Mohamed A. El-Erian, President of Queens’ College at the University of Cambridge, is a professor at the Wharton School of the University of Pennsylvania. He is the author of The Only Game in Town: Central Banks, Instability, and Recovering from Another Collapse (Random House, 2016) and a co-author (with Gordon Brown, Michael Spence, and Reid Lidow) of Permacrisis: A Plan to Fix a Fractured World (Simon & Schuster, 2023).
CAMBRIDGE – Businesses, governments, and investors were already navigating a foggy global landscape before the tragic events unfolding in the Middle East. But the horrible conflict between Hamas and Israel, which has already led to enormous suffering and claimed the lives of thousands of civilians, including so many children, has introduced a new layer of uncertainty for the global economy, the subject of this commentary. Even in the highly unlikely event that the geopolitical situation improves rapidly in the region and beyond, a deep sense of uncertainty will remain, driven by five economic and financial factors.
First, the global economy’s major growth engines are currently under strain. With Europe teetering on the brink of recession and China stalling, the US economy has emerged as the main driver of global growth. This became particularly evident in the third quarter of 2023, with the United States’ growth estimates impressing once again.
But even America’s growth outlook is uncertain. Over the past 15 months, the consensus of analysts about the US economy’s direction has oscillated wildly between four scenarios: soft landing, hard landing, crash landing, and no landing. Although the prevailing view now is that the US is headed for a soft landing, forecasts may well shift toward a hard one over the coming weeks.
When the growth narrative of the world’s largest economy, with its mature institutions and diversified productive base, can change so easily, it is no wonder that uncertainty in the rest of the world is even more pronounced. Instead of resembling a normal bell-shaped distribution of potential outcomes with a single peak and slender tails, the global outlook looks like a multimodal distribution with fat tails on either end, suggesting a higher likelihood of extreme events.
On the positive side, as Gordon Brown, Michael Spence, Reid Lidow, and I argue in our new book Permacrisis, advances in generative artificial intelligence, life sciences, and clean energy have the potential to enhance productivity and boost potential GDP growth significantly. On the other end of the distribution, there is the risk that a set of vicious cycles will aggravate cascading effects.
Second, the journey toward this uncertain future is fraught with peril. The most immediate risk is the recent spike in global borrowing costs as markets adapt to the likelihood that the US Federal Reserve and other major central banks, having hiked interest rates aggressively – albeit belatedly – to counter inflation trends they initially misdiagnosed – will maintain elevated rates for an extended period.
Third, the persistence of this interest-rate outlook increases the risk of recessions and financial-market turbulence. We saw early signs of this in March when balance-sheet mismanagement and slippages in bank supervision led to the failure of some regional US banks.
Fourth, the global economy and key financial markets like the one for benchmark US government bonds now lack key top-down anchors such as growth momentum, confidence in policymaking signals, and stabilizing financial flows.
As economic-policy tools become more subordinate to political and geopolitical considerations, the already weak outlook for global growth may well deteriorate. Monetary policy faces a credibility threat and genuine structural uncertainties about the equilibrium level of interest rates and the delayed effects of a remarkably concentrated rate-hiking cycle. Moreover, shrinking central-bank balance sheets and the absence of an effective policy framework compound the challenge of determining the right inflation targets in a world economy characterized by an insufficiently flexible supply side.
Amid growing deficits and rising interest payments, there is also the question of who will absorb the significant surge in government debt issuance. For more than a decade, the Fed has been the most reliable buyer of US government bonds, owing to its seemingly limitless money-printing capabilities and minimal price sensitivity. But, having been forced by inflation and other excesses to shift from quantitative easing to quantitative tightening, the Fed is now a reliable net seller. International buyers also appear more cautious, partly owing to geopolitical tensions. Moreover, many domestic institutional investors, such as pension funds and insurance companies, have already accumulated significant bond holdings, incurring substantial mark-to-market losses.
Without these economic, policy, and technical anchors, the global economy and capital markets resemble boats in a rough and unpredictable sea. That brings us to the fifth driver of global uncertainty: the inadequate response to long-term crises like climate change and widening economic inequality. The longer we wait to tackle these problems, the greater the eventual costs will be. Our insufficient actions today ensure that we will face more complicated economic and political obstacles down the line.
As we write in Permacrisis, today’s world has been shaped by three ongoing failures: the repeated inability to achieve consistent and inclusive growth that also respects our planet; recurrent domestic-policy errors; and the constant lack of effective global policy coordination at a time when shared challenges demand collective action. Together, these failures have had profound economic, financial, institutional, sociopolitical, and geopolitical ramifications.
That is the bad news. The good news is that we have the capacity to solve these problems and turn today’s vicious cycles into virtuous ones. But to implement the major shifts required to achieve this goal, we need visionary political leadership at the national level and increased global awareness of our shared challenges. Absent such leadership, we risk leaving our children and grandchildren a world plagued by economic and financial instability, domestic political unrest, and geopolitical turmoil.
