Our models also enable us to estimate the impacts on major emerging markets, including the drag from a stronger US dollar. Turkey and Brazil show up as having the most to lose.
The silver lining from weaker growth should be lower inflation, and that’s what our model suggests. For the US, for example, the results show inflation lower by 0.7 percentage point at the end of 2023, enough to take several Fed rate hikes off the table. Unfortunately, it’s not that simple.
With the downside scenario for Europe assuming even higher energy prices, the overall impact could actually be lower growth and higher inflation.
It is, of course, also possible to construct an upside scenario. An end to conflict in Ukraine or an unusually warm winter could spare Europe from recession. China might exit Covid lockdowns earlier or add more stimulus to offset the property slide than we expect. US labor markets might deliver the immaculate disinflation that the Fed is hoping for. Some combination of those positive surprises might cheer markets and lift global growth for the year above expectations.
Still, the base case is for 2023 to be a year of lackluster growth and still-high price pressure. And the lesson of the last few years is that things can always get worse.
Methodology
We estimated global spillovers using a two-step approach. For the US, euro area, China, Japan, and the UK, we estimate the effects of shocks from the US, euro area, and China with the European Central Bank’s global model.
The advantage of this model is that it jointly models trade and financial channels and incorporates the dominant currency paradigm and the financial channel of the exchange rate. As a cross-check, we also run alternative scenarios with the SIGMA model of the Federal Reserve Board.
Spillovers to all other countries were estimated by using small structural (Bayesian) vector autoregressive models. We run conditional forecasts on the adverse growth paths of the US, euro area, and China.
• In the VAR models, the US, euro area, and China are assumed to be block exogenous to the individual countries.
• Spillovers are based on an historical relationship between the big blocks and the shock recipient countries.
• For all countries, we use standard Minnesota priors with four lags on quarterly data from 2001-2022, excluding the Covid period from the sample.
This article was provided by Bloomberg News.