In the wake of recent economic turmoil and geopolitical tensions, it’s essential to critically examine the intermediate-term outlook for the global economy. Satyajit Das draws insights from a recent International Monetary Fund (IMF) forecast and highlights some troubling prospects. This analysis unveils key challenges that may adversely affect global financial stability.
Yves here. Satyajit Das, referencing a recent IMF prediction, assesses the intermediate-term outlook for the global economy and discovers numerous concerning indicators. While Das does not align with the Modern Monetary Theory (MMT) perspective, he argues that the rising inflation we are witnessing largely stems from a decline in productive capacity due to shortages. Under such conditions, any deficit spending would exacerbate cost pressures. He also points out the potential risk of future deflation as the harsh realities of inflation and the resulting losses in real income kick in. This scenario is particularly evident in China. As we have previously noted, the attempt to stimulate spending through increased debt has proven ineffective. Richard Koo elaborates on this phenomenon in his book, The Escape from the Balance Sheet Recession and the QE Trap:
….traditional theories never considered recessions brought about by a private sector that was minimizing debt instead of maximizing profits. But the private sectors in most countries in the West today are minimizing debt or maximizing savings in spite of zero interest rates, behavior that is at total odds with traditional theory. The private sector is minimizing debt because liabilities incurred during the bubble remain, while the value of assets bought with borrowed funds collapsed when the bubble burst, leaving balance sheets deeply underwater. With everyone saving or paying down debt and no one borrowing, even at zero interest rates, the economy started shrinking.
Such recessions are not new and have occurred on a number of occasions in the past, most notably the Great Depression, but orthodox economics has no name for recessions triggered by a private sector that chooses to minimize debt. So I called it a balance sheet recession.
Another pressing issue is the heightened level of uncertainty, prompting investors to demand higher risk premiums for their investments. This shift results in increased bond yields and higher expected returns from equities, all else being equal. Once investors transition out of an unrealistic optimism, this newfound realism is likely to create more downward pressure on asset values.
By Satyajit Das, a former banker and author of numerous technical works on derivatives and several general titles: Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011) and A Banquet of Consequence – Reloaded (2016 and 2021). His latest book is on ecotourism – Wild Quests: Journeys into Ecotourism and the Future for Animals (2024). This is an expanded version of a piece first published on 19 May 2026 in the New Indian Express print edition.
In April 2026, the International Monetary Fund took the unusual step of releasing a “reference forecast” that posited a gradual easing of the disruptions stemming from the war with Iran by mid-2026. They also included “adverse” and “severe” scenarios to reflect the existing uncertainties and multifaceted challenges facing the global economy.
A primary concern remains inflation. The closure of the Strait of Hormuz and attacks on energy production facilities in Gulf Cooperation Council countries allied with the US have curtailed global oil and gas supplies by roughly 12 and 20 percent, respectively. This represents the most significant interruption in energy supplies on record, surpassing the effects of the 1979 Iranian revolution, the 1973 Arab oil embargo, Saddam Hussein’s invasion of Kuwait in 1990, or the Iran-Iraq war in the 1980s.
Rising energy prices are contributing to inflation. Global energy intensity has decreased from 131 liters per $1,000 of GDP at 2025 prices in 1973, to 116 liters in 1980, and to just 52 liters today. While this signifies a 60% reduction in average oil burden compared to 50 years ago, oil consumption is now heavily concentrated in critical sectors without convenient substitutes, such as freight transport, making them less price-sensitive and non-discretionary in nature. The full repercussions of soaring prices on essentials like food and a diverse array of other products will gradually unfold as increased energy costs and shortages of petroleum derivatives like fertilizer bleed into the economy. Given the extended timeline for restoring energy and other supply chains post-hostilities, prices are likely to remain elevated for a prolonged period. Persistently high inflation will likely result in prolonged higher interest rates, particularly for long-term maturities.
The second major concern revolves around growth. Outside of the US, where vigorous AI investments, tax cuts, and government spending are driving economic expansion, activity elsewhere is stalling. In numerous countries, escalating prices, uncertainty, and volatility are eroding consumer and business confidence, leading to a downturn in consumption and investment. In the US, households in the lower third of the income distribution are now spending 7 percent less, while the upper third remain largely unaffected. This K-shaped economy, where the financial performance of different socio-economic groups diverges, is not sustainable.
