An article by: Andrea Beltratti

Andrea Beltratti, Professor of Finance Department at Bocconi University, paints a picture of the global economy. From the war that led to the reduction of gas and oil supplies to the mistakes of the European Central Bank in fighting inflation. Europe is in crisis, and China seems to be unable to rebuild its economy. Meanwhile, the costs of war are becoming higher than the costs of peace.

At what stage of the fight against inflation are we?

Many comments about economic performance in 2023 seem to ignore the expectations and hopes that existed on January 1 of this year for a trend that could be summarized as hope that a moderate recession would be sufficient for central banks to contain inflation. These expectations are based on two almost century-old economic “laws” that still shape the vision of central banks around the world: 1) demand determines supply (Keynes, 1936); 2) there is an inverse relationship between wage growth and unemployment (Phillips, 1958). Since there are only four months left before the end of the year, we can ask where we are in the fight against inflation, what possible costs will have to be incurred, and what mistakes have been made? To do this, we need to look to the East and the North, paying attention to Russia, China, Germany, and, finally, the European Central Bank.

It’s hard to imagine that cuts in gas and oil supplies could go hand in hand with a booming economy.

Russia is the largest country in the world (about twice the size of the United States): it occupies 11% of the planet’s territory and has about a quarter of the world’s natural gas reserves. It’s hard to imagine that shrinking gas and oil supplies could be accompanied by economic good times, especially given the difficulties in the global supply chain that has been severely tested by the pandemic and economic sanctions. After all, as early as in the 18th century, the trade war between Great Britain and France caused economic damage to all parties, not just one. Most analysts predicted that the conflict would drag on, not least because the loss of life on both sides was making peace more politically costly. Therefore, we run the risk of continuing to live in conditions of war.


Economic slowdown in China is bigger than expected

The economic slowdown in China is taking proportions much larger than expected. The difficulties of the real estate market have been known for a long time (the Evergrande case is no news, of course). What is news, perhaps, is the understanding of the relative impotence of the Chinese government, in spite of it having financial and industrial policy instruments that are much more powerful than ours, both in terms of financial resources availability and the speed with which decisions are implemented. The worsening situation in China could be good news for the conflict in Ukraine: China will be higher motivated to take a more balanced position in the international context, helping to find a political and economic compromise capable of restoring international trade.

Germany is slowing down along with the entire European economy

European economy: the slowdown is now evident and confirmed by the monthly data released at the end of August. It shows deterioration of the situation, especially in Germany that, after two quarters of recession, does not seem to break the deadlock in the third quarter. This kind of development is somewhat unexpected, given the well-known sensitivity of the German business cycle to the global one. It would make sense for the country to take fiscal measures – in its own interests and in the interests of the eurozone – that could balance the reduction in external demand with increased domestic demand. But the new German leadership is not showing the abilities that the previous one had. This is not so bad, at least for Italy: it would be much worse to face the global recession alone. As in the case of China, the impetus for Germany at this stage also becomes closer cooperation, for example, within the framework of the European Stability Pact.


Mistakes by ECB: poor communication and untimely interventions

ECB: In early January, after the fastest rate increase in history, there was hope that central banks would need a few more changes to curb inflation, although they knew it would take time to return this rate to a base level around 2%. What happened from January to August only partially meets expectations: The ECB raised the refinancing rate at the end of July for the ninth time in a row to 4.25%, see, as inflation fell from double digits to 5.3% (the lowest level since early 2022), while core inflation remained at 5.5%. The ECB said that decision-making before the end of the year “will depend on the emergence of new data.” Blaming the ECB now is useless, but above all, belated. The mistakes by the ECB were primarily in communication (moreover, this activity is of great importance for any central bank) that began with statements ranging from “we are not here to close spreads” (these words were refuted after a few hours) to “inflation in 2021 is temporary and does not pose a serious long-term problem” and very recent words claiming that “inflation is the fault of companies.” This series of mistakes, along with the accumulated delay in responding to the first signs of inflation in 2021, has reduced the credibility of this institution by some investors and now calls for a tougher line.

The situation with real interest rates above zero is a sign of health, not weakness.

Scenario: We do not know what data will appear in the coming weeks. However, it is hard to imagine that core inflation will fall faster than it has up until now. A recession will help with this, but only to a limited extent and in the short term, even if the economic slowdown in China puts pressure on European exports, and the ECB will be forced to restore its credibility as a guarantor against inflation (by the way, according to its Charter, this is the only real task of the bank) through a conservative, maximally cautious interpretation of the new data, although this will cause dissatisfaction among politicians. Therefore, some aftershocks should be expected. But let’s look at two positive aspects. Firstly, the current situation should be viewed in the perspective of the last 15 years: since 2009, people have been wondering when the world economy will be able to implement a strategy for a real exit from the US mortgage crisis? Now we can finally look at what is happening in a positive way. Real interest rates above zero are a sign of health, not weakness, and bring many benefits to asset owners. Of course, achieving a new stable normality will still require a little suffering. But who could have predicted a year ago that the world would meet and overcome the fastest rise in interest rates in history without serious financial problems? Secondly, for several months, everyone took a rational viewpoint on ending the war, arguing that it would end when the costs outweighed the benefits. From this standpoint, the current situation shows clear signs of an exponential increase in costs for the international community, at least in terms of reduced business activity. The war that began almost two years ago and engulfed 0.03% of the world’s territory is likely to have very high global economic costs. After all, even globalization, like any food, is not free.

Economist, Academic Director of the Executive Master in Finance

Andrea Beltratti