Volatility from macroeconomic and geopolitical factors has dominated the business environment lately and tested management teams in ways that may once have seemed unimaginable. However, at the outset of 2023, energy prices are off their peaks, inflation is no longer accelerating, and economic growth appears to be holding up. These positive signs make it tempting to expect a narrower range of potential macro outcomes and, as in any new year, seek a fresh start. We see 2023 as a test of whether such a fresh start is now possible.
With geopolitical tensions high, key supply–demand imbalances unresolved, and interest rates on an upward march, business leaders may be contemplating whether comparisons to the 1970s are appropriate or if the path forward will resemble more familiar business cycles. The big-picture question for leaders is: Will their companies ever return to a prepandemic-like world of 2 × 2 uncertainties, or has there been a permanent reset to a 3 × 3 world, where uncertainties are multiplied (Exhibit 1)?
To help leaders answer this question, McKinsey has developed a wide range of macroeconomic scenarios for 2023 and beyond. The scenarios consider favorable and not-so-favorable long-term outcomes and delineate the shorter-term choices that will largely determine which path the global economy could ultimately take. Leaders must decide which actions they should take regardless of how the environment plays out and what calibrated risks they should pursue in a bid to move their companies boldly forward. Some might conclude that their business model and strategic moves would remain largely the same across the macro outcomes they consider plausible, while others may see different opportunities and risks.
To put the scenarios into context, we begin with our views on the top issues of 2022: inflation and labor market dislocations. We believe it is important to lay out the facts on these topics, which have thus far avoided consensus, so leaders can create lasting solutions.1 We then share McKinsey’s new macroeconomic scenarios, focusing on the United States and the eurozone.2
We find that the best leaders and companies navigating these volatile times are both prudent about managing the downside and aggressive in pursuing the upside. We hope such leaders can use these scenarios to make practical decisions to reach their goals.
Understanding 2022’s economic headlines: Inflation and labor markets
Looking back one year, the world was facing numerous tests. In January 2022, the COVID-19 Omicron variant was spreading fast. Logistics teams continued to struggle with fractured supply chains amid record demand.3 Commodity prices were up 30 percent, global container shipping rates nearly tenfold, and inland freight haul rates soared.4 Labor market imbalances, most acute in the United States and the United Kingdom, boosted wages up to two times the pre-COVID-19 pace. Inflation was reaching what appeared at the time to be generational highs.5
Even so, there was hope that the worst pandemic repercussions were over. Then, in February, hope turned again to anxiety when Russia invaded Ukraine. Many businesses joined the chorus of condemnation,6 and the ensuing war ignited the worst humanitarian crisis in Europe since World War II, a global food and energy crisis,7 and an acceleration of the negative disruptions already under way.
How did the world end up with the highest inflation in a generation?
From March 2020 to November 2022, consumer prices rose nearly 16 percent in the United States, 15 percent in the eurozone and the United Kingdom, 16 percent in India, and 21 percent in Brazil.8 These increases are two to three times greater than what would have been expected based on pre-COVID-19 outcomes. Even in Japan, which has been fighting deflationary pressures for decades, prices in November 2022 were up 3.8 percent during the previous 12 months, the highest monthly inflation rate recorded in more than 40 years.9
What about ‘money printing’?
‘Too much money chasing too few goods’ is an often-used refrain to explain the origins of inflation. Milton Friedman, this view’s most prominent historical advocate, famously wrote in 1963 that “inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”1 The implication is that central banks can directly control the rate of inflation by regulating the growth of the money supply.
The US money supply2 increased nearly 40 percent from February 2020 to December 2022, inspiring quantity-theory adherents to give Federal Reserve chairman Jerome Powell a proverbial yellow card for causing the current bout of inflation. However, whether Powell actually deserves blame depends on the “velocity of money.” Just as we look at a company’s inventory-to-sales ratio, the velocity of money tells us how many times the money supply needs to turn over relative to total spending in the economy (price times volume). If velocity is stable, then the growth of the money supply has a direct link to prices and inflation.
