Yves here. Satyajit Das, releasing the latest IMF forecast, looks at the prospects for moderate conditions in the global economy and finds a lot not to like. Das disagrees with the MMT school of thought, but in already stagnant inflation, deficit spending (especially when inflation is caused by a reduction in productive capacity due to shortages) means that deficits will only add to cost pressures. He also talks about the risks of inflation over time such as the difficulty of inflation and the real profit loss. China is already in that place. One effect is, as we have noted, to try to use more credit creation to encourage more spending failures. Richard Koo describes this disease in his book, The Escape from the Balance Sheet Recession and the QE Trap:
….traditional theory did not consider the recession brought about by the private sector reducing debt instead of increasing profits. But the private sector in many Western countries today is reducing debt or increasing savings despite zero interest rates, behavior that is completely at odds with conventional wisdom. The private sector reduces debt because the debt incurred during the bubble lasts, while the value of the assets purchased with the loan decreases when the bubble bursts, leaving balance sheets underwater. With everyone saving or paying down debt and no one borrowing, even with zero interest rates, the economy began to shrink.
Such recessions are not new and have occurred many times in the past, most notably the Great Depression, but the general economy does not have the name of a recession caused by the private sector choosing to reduce debt. So I called it a balance sheet recession.
The second problem: high levels of uncertainty lead investors to assign higher risk premiums to investments, as higher bond yields or higher expected returns from stocks are required, all other things being equal. Once investors are out of hopium mode, the newfound calm may put more downward pressure on asset prices.
By Satyajit Das, former banker and author of many derivative technical works and several mainstream titles: Traders, Guns & Money: Knowns and Unknowns in the Wonderful World of Derivatives (2006 and 2010), Extreme Money: Masters of the Universe and the Cult of Risk (201 – 16 and 20116) and Aqued Aqued (2011) 2021). His latest book on ecotourism – Wild Quests: Journeys into Ecotourism and the Future for Animals (2024). This is an extended version of an episode originally published on 19 May 2026 at New print edition of Indian Express.
In April 2026, the International Monetary Fund took the unusual step of issuing an “indicative forecast” that assumed the disruption caused by the war with Iran would disappear by mid-2026. They added “bad” and “difficult” scenarios that reflect the growing uncertainty and many problems facing the global economy.
The current concern is inflation. The closure of the Strait of Hormuz and attacks on energy production facilities in the US-allied Gulf Cooperation Council countries have reduced global oil and gas supplies by 12 percent and 20 percent respectively. The biggest disruption of energy supply in history, the biggest is the impact of the Iranian revolution of 1979, the Arab oil embargo in 1973, Saddam Hussein’s invasion of Kuwait in 1990, or the Iran-Iraq war in the 1980s.
Higher energy prices feed inflation. Global energy intensity has decreased from 131 liters per $1,000 of GDP in 2025 prices in 1973, 116 liters in 1980 to 52 liters today. Although this means that the average oil burden is 60 percent lower than 50 years ago, oil needs are now concentrated in critical areas without replacing simple ones, such as freight, which are highly price sensitive and indiscriminate. The full impact of higher prices on essentials such as food and a wide range of other products will emerge gradually as higher prices and shortages of petroleum products, such as fertilizers and other chemicals, bleed into the economy. With the full restoration of energy and other essential supplies likely to take some time after the end of the conflict, supply chains may remain stuck, and prices raised for a long time. Higher inflation means higher rates for longer periods of time, especially for longer maturities.
The second concern is growth. Outside of the US where manic AI investment, tax cuts and government spending continue to expand, economic activity is at a standstill. In many countries, high prices, uncertainty, and volatility undermine confidence. Consumption and investment are slow. In the US, households in the bottom third of the income distribution now eat 7 percent less, although spending by the top third remains unaffected. This K-shaped economy, where the performance of different economic and social groups differs, is unsustainable.
The impact will be greater for energy importers and countries with existing weaknesses, such as less dependent economies, lower incomes, or higher debt levels. Europe, already having its challenges before the Iran war, is facing storms. But Asia and Africa are likely to be most affected. Low-income groups are particularly vulnerable. Higher fuel and fertilizer costs will impact farmers, most of whom live at subsistence levels. The rising cost of diesel has already crippled many industries. Small street vendors will struggle to survive due to the high price of cooking gas and plastic containers. Tourism-dependent countries are seeing a sharp drop in bookings reminiscent of the Covid19 pandemic as disposable incomes drop and high jet fuel costs reduce the availability of cheap flights.
The specter of inflation, low growth and high inflation, reminiscent of the 1970s and after the oil boom, hangs over the world economy. If the war in Iran continues or escalates, then a global recession or even depression cannot be reduced.
The damage to public finances is enormous. The military cost of Iran’s “trip” or US “game” alone could be over $70 billion. The administration wants to increase defense spending by 44 percent to $1.5 trillion. The total economic cost, including the cost of repairing infrastructure and human casualties, interest on the debt, and the impact on the economy, could exceed $1 trillion. The cost of the Iraq war is now estimated at $2 trillion or more.
Subsidies or other means of reducing the cost of living pressures caused by high prices add to government spending. A continued deterioration in economic conditions will reduce tax revenue and increase social spending that accelerates the deficit. These costs must be financed and will increase pressure on rates and may squeeze other borrowers.
A combination of factors risk creating a financial crisis. High rates, slow growth and concerns about the government’s debt, which is already in place, could trigger a coordinated sell-off across the large-cap public stock and bond markets. The threat is even greater in private markets that are inherently opaque and lack transparency.
The long-term risk is deflation. In economics, the answer to higher prices is higher prices. The effect of the destruction of demand, which usually lasts for a long time, eventually lowers the price as consumption falls. Along with the impact on supply and costs of China’s industrialization and AI, the downside risk is negligible.
Inflation can be particularly damaging to indebted economies. Fluctuating or declining income and tax revenues combined with deferred consumption and investment in anticipation of lower future prices can make meeting debt payments difficult. Real credit levels could rise and exacerbate the problem. It will encourage a fall in asset prices that support the lending that causes banking problems. The world experienced the Great Depression of the 1930s, the lost decades in Japan, and the effects of the European debt crisis in Southern Europe causing severe financial and social difficulties.
The problems are compounded by constraints on governments’ ability to take corrective action. Many states have high debt levels. Higher interest rates and rising interest costs can increase limits. Reducing rates is difficult amid inflationary pressures. Many central banks have bloated balance sheets after multiple rounds of quantitative easing. Money market conditions are already easing.
Policy makers may need to expand their policy options. This may include revenue and price controls. Nationalization of certain industries to control subsidies and prices is another possibility. Inflow and outflow controls and capital compression, where domestic investors are forced to finance governments through the purchase of bonds issued at negative real rates, is another approach. Clear controls and taxes on exports and imports or financial transactions are possible. Institutional reforms, such as cooperation between governments and central banks to finance spending and financial regulation, may be considered.
But resorting to these processes and realizing that the legal backstop on asset prices is weak or non-existent can cause or accelerate economic and financial instability.
Interestingly, businesses and investors seem to be oblivious to these risks. This trust, ignorance, or disagreement may seem inappropriate. Shakespeare noted that “desperate times breed desperate ways” but they can also produce hopeless hope.
© Satyajit Das 2026 All Rights Reserved
