We explained in our November research report "Walking the Path to the Next Global Financial Crisis" why concerns about prolonged economic stagnation, or even serious recessions, should be taken seriously.
During the 2008-2010 global financial crisis, governments' responses had turned a banking crisis into a public debt crisis. In response to Covid-19, governments doubled down on their debt, and central banks took unprecedented steps to lower interest rates and create money.
Many governments are in debt traps. Raising interest rates would make their debt problems even worse, but not doing so would fuel inflation.
That dilemma now faces governments and central banks in the United States, the UK, and Europe. Inflation has soared. The risk of stagflation, or worse, has increased as central banks raise interest rates.
The official forecasting agencies have not yet predicted a recession. Perhaps they do not want to precipitate one by predicting it. Their prediction is that the gradual tightening will suffice.
The World Economic Outlook for April 2022, published by the International Monetary Fund, exemplifies this genre. In advanced economies, unemployment rates are forecast to be lower in 2022 than any year since 1980, and will remain lower through 2027. By 2023, inflation will be under control. Economic growth will be modest.
Deutsche Bank economists, however, predict a 'major' US recession by 2023 or 2024. According to Goldman Sachs economists, there is a 36% chance of recession in the next two years. Bloomberg surveyed economists last month (in May) and found that there is a 30% probability of a recession in the next year.
The problem is that central banks have limited scope to play fast and loose with a 'sound money', low inflation objective. Only as long as people at large believe the easing is temporary will they be able to ease up without inflation exploding.
Once people perceive that central banks are trapped in maintaining low-interest rates due to the public debt problem, confidence in low inflation will erode. Then stagflation and recession risks rise.
New Zealand's Budget 2022 assumes that our major trading partners will not plunge into a major recession. So do the Reserve Bank of New Zealand’s forecasts.
The odds of them being correct have slipped since our report last November.