On the eve of Davos 2023, we ask the experts: Can you cut inflation without causing a recession?

The latest World Economic Forum's Chief Economists Outlook was published today, 16 January 2023, and inflation is a key discussion point within it. After years of relatively low inflation, inflation soared across the world last year. The last quarter of 2022 saw some easing of inflationary pressures, however, and there is some evidence to show that the medium-term inflation outlook for 2023 may continue along the same path.

The latest IMF forecast is that global inflation will dip to 6.5% this year, from 8.8% in 2022. The Chief Economists' Outlook finds that a number of factors contribute to this: rapid and synchronised monetary tightening, stabilisation of supply conditions and commodity prices and an easing of demand pressures.

We will see significant regional variations in the inflation outlook for 2023, however, according to the latest survey of chief economists for the Chief Economists' Outlook. Although 'very high' inflation is not forecast anywhere, 57% of respondents shared high inflation expectations for Europe, while just 5% of respondents foresee the same fate for China. Year-on-year, the proportion of respondents expecting high inflation in Europe increased from 47% to 57% since September 2022, while for the US it fell sharply from 43% to 24%.

Erik R. Peterson, Partner and Managing Director, Global Business Policy Council at Kearney has a relatively optimistic response to this question. "Traditional economic theory holds that inflation is actually a good thing when appropriately contained and that 'killing' it would be less economic than merely 'wounding' it by bringing it down to a manageable level," he says.

"To be sure, it is critical for central banks to arrest the current high rates of inflation, but the prospects are that price pressures (accelerated by aggressive tightening by central banks) will dissipate significantly this year. Policymakers are well aware that the trade-off in addressing inflation is foregone growth and perhaps even recession in the short term, and the optimal outcome would be a 'soft' landing."

Fernando Honorato Barbosa, Chief Economist of Banco Bradesco, foresees a mild recession on the horizon, as a result of inflationary easing. He explains: "The pandemic was one of those life-threatening events that we hope not to relive anytime soon. Central banks and policymakers had to respond to it despite the low visibility. It was like landing a big jet having no radar and under absolutely hostile and unknown weather conditions. Nevertheless, they successfully landed it. With the benefit of hindsight, however, the fiscal and monetary expansions were excessive, producing the largest inflation and supply shortage in 40 years in most developed economies.

"Now, it is time to get back to a more synchronised economic policy. Fiscal and monetary [policy] should work together to assure that inflation will not last much longer and to prevent that dramatic action from being required later, as happened in the 1980s. The cost of postponing the fight against inflation could be significant. Throughout this path of correction, a global recession seems inevitable by 2023. Considering the high efficiency of monetary policy these days, it should be a mild one. Two per cent inflation is achievable and desirable, it produces the best incentives for growth and efficient capital allocation and it ultimately protects the poor and wages."

Inflation can be killed without causing a recession, but history shows how difficult this can be to achieve, adds Ira Kalish, Chief Global Economist at Deloitte Touche Tohmatsu. "For this to happen, there would have to be factors other than tightening of monetary policy to help stifle inflation. The best hope for this scenario is in the US, where inflation is already decelerating largely due to an improvement in supply chain efficiency and declining energy prices. Although monetary policy has tightened substantially, the US economy has remained surprisingly resilient, with both consumer spending and business investment relatively immune to higher borrowing costs. It is possible that the US will avoid a recession in 2023 and still get inflation down to the desired level. This is not, however, a likely scenario for Europe, where a combination of monetary tightening and energy shocks make a recession almost inevitable in 2023.

"Meanwhile, the 2% target remains in place for major central banks. While an argument has been made to adjust the target given tight labour markets and shaken global supply chains, doing so would likely shock financial markets and reduce central bank credibility. This, in turn, would probably lead to much higher borrowing costs, thereby stifling recovery."