When Paul Volcker took the reins at the Fed in August 1979 with a mandate to quash inflation, he tested the quantity theory by having the Fed directly control the growth rate of the money supply. It didn’t take long for the Fed to realize that this control didn’t have the desired impact. It turned out that, in practice, money’s velocity isn’t stable and the money supply can’t be used as a reliable instrument for monetary policy.3 Volcker quickly pivoted to focusing on raising interest rates, which reached nearly 20 percent before the fight against inflation was over.
Facing similar circumstances, Gerald Bouey, governor of the Bank of Canada, quipped in 1982, “we didn’t abandon monetary aggregates, they abandoned us.”4 A decade later, Fed chairman Alan Greenspan said, in his July 1993 testimony before the US Congress, that “the historical relationships between money and income, and between money and the price level, have largely broken down, depriving the aggregates of much of their usefulness as guides to policy.”5
The Fed’s postpandemic policy did contribute to inflation, but in a more indirect way. During the 2008 financial crisis, central banks learned that once they have lowered to zero the short-term interest rate that they control, asset purchase programs (also known as “quantitative easing” or QE) that buy up long-duration securities can push longer-term interest rates lower and generally loosen financial conditions. The impact of this extra stimulus can be illustrated with a “proxy rate”6 that translates QE into equivalent movements of short-term rates (Exhibit A).
The QE programs pursued by the Fed and European Central Bank during and after the financial crisis didn’t spark inflation, which remained below historical averages. Similarly, the programs the Bank of Japan pursued, starting in the late 1990s, couldn’t reverse the deflation that Japan experienced for most of the 2000s. During these episodes, there was a great deal of excess capacity in the United States, eurozone, and Japanese economies, and the extra stimulus provided by QE didn’t measurably impact inflation.
The Fed again turned to QE in March 2020 when the pandemic struck, as it successfully raced to ensure global financial markets didn’t freeze in the panic. Critics say the Fed stuck with the QE program for too long and that this additional stimulus contributed to cyclical demand and wage pressures, which added to inflation. Our estimate is that cyclical pressures accounted for about one-third of the total increase in inflation through September 2022, with this share increasing as commodity and supply shocks faded. We don’t know how much of these cyclical pressures were caused by QE, stimulus programs, or accumulated savings. The proxy rate shows that the reversal of the QE program has amplified the tightening of financial conditions as the Fed has aggressively raised rates.
While historical experience demonstrates that QE doesn’t directly lead to inflation in the prices of goods and services, it can indirectly spur demand by loosening financial conditions. It’s also widely held that episodes of QE have buoyed asset prices as market players search for yield by buying higher-risk assets.7 QE has become a standard tool for central banks around the world. To understand the path of policy in 2023, business leaders should recognize these tools for what they are.
Many competing views have been offered about the current inflation’s origins and the reasons for its persistence, but we see the facts as much simpler than the debate suggests (see sidebar “What about ‘money printing’?”). Recent work by economists at the Brookings Institution and the Federal Reserve Bank of San Francisco provide a useful analytical framework to explain the origins of US consumer price inflation, which we adapt here.10 In addition to approximately 2 percent normal annual inflation, the following three factors should be considered:
- The direct impact of commodity shocks and supply chain dislocations: disruptions in oil, gas, and basic food markets, and supply–demand mismatches (for example, when semiconductor shortages caused used car prices to spike).
- The pass-through of businesses’ higher material costs: commodity shocks and supply chain dislocations slowed production and raised business material costs.
- The pass-through of higher wage costs: the shock to labor markets led to a doubling of wage growth as businesses competed for scarce workers to meet surging demand.
Inflation over the past three years demonstrates the above factors in action. In 2020, the economic collapse, unprecedented stimulus programs, and surprise V-shaped rebound left US inflation at about 2 percent. Then, in 2021, inflation initially picked up steam as pent-up demand from pandemic lockdowns bumped up against commodity market and supply chain dislocations, and businesses began raising prices. Energy prices were still elevated when concerns about a Russian invasion of Ukraine drove them even higher at the end of 2021, ultimately bringing US inflation close to 9 percent. In 2022, these factors were compounded by and eventually overtaken by demand-driven wage pressures, which became the dominant driver of inflation (Exhibit 2)—and inflation expectations rose.