The effects will be most pronounced for energy-importing nations and those already facing vulnerabilities, such as limited economic diversity, low-income levels, or high debt burdens. Europe, which was grappling with challenges even before the Iran conflict, is now facing additional headwinds. However, Asia and Africa stand to suffer the most. Lower-income groups are especially at risk; the soaring costs of fuel and fertilizer will directly affect farmers, many of whom live below subsistence levels. Rising diesel prices have already thrown many industries into disarray. Street vendors may struggle to survive due to increased expenses for cooking gas and plastic containers. Countries reliant on tourism are experiencing a steep decline in bookings, reminiscent of the Covid-19 pandemic, as disposable incomes shrink and elevated jet fuel costs make affordable air travel less accessible.
The haunting specter of stagflation—characterized by low growth coupled with high inflation, reminiscent of the 1970s following oil crises—looms over the global economy. Should the crisis in Iran continue or escalate further, we cannot rule out the potential for a worldwide recession or even depression.
The consequences of the current situation on public finances are significant. The military costs associated with the US’s involvement in the Iran conflict may already exceed $70 billion. The administration is planning to increase defense spending by 44 percent to $1.5 trillion. The broader economic repercussions, such as repairing infrastructure, addressing human damage, servicing existing debt, and the overall economic impact, could surpass $1 trillion. The total estimated cost of the Iraq war has now reached $2 trillion or more.
Government measures to alleviate living costs caused by rising prices will further inflate public spending. Should conditions deteriorate further, tax revenues will likely decrease while welfare spending rises, intensifying deficits. This additional expenditure will require financing, which would impact interest rates and potentially burden other borrowers.
The confluence of these factors increases the risk of a financial crisis. Rising interest rates, sluggish growth, and looming concerns about government debt could trigger synchronized sell-offs in overvalued public stocks and bond markets. The threat is even more pronounced in private markets, which are generally illiquid and lack transparency.
In the long run, there is a significant risk of deflation. In economic terms, the remedy for higher prices often results in even steeper price increases. The destruction of demand—frequently lasting—ultimately drives prices down as consumption collapses. Coupled with the ramifications of Chinese industrial overcapacity and AI advancements, the threat of falling prices is far from negligible.
Deflation could prove devastating, particularly for heavily indebted economies. A stagnation or decline in incomes and tax revenues, combined with delayed consumption and investment driven by expectations of lower future prices, will complicate debt repayments. This would effectively elevate real debt levels and exacerbate the crisis. It could lead to declines in asset prices that underpin borrowing and trigger banking crises. Historical precedents like the Great Depression of the 1930s, Japan’s lost decades, and the aftermath of the European debt crisis in Southern Europe highlight the severe financial and social challenges that can arise.
Adding to this dilemma are constraints on governments’ abilities to implement corrective measures. Many states are grappling with high debt levels. Rising interest rates and associated expenses only amplify these limitations. Reducing rates becomes a challenge amid inflationary pressures. Additionally, many central banks are already burdened with expanded balance sheets due to numerous rounds of quantitative easing, and money market conditions remain lenient.
Policymakers may need to broaden their policy approaches. Options might include implementing income and price controls, or even nationalizing specific industries to stabilize supply chains and prices. Introducing capital controls on the inflow and outflow of funds and financial repression, where domestic investors are compelled to finance governments through the purchase of bonds at negative real rates, could also be considered. Other possibilities include explicit controls and taxes on imports, exports, or financial transactions. Structural changes, such as improved cooperation between governments and central banks to fund expenditures and manage currencies, may be explored.
However, resorting to such measures, alongside the growing awareness that the official safety net supporting asset prices is currently weak or non-existent, might itself catalyze or heighten economic and financial instability.
Interestingly, it appears that businesses and investors may be largely unaware of these looming risks. This prevailing optimism, whether grounded in ignorance or cognitive dissonance, may prove to be misguided. As Shakespeare noted, “desperate times breed desperate measures,” but they may also cultivate desperate hope.
© Satyajit Das 2026 All Rights Reserved
