Powerful non-economic forces once again shaped economic developments over
the past year. The emergence of the Omicron variant of Covid-19 dashed hopes of
a quick and smooth global “pandexit”. Meanwhile, the invasion of Ukraine triggered
the largest European armed conflict in decades. First and foremost a humanitarian
disaster, the war also had major repercussions for commodity and financial markets,
and global supply chains.
For much of the year, growth was resilient. The global economy expanded
strongly in 2021, although in the United States and China it fell short of expectations.
As the review year progressed, the expansion lost some momentum, with supply
constraints, Omicron and the war in Ukraine blowing headwinds.
Against this backdrop, global inflation rose to multi-decade highs. At first,
higher inflation was seen as transitory, reflecting increased relative prices for a small
number of pandemic-affected items. But it proved persistent, broadening over
time. In response, central banks generally brought forward the timing and pace of
policy tightening.
Higher inflation and shifting expectations of the policy response
led to bouts of financial market volatility, with financial conditions tightening
substantially as the year progressed, albeit from an exceptionally easy state.
This combination of forces makes for a challenging outlook. The mix of high
inflation, high and volatile commodity prices and significant geopolitical tensions
bears an uncomfortable resemblance to past episodes of global stagflation. An
uncertain growth outlook in China reinforces the downside risks. Unlike in the past,
stagflation today would occur alongside heightened financial vulnerabilities,
including stretched asset prices and high debt levels, which could magnify any
growth slowdown.
In this environment, policymakers face several challenges. In the short term,
the priority is to bring inflation down while limiting as far as possible the cost to
economic activity and preserving financial stability.1 At the same time, there is an
Key takeaways
• Two powerful forces – the Covid-19 pandemic and the Russian invasion of Ukraine – shaped economic
outcomes over the past year.
• Growth was resilient, at least until the outbreak of the Russia-Ukraine conflict. Inflation rose to
multi-decade highs against a backdrop of persistently goods-intensive demand and constrained
supply.
• Stagflation risks loom large, owing to high inflation, the war in Ukraine and slower growth in China.
Pre-existing macro-financial vulnerabilities magnify the risks, which could disrupt financial systems
and strain emerging market economies.
• The most pressing monetary policy task is to restore low and stable inflation, while limiting as far as
possible the cost to economic activity and preserving financial stability. Over the medium run, there
is a need to sustainably rebuild monetary and fiscal buffers. Governments should reignite supply
side growth drivers.
2 BIS Annual Economic Report 2022
imperative to rebuild monetary and fiscal buffers through a durable normalisation
of policy settings. Recent economic developments further complicate this task.
Fiscal policy in particular faces pressure to address higher living costs and, in some
countries, increase military expenditures, while having to honour longer-term
commitments to “green” the economy. These challenges put a premium on supply
side reforms to promote sustainable growth.
This chapter first describes the key economic and financial developments over
the past year. It then examines the looming stagflation risks. Finally, it elaborates on
the policy challenges