Pandemic reveals larger risks to global growth

Global economic uncertainties remain high, despite an easing in concerns about the fallout from the Russia-Ukraine conflict. Evidence suggests risks to growth are significantly greater than prior to the COVID-19 pandemic.

We (at Oxford Economics) have extended our analysis of past forecast errors to incorporate the economic disruption seen during the pandemic. Our latest estimates imply a higher probability of tail risks in the near term and further ahead. Updated figures from central banks paint a similar picture.

Increased uncertainty accords with pandemic experience. Growth varied hugely across countries in the aftermath of earlier public health crises. The pace of expansion has also diverged markedly during the recovery from the pandemic.

Market pricing and business perceptions are also consistent with sizeable risks. But other forecasters appear to be vastly understating global economic uncertainty. Research suggests that, on average, professional forecasters have systematically under-represented risks in previous decades. Many appear to be repeating the errors of the past.

A natural guide to navigating future uncertainty is looking at experience from the past. To gauge the scale of risks to the global outlook, we examined the pattern of our past forecast errors－both before and after the pandemic－and revisited our earlier analysis of historical recoveries from public health crises.

As part of our regular review of alternative risk metrics, we also analyzed a raft of other evidence, which included market pricing and the perceptions of businesses, households, and other forecasters.

Some metrics reveal a large reduction in war-related concerns during the second quarter of 2022. But, taken together, the weight of evidence points to elevated levels of uncertainties, well above those seen prior to the pandemic.

In the early stages of the pandemic, we examined the performance of economies directly affected by previous public health crises. We reviewed 252 country recovery episodes from the modern era and calculated the deviation of GDP from the pre-pandemic trend. The focus was on severe crises with significant numbers of infections that are most comparable to the novel coronavirus pandemic.

A key feature of earlier pandemics is the remarkably wide distribution of recoveries. Many were characterized by significant adverse economic impacts that increased over time. Others exhibited much more muted medium-term weakness, especially when supported by the establishment of early recovery.

Fortunes have also diverged widely in the wake of the COVID-19 pandemic－even though, at the global level, recovery has so far broadly matched the "typical" median post-pandemic experience. This highlights the risks inherent in recovery from such substantial economic shocks.

In the United States, for example, we anticipate a similar level of GDP in the middle of this decade as anticipated prior to the pandemic. By contrast, in India, the level of GDP in 2025 is still expected to be 9 percent below our pre-pandemic forecast.

Another guide to the scale of economic uncertainty is past forecast errors. This is central to the approach employed in Oxford Economics' forward-looking distributions, which indicate the likelihood of different macroeconomic outcomes. The methodology behind these distributions, which are used in our IFRS 9 service, is comparable to that used by central banks when assessing risks to their central projections. IFRS 9 is a financial reporting standard developed and approved by the International Accounting Standards Board.

Updating for forecast errors during the pandemic, we find a widening of our distributions for future GDP growth. Bank of England estimates show a similar increase in uncertainties compared with before the pandemic.

Investors also appear more uncertain. Based on estimates derived from option markets by the Federal Reserve Bank of Minneapolis, the market-implied distribution of equity market outcomes has further widened recently and is markedly wider now than before the pandemic. A similar picture emerges for other variables, such as heightened uncertainties about the US Federal Reserve's policy and exchange rates.

By contrast, many professional forecasters express a high degree of certainty about their central forecasts, appearing especially sanguine about the eurozone's prospects.

The latest European Central Bank survey suggests professional forecasters see, on average, just a 1-in-40 chance of the eurozone's contraction next year. This is even lower than before the pandemic－although research shows professional forecasters had previously underestimated the uncertainty about their central forecasts.

Business uncertainty has also fallen to below pre-pandemic levels. This follows a recent easing in Ukraine crisis-related concerns that, based on our index of geopolitics-related Google search queries, is also apparent among households. But businesses still see a significant chance of large economic shocks, attaching a 1-in-7 probability to global recession in 2023.

Overall, our alternative risk metrics confirm that economic risks remain skewed to the downside. Like our scenario-based risk-weighted projections, all point to weaker growth than in our baseline forecast (by 0.4 percentage points on average in 2023). Moreover, the weight of evidence suggests that the risk of sharply weaker growth is elevated－well above the levels seen prior to the pandemic.

The author is head of Macro Scenarios at Oxford Economics.

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