Each year, economic forecasts are issued by governments and financial institutions around the world. These forecasts mostly extrapolate from known variables and foreseeable trends. For this reason, they can be significantly thrown off by a single “unpredictable” event, some of which not really unpredictable. The last three years provide striking examples. The effects of the pandemic took everyone by surprise during 2020, despite death tolls rapidly rising in China at the end of 2019, and repeated warnings from health officials regarding pandemic unpreparedness. Inflation was deemed temporary in 2021, despite massive monetary and fiscal stimulus that ran for more than a decade prior. Few anticipated that Russia would attack Ukraine during 2022, despite its annexation of Crimea in 2014, and troops gathering at the Ukrainian border early in 2022 under the pretense of military exercises. Early signs were there, three years in a row, and literally ignored.

Even in the best of times, forecasts are often unreliable. Simply put: “it’s tough to make predictions, especially about the future” as former baseball player and manager Yogi Berra famously said. Nonetheless, we should remain vigilant at the early signs of trouble. Being watchful, resilient, prepared and flexible are a good mantra, especially in highly uncertain times. Looking out and being well-aware of forecasting risks are important first steps. Let’s take note of the economic forecasts for 2023, and consider significant wildcards that may once again prove them wrong.

Inflation Prospects

Inflation is expected to moderate during 2023, but remain well above central bank targets of 2%, which means that interest rates are unlikely to come down in the near future. Chief economists recently surveyed by the Word Economic Forum (WEF) believe that inflation will remain “high or very high” in the United States and Europe.¹ Their views appear to be consistent with the Organization for Economic Co-operation and Development (OECD), which is forecasting annual inflation rates of 3.9% for the United States, 6.8% for the Eurozone, and 6.6% for the United Kingdom (Figure 1). These forecasts are higher than those of the International Monetary Fund (IMF), which is anticipating average inflation of 4.6% for advanced economies such as the United States and Europe.²

Growth Estimates

Sixty-three percent of chief economists surveyed by the WEF believe that a global recession is “somewhat likely or extremely likely” in 2023.³ Factors driving the risk of recession include persistent inflation, tighter monetary and fiscal policies, weaker demand for goods and services, and continued geopolitical conflicts affecting supply chains, energy prices, and business and consumer confidence. Contrary to the views of chief economists, the OECD is forecasting global growth of 2.2% for 2023. But growth is expected to be very low at 0.5% for the United States and Eurozone, and a contraction of 0.4% is expected for the United Kingdom (Figure 2). For its part, the IMF is forecasting higher global growth of 2.9%, including 1.4% for the United States and 0.7% for the Eurozone.⁴

Wildcards

The IMF is forecasting higher growth and lower inflation than the OECD, which is a conundrum given that higher growth normally causes higher inflation. However, the IMF outlines “Risks to the Outlook” in a separate section of its forecast. These risks are the variables most susceptible of invalidating growth estimates according to the IMF. They reflect that some assumptions built-in the forecasts are less predictable than others. Interestingly, the IMF states that the balance of risks to its outlook “remains tilted to the downside, with scope for lower growth and higher inflation” than predicted.⁵ This statement suggests that the most unpredictable variables, commonly known as wildcards, predominantly have downside effects. The IMF describes them as follows:⁶

• Persistent inflation – Labor shortages leading to wage growth, a strong recovery in China causing higher demand for commodities, and continuing high energy prices could de-anchor inflation expectations from traditional targets, requiring tighter monetary policy.

• Sovereign debt distress – Sixty percent of low-income countries, and twenty-five percent of developing countries have a high risk of financial distress due to high levels of debt, lower anticipated growth, and higher borrowing costs. Defaults could have significant domino effects.

• Sudden financial market repricing – Stock market volatility resulting from headline inflation news and anticipated monetary policy decisions could complicate the fight against inflation, or strain liquidity and the functioning of capital markets, with ripple effects on the real economy.

• Escalation of the war in Ukraine – The economic consequences of war escalation in Ukraine include higher energy and food prices. A failed extension of the Black Sea grain initiative could lead to social unrest in low-income countries dependent on grain exports from the region.

• Geopolitical fragmentation – International sanctions aimed at pressuring Russia to end its military aggression in Ukraine may result in a major realignment of global trade. Countries that favor doing business with Russia may become increasingly isolated as the war persists.

• Stalling recovery in China – Major risk factors to economic recovery in China include health challenges related to the pandemic, and a deepening real estate crisis causing financial sector instability. These risks could in turn set-off additional supply chain problems globally.

Observations

From my perspective, geopolitical conflicts are the most significant wildcards that can negatively affect economic forecasts. Russia is doubling down its military efforts to invade Ukraine, while NATO members are providing heavier armament and ongoing logistical support for Ukrainians to defend themselves. The conflict is severe, with no apparent end in sight. The risk that it may widen to neighboring countries is underestimated. So is the possibility of civil war within Russia if its army becomes divided as human losses mount. Escalating tensions related to Taiwan, and between Iran and its Middle East neighbors are also of grave concern. The unfolding of the war in Ukraine, and the conditions that prevail within Russia, will greatly influence other conflicts and global trade.

The inflation threat is also underestimated. The drivers of inflation are very different from the past. They include tight labor markets, acute shortages of skilled labor, and a lower labor participation rate due to aging populations in advanced economies. China also has an aging population challenge that will intensify in coming years. These factors reduce the supply of goods and services, but there is no immediate corresponding offset in demand. The war in Ukraine, and the realignment of global trade aggravate the supply-demand imbalance. Droughts, flooding and extreme weather events are increasing in frequency and severity, which further diminish supply and increase demand. Inflation may prove a lot more difficult to resolve than currently anticipated.

Difficult economic conditions in low-income and developing countries are expected in the foreseeable future, as governments wrestle with cost of living crises, large debt loads, high borrowing costs and weakening currency values. Low-income and developing countries are also the most impacted by the negative effects of climate change. Difficult economic conditions and climate disasters increase poverty, which aggravates social unrest, criminality, uncontrolled immigration, and the risk of failed states where governments (duly elected or not) are unable to maintain law and order. Social unrest in many parts of the world at once, and especially if it was to happen in major economies, could have devastating consequences for world peace and financial stability.

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¹ Word Economic Forum, Chief Economists Outlook (Center for the New Economy and Society, January 2023), p.10.
² International Monetary Fund, World Economic Outlook Update, Inflation Peaking Amid Low Growth (January 2023), p.5.
³ Word Economic Forum, Chief Economists Outlook, (…), p.7.
⁴ International Monetary Fund, World Economic Outlook Update (…), pp.3-4.
⁵ International Monetary Fund, World Economic Outlook Update (…), p.5.
⁶ International Monetary Fund, World Economic Outlook Update (…), pp.5-8.