Do the recent banking disruptions make recession more likely? Chief economists explain

In March 2023, global financial markets were rattled by significant banking crises around the world.

In the United States, a flurry of bank runs brought down Silicon Valley Bank, an institution deeply intertwined with technology investors, and multiple other mid-sized financial institutions. Meanwhile, in Switzerland, a collapse in confidence of the beleaguered Credit Suisse resulted in a government-brokered takeover by UBS.

As the World Economic Forum’s latest Chief Economists Outlook noted, “these bank failures, and the market panic they induced, briefly sparked fears of the kind of systemic financial vulnerabilities that caused the 2007-08 global financial crisis.”

Of the chief economists surveyed in the report, nearly 70% characterized the recent banking crises as isolated episodes rather than signs of systemic weakness. Nonetheless, a large majority of respondents also said they expect further bank failures this year. As the report notes, “fears of systemic disruption have since abated, but concerns persist about pockets of financial vulnerability being revealed as rapid recent increases in interest rates begin to bite.”

So have recent banking disruptions made recession more likely globally or in particular economies? In the following statements, three chief economists provide insights.

“The last two years have seen a collapse in real wages across most major economies. Ordinarily this would have triggered a significant economic downturn, but the combination of increased credit use and an unusual windfall of pandemic-era savings kept consumer spending relatively buoyant.

“The severity of the economic slowdown in 2023 depends on whether real wages stabilise before savings and access to credit are exhausted. As such, if banking system volatility accelerates the tightening of lending standards, that must increase the risk of a more abrupt economic slowdown.

“The impact of tighter credit standards on consumers is likely to be uneven. In the US in particular, lower income households have resorted to credit for day-to-day living expenses. Unfortunately, data quality offers limited insights into the economic damage in real time. Proper analysis needs an understanding of which banks are tightening lending standards, and then which groups in society normally borrow from those banks – data which is not readily available.

“The hints in the numbers that we do have suggest that, for now, the banking disruption should be seen as a modest increase in the probability of a downside risk case and not a more negative base case for growth.”

“Economic turbulence and geopolitical tensions ignited recession fears prior to the outbreak of the recent banking turmoil. This risk has only heightened as the inevitable build-up of vulnerabilities from rapid interest rate increases emerge. Although central bank action has contained the banking sector disruption and risk of financial contagion, there may be more surprises to come.

“All the ingredients for continued interest rate hikes are still present. Consequently, not only has the risk of a recession increased but as has its potential potency. Developed economies, notably the US, the UK and Europe, are the most susceptible to economic downturn. The longer its duration, the greater the likelihood of the recession deepening and eventually eroding conditions in emerging and developing countries.”

“The risk of a credit crunch has increased as we undergo the fastest interest rate tightening since the 1970s. It is essential that we win the fight to regain price stability in my view. With central banks arguably late to the game in hiking interest rates, and after the significant fiscal stimulus in the US, I do not see how wage inflation can come down without a significant slowdown in the labour market, and consequently growth.

“However, 2023 is not 2008. In my view, we were already in a regime for inflationary recessions well before the banking turbulence occurred. The higher funding costs and tighter lending conditions that we are seeing now are increasing the likelihood of recessions. Slower growth is needed to slow inflation; in that sense, the banking disruption is not signalling the start of another global financial crisis as in 2008.

“Today is also different because banks are much better capitalised. However, on the downside, the financial market plumbing is also very different today from the global financial crisis. It will be very challenging for central banks to keep financial stability and monetary operations separate, with the corollary being regular wake-up calls from the market volatility ghost.”