World Recession 2023: How Severe?

How severe will the 2023 world economic recession be? This question arises because there is great concern for the world economy, which has just recovered from the COVID-19 pandemic.

It is not easy to estimate. However, by looking at the important dynamics in place and the steps taken, especially by the major countries, we can form a picture of the severity of the global recession and envision its recovery.

There is no formal definitive threshold at which the world economy can be said to be in a recession. However, the consensus agreed upon by international institutions, such as the International Monetary Fund and many leading economists, states that if growth is less than 2.5 percent, the world economy can be classified as in a recession.

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The IMF report, “World Economic Outlook”, October 2022, estimates that the world economy will only grow 2.7 percent in 2023. With this forecast, the IMF and many economists call 2023 a “feel-like recession”. In January 2023, the IMF revised world economic growth upward to 2.9 percent, accompanied by various other macro-indicators.

Even though it would be more accurate to call it an economic slowdown, the world economic condition is quite serious, quite far from the long-term trend, which is on average around 3.8-percent growth. The economic slowdown has also been accompanied by high prices, making it difficult to take strong countercyclical steps to boost the world economy.

Lighter

A global recession is different from a country's recession. The United States economy, for example, is said to be in a recession if it experiences a contraction (negative growth) against the previous quarter for two consecutive quarters. Even that is only a technical recession. A wider recession, if the decline is significant, will have a major impact on important sectors such as industry, trade and employment. It is not certain that a country experiencing a recession will experience a contraction in growth throughout the year.

Even if it is called a global recession, world economic conditions in 2023 are predicted to be milder than in previous crises, the most recent being the recession caused as a direct impact of the COVID-19 pandemic. In 2020, the world economy contracted to 3.0 percent. A little bit further back is the 2009 world economic recession that occurred due to the 2008 global financial crisis.

Even if it is called a global recession, world economic conditions in 2023 are predicted to be milder than in previous crises.

In 2009, the world economy contracted by 0.1 percent. Indonesia's economy grew 4.7 percent and rebounded to 6.4 percent in 2010. With the IMF's 2023 projection, economic growth of more than 5 percent is not difficult to attain in Indonesia.

In summary, the probability of a severe global recession is not high. However, as I wrote in Kompas (6/5/2022), world economic turmoil can have a significant impact on certain regions due to high inflation due to supply chain disruptions when global demand recovers and conflicts exist between Russia and Ukraine.

Current situation

As of early February 2023, there has been an improvement in the world economy, which has been in turmoil since 2022. The prices of various commodities have declined due to expectations of a slowdown in the world economy, although they are still above those before the pandemic.

Inflation is under control in a number of major countries. Economic growth until quarter IV-2022 in a number of countries and regions is relatively stable. A moderate slowdown occurred in several countries. Contractions are of course also occurring in Russia and Ukraine.

The next important global step is to normalize inflation, among other things, by increasing interest rates. Attention is focused on the United States, because US interest-rate policy has the potential to affect capital flows and the US economy itself. The latest developments show that inflation in the US can be controlled to 6.5 percent in December 2022 from 9.1 percent in June 2022.

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Two different views emerge regarding the increase in US interest rates. First, some people are concerned that an aggressive increase in interest rates could result in a contraction in the US economy. The reason is that current inflation is caused more by the pandemic and price increases due to a slow recovery in supply than an increase in demand.

Others are of the view that interest rate policy should play a role in controlling inflation. Moreover, current inflation contains the persistence of the previous loose monetary policy and the delay in the US Federal Reserves (Fed) in raising interest rates.

The US implemented a tight monetary policy with a dramatic increase in interest rates when taming inflation in the late 1970s to early 1980s.

US inflation was high at that time, amounting to nearly 15 percent in March 1981, partly due to high crude oil prices, which demanded an increase in the benchmark interest rate to close to 20 percent. This step succeeded, even though the US economy had to experience a contraction in 1981 and 1983.

At the end of 1983, US inflation was controlled to 3.8 percent. The bottom line is the importance of credible and convincing policies to form a strong anchor for long-term price stability.

How aggressive is the increase in US interest rates, the Federal Funds Rate (FFR)? Recent developments show a smaller increase in FFR. The next increase will be determined by existing developments. In the existing situation, the fundamentals of the US economy are still quite strong.

The impact of increasing interest rates has not been too great for the US economy.

Even though it is slowing down, the economy is still growing 1.0 percent year-on-year (yoy) or 2.9 percent quarter-to-quarter in quarter IV-2022. Overall, in 2022, the US economy will still grow 2.1 percent. The low unemployment rate (3.4 percent, December 2022-January 2023), and various other indicators, show that the US economy can avoid recession in 2023.

The impact of increasing interest rates has not been too great for the US economy. This means that the policy of increasing interest rates is still possible, depending on how quick the Fed reaches its 2-percent inflation target. With inflation beginning to come under control, the increase in interest rates will not be as dramatic as before, but will remain consistent so that the inflation target is achieved this year.

It can be avoided

Although the world economy in 2023 can avoid recession, there are two other factors that can affect the world economy. First, the emergence of the global financial crisis, triggered partly by the flow of capital. So far, there have been no signs of a dangerous crisis. Several countries have experienced difficulties with weak external resilience and large debts, especially foreign ones.

The strengthening of the US dollar and high energy and food prices have resulted in these countries experiencing difficulties in fulfilling their external obligations, but these are local in nature and do not have major implications.

Also read: Impact of the Global Economic Recession

Second, the Russia-Ukraine conflict. Even though there has not yet been any definite resolution to the conflict, as long as there is no extraordinary and widespread escalation, the economy will create a new normal by minimizing its impact on the world economy. The economic areas that were initially affected by the conflict will seek new mechanisms to keep growing.

The outlook for the world economy in 2023 is not as bad as many people think. Coupled with China's economy, which has begun to relax, a world economic recession can even be avoided.

KARINA ISNA IRAWAN

Bambang Prijambodo

Bambang Prijambodo, Senior economist, former deputy for economics at the National Development Planning Ministry/Bappenas

This article was translated by Kurniawan Siswo.