If US inflation had increased each year along with 2.2 percent prepandemic annual expectations,11 then by the end of September 2022, the level of prices would have been 6.2 percent higher. Only it wasn’t. The total increase in the price level since January 2020 was 14.9 percent. Two-thirds of those extra 8.7 percentage points can be credited, either directly or indirectly, to commodity and supply chain shocks (Exhibit 3). The remaining third was largely the result of an increase and shift in the composition of demand that outstripped companies’ capacity to produce and the wage and price increases that followed. This demand was supported by stimulus programs, accumulated savings, and accommodative monetary policy.
The eurozone story starts in the same way, with inflation rising because of pandemic-era commodity and supply chain shocks. Unlike in the United States, policy makers and businesses leaders in the eurozone were able to keep workers attached to their jobs through existing furlough programs and job subsidy channels that reduced labor market disruptions and wage inflation.12 However, the impact of the Ukraine invasion on eurozone inflation was far greater than in the United States, dramatically raising energy prices across the continent. Consequently, eurozone inflation has been almost exclusively caused by the continued direct impacts of energy supply shocks combined with the aftermath of supply chain disruptions, and the pass-through of these costs by businesses.
What happened to the US labor market?
In March and April 2020, pandemic-related shutdowns caused US private-sector companies to shutter their doors en masse, eliminating more than 21 million jobs.13 Adjusted for the size of the economy, this level of job loss was only surpassed during the Great Depression.14
US workers and businesses are still dealing with the consequences nearly three years later. One of the most visible outcomes—from the point of view of employers—has been the difficulty of hiring. In the first ten months of 2022, the unemployment rate averaged 3.7 percent and total private-sector job openings averaged 10.1 million per month. Compare those figures with several points in 2019 and early 2020, when unemployment rates were similar but total private-sector job openings averaged 6.4 million per month.
It’s the jobs riddle of the postpandemic era: At 3.7 million additional job openings per month, why are vacancies 60 percent higher than just before the pandemic?
Many analysts focus on the fact that fewer people joined the labor force than expected,15 a deficit we estimate to be about 1.6 million. Lower participation has indeed contributed to labor market tightness but doesn’t explain why there are 3.7 million additional monthly job openings. A deeper analysis of age brackets, job types, and employee behavior reveals three additional causes (Exhibit 4).
First, the US population is aging quickly, so part of the decline in labor participation is due to entirely normal retirement behavior. The 16- to 64-year-old group increased by 1.5 million people between January and November; however, in the same period, 3.5 million baby boomers reached age 65. In any typical year, 80 percent of those turning 65 retire and about 26 percent of those aged 16 to 64 don’t join the labor force.16 Normal behavior patterns would thus explain why, within these age cohorts, 2.8 million people retired and 400,000 others did not work.
Second, there is evidence of a lasting jobs–skills mismatch17 in the wake of the “layoff” of 2020. Workers did not simply re-up with their same jobs when the pandemic subsided. Instead, shifts in demand across industries and geographies occurred and workers moved, lost or gained skills, or took new and different jobs. We estimate that in 2022, it took an average of 40 percent longer for an employer to fill a vacancy than it did in 2019.18 By November 2022, the differential recovery of employment across industries had changed the mix of jobs, as workers found employment in growing sectors (Exhibit 5). The persistence of excess vacancies demonstrates that the mismatch of skills and geographies continues.
The third reason for scarce labor is due to more workers reevaluating what they want from a job—and from life. Employees are leaving traditional employment for temporary, gig, or part-time roles, or are starting their own businesses. Some are quitting because of life demands—they need to care for children or elders. Health problems for many persist. Some workers are ready for a break and feel confident they will find another job when they want one.
None of these three factors will be easily or quickly resolved. But they are knowable and business leaders can change their approach to the talent equation.
Scenarios for what could happen next
When the pandemic struck, the primary sources of uncertainty for individuals, businesses, and governments were the impact of the virus’s spread and the effectiveness of responses. Other concerns just had to wait. When Russia invaded Ukraine, uncertainty regarding the duration and scale of the disruption, sanctions, and policy responses was the focus.
