What would we do if we avoided the possibility of a recession in 2023?
Posted January 7, 2023, 8:30 am
It is impossible to avoid it. At the beginning of the year, the festival of economic forecasts is in full swing. But does this exercise still make sense? Covid has overturned predictions for 2020. Those for 2022 were disrupted by the war in Ukraine. And Cassander was wrong to announce that the US is in recession this year.
In our opinion, managers and investors would do better to ask themselves what events might trigger them, rather than what kind of crises await them. Reversing the logic, we leave the hypothesis to develop scenarios. Building different frameworks allows you to identify potential risks and better react when one of them occurs. Dwight Eisenhower said that plans are useless, but planning is important. He was right, because what is valuable is not the prediction itself, but the preparation for the tests.
Three possible causes of recession
In practice, there are three main factors of decline. It can happen primarily when the confidence of economic actors is undermined. They then stop spending or investing. To have a significant impact, these shocks must be larger than the real economy can absorb—for example, during a prolonged lockdown.
A second possible factor is monetary policy, especially when central banks decide to raise interest rates too quickly, too much, or for too long, which stifles the economy.
Finally, recessions can occur when a financial bubble bursts. Like the global crisis of 2008 or the European debt crisis of 2011.
Now let’s apply this chart to 2023. The shock of rising energy prices in the Eurozone pushed the most vulnerable economies into recession. However, not all fears expressed in 2022 have been confirmed. Many European companies have been able to resist. In the third quarter, German industrial production was at the level of 2021, and natural gas was used 10-20% less.
Less aggressive rate hikes
Admittedly, recession cannot be ruled out, especially if the energy shock intensifies. But otherwise, the real economy may continue to surprise. European companies still have huge investment needs to continue their transformation, have the capacity to achieve them, and the labor market remains under strain.
What about the second factor? So far, European inflation has been largely driven by energy prices, with no influence from the ECB. Therefore, interest rate hikes were less aggressive than in the US. Only if inflation gains ground can monetary policy become the engine of recession in the eurozone.
Finally, it is reassuring for markets to note that tighter financing conditions are not driven by higher risk of insolvency or default, but rather by price volatility and lower valuations.
Difficulties seem to be avoidable
One thing is certain: 2023 will be difficult for our companies. The economic environment will remain extremely unusual, which will not facilitate transformations, especially the ecological transition, which will only increase in scale and relevance for companies. But barring new severe shocks, it seems possible to avoid the worst of the recession in Europe.
Indeed, the era of negative interest rates appears to be firmly over; the labor market will remain dynamic and investment will continue to strengthen. Three topics that Europe has not always scratched the surface of in the past. And in this foggy context, not just a plan, but above all, a lot of planning is required.
François Candelon is the global director of the BCG Henderson Institute and Philipp Carlsson-Szlezak is the chief economist of BCG.