher economic dynamism in the euro area and Italy.

For the medium-term, I am cautiously optimistic that the Italian economy will be able to deliver higher productivity and growth rates than in the past decades where economic output and household incomes almost stagnated on average.

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What caught my eye: Labor markets and inflation, central bank digital currencies, international trade, and much more…

“Bottlenecks, labour markets and inflation in the wake of the pandemic” Speech by Hyun Song Shin, Economic Adviser and Head of Research of the BIS, G20 International Seminar “Recover together, recover stronger”, 9 December 2021.

https://www.bis.org/speeches/sp211209.htm

“Revisiting the EU framework: Economic necessities and legal options” by Miguel Maduro, Philippe Martin, Jean-Claude Piris, Jean Pisani-Ferry, Lucrezia Reichlin, Armin Steinbach and Beatrice Weder di Mauro:

“Project Jura – Cross-border settlement using wholesale CBDC”:

https://www.bis.org/publ/othp44.htm

Mundell-Fleming Lecture: 2021 IMF Annual Research Conference by Pierre-Olivier Gourinchas (University of California, Berkeley) on International Macroeconomics: From the Great Financial Crisis to the Great Lockdown, and Beyond:

https://www.imf.org/en/Videos/view?vid=6282142610001

“Finance and technology conference 2021 on crypto-assets and asset tokenization” November 5th, 2021, Swiss Tech Convention Center, EPFL:

“Trade, development and political economy: The life and work of Ronald Findlay, 1935-2021” by Douglas Irwin:

https://voxeu.org/article/ronald-findlay-1935-2021

“Focus on bank supervision, not just bank regulation” by Peter Conti-Brown and Sean Vanatta:

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Some of my blog posts and economic forecasts are first reserved to my paying subscribers. After two weeks, all articles are publicly available. If you would like to get instantaneous access, you can subscribe for 5 US dollars per month (or the equivalent amount in your currency). You can unsubscribe at any time:

Email: info@eagle-economist.com

Quote of the week – David Hume

“In our reasonings concerning matter of fact, there are all imaginable degrees of assurance, from the highest certainty to the lowest species of moral evidence. A wise man, therefore, proportions his belief to the evidence.”

David Hume

The last quotes were from Hannah Arendt, Janet Yellen, Niccolò Machiavelli, Joseph Schumpeter, Piero Sraffa, Winston Churchill, Christina Romer, Esther Duflo, Peter Drucker, Frank Knight, Joan Robinson, Robert Mundell, Alfred Marschall, Janet Yellen, Ludwig von Mises, Thorstein Veblen, Deirdre N. McCloskey, Paul Samuelson, Elinor Ostrom, Robert Solow, Joan Robinson, and Friedrich A. Hayek.

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Some of my blog posts and economic forecasts are first reserved to my paying subscribers. After two weeks, all articles are publicly available. If you would like to get instantaneous access or to support me, you can subscribe for 5 US dollars per month (or the equivalent amount in your currency). You can unsubscribe at any time:

Email: info@eagle-economist.com

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