[Before the Gaza conflict, I expected a soft landing for the United States, but a harder one for the rest of the world. Now, I expect the world may be entering its most dangerous period since the 1930s.]
If anything will dominate 2024, it will almost certainly be the US presidential election. This election is important not only for the United States, but for the world. The outcome may depend on the economic outlook for 2024, which in turn will depend in part on how the recent Middle East conflict evolves.
My best guess (and worst nightmare) is that Israel will continue to ignore international calls for a ceasefire in Gaza, where 2.3 million Palestinians have been impoverished for decades. What I saw during a visit to Gaza as the World Bank's chief economist in the late 1990s was heart-wrenching enough, and it has only gotten worse since Israel and Egypt imposed a total blockade 16 years ago in response to the Hamas takeover of the enclave.
Regardless of the atrocities committed by Hamas on October 7, 2023, the Arab street will not tolerate the atrocities suffered in Gaza. Given this, it is hard to see how we can avoid a repeat of 1973, when Opec's Arab members organized an oil embargo against countries that supported Israel in the war. Such retaliation would not really cost Middle Eastern producers, as higher prices would make up for the loss of supply. No wonder the World Bank and others warn that oil prices could rise to $150 a barrel or more. This will trigger another round of supply-driven inflation, just as post-COVID-19 inflation is being brought under control.
A closer look at the data shows that the post-pandemic inflation was not primarily caused by excess aggregate demand, but by supply shortages and changes in demand associated with the pandemic, which were exacerbated by the Russia-Ukraine conflict in February 2022.
Those of us who defend this position believe that inflation will be brought under control and then begin to fall, although no one can predict exactly when. And that's exactly what happened. Unfortunately, central banks have wrongly identified the root cause of inflation as excess demand and have done all they can to suppress it. That means raising interest rates fast and furious.
Nonetheless, the US is fortunate that the two mistakes will cancel each other out. Fiscal policy promises to be stronger than expected, with the Inflation Reduction Act now expected to boost spending three times more than expected, but the Fed's excessive tightening of monetary policy offsets this and achieves a soft landing.
Looking ahead, America's energy independence means that the main effect of high oil prices is to redistribute income from consumers to oil producers. True, this regressive outcome could be reversed by a well-designed windfall profit tax.
The rest of the world has not been so lucky. In Europe, where weaker fiscal policy has failed to offset tighter monetary policy, higher energy prices will be devastating. Across the global South, many countries have too much debt, which could become unsustainable in a global economic slowdown, especially if combined with high interest rates and higher oil and food prices.
Before the Gaza conflict, I expected a soft landing for the United States, but a tougher one for the rest of the world. Now, I expect difficulties everywhere, and the likelihood of Trump returning to the White House increases. The world may be entering its most dangerous period since the 1930s.