Today, a complex and varied set of forces is potentially introducing a new era, with multiple sources of risk, opportunity, and potential transformation. Leaders must weigh how the world order, technology, demographics, energy and resources, and capital will evolve and affect their businesses (see sidebar “The ‘cusp’ and McKinsey’s economic scenario framework”). With these forces in mind, there are two primary dimensions that define McKinsey’s new scenario framework, as Exhibit 1 shows.
- The first dimension is the state of long-term structural balance and international cooperation. This dimension captures how well the supply of materials and manufactured goods, and the people, data, and capital they require, can satisfy global demand at affordable prices. It is strongly influenced by local regulations that determine supply responses as well as by the institutions and frameworks that govern diplomatic relations and international exchange. A key example of an issue within this dimension is how effectively the world can establish the regulations and relationships required to deliver an affordable energy transition.
- The second dimension is the short-term level of fiscal support and state of monetary policy. This dimension captures how well government spending and market-based incentives are targeted. It also captures how central banks affect the availability of credit and overall financial conditions. It is strongly influenced by national political dynamics. A key example of an issue within this dimension is how effectively current moves by central banks can rein in inflationary pressures.
How these two dimensions vary and interact shape choices made by individuals, businesses, and not-for-profits (including nongovernmental organizations [NGOs] and universities) to spend, invest, and pursue innovative solutions. The interplay between dimensions will largely determine the range of macroeconomic outcomes in McKinsey’s new global scenarios, including how fast productivity, wages, and profits might grow; how labor force participation could rise or fall; how much consumers may spend and businesses invest; what heights inflation may reach; and how affordable the energy transition could be.
The following two scenarios, labeled A1 and C2, depict the range of outcomes that CEOs and their executive teams will most likely need to consider entering 2023. A third scenario, C3, portrays a sobering downside reminiscent of the economic experience of the 1970s (see sidebar “The C3 scenario: Deep recession, long-term growth limitations, and significant regime change in inflation management”). A recent tally of economic forecasts shows a wide range of GDP growth estimates for 2023, from a low of –1.4 percent to a high of 1.2 percent in the United States, and –0.8 to 0.8 percent in the eurozone.19 The McKinsey scenarios illustrate this range and include additional downside risks that should be considered.
The A1 scenario: ‘Soft landing,’ accelerating into prosperity with target inflation
In the A1 scenario, individuals, businesses, and governments renew their commitments to accelerating global cooperation. Societies commit to absorbing the costs of ensuring resilience, reliable access to critical sectors, the vitality of local economies and communities, and promoting regulations that expand affordable supply. The conflict in Ukraine and other international tensions escalate no further and perhaps even begin to wind down.
Economic policy makers in the eurozone and the United States create incentives to boost public- and private-sector investments that help resolve near-term energy supply–demand imbalances. Coordinated actions by central banks steer 2023 without a recession. Inflation begins returning to central bankers’ 2 percent targets (Exhibit 6) and real GDP growth accelerates to approximately 3 percent as growth returns.
The commitment to global cooperation and effective economic-policy choices together create long-term incentives for investment and innovation and deliver strong productivity growth and supply expansion. This helps counter the demographic headwinds of aging societies and enables an affordable energy transition. Post-2025, a sense of shared prosperity emerges as the US economy delivers more than 3 percent annual real GDP growth, the eurozone maintains growth well above 2 percent, and the income from this growth benefits stakeholders across society (Exhibits 7 and 8).
The C2 scenario: Deep recession followed by anemic growth with entrenched higher inflation
The C3 scenario: Deep recession, long-term growth limitations, and significant regime change in inflation management
In the C3 scenario, commitments to global cooperation are in jeopardy. Divergent interests stymie the development of institutions and diplomatic frameworks that enable the global flow of goods, ideas, and capital. This severely limits access to critical sectors and hinders the expansion of global supply. The conflict in Ukraine and other international tensions continue and may escalate further, with negative implications for global markets.
In the face of continued supply shocks, policy makers in the eurozone and the United States find themselves unable to act effectively. As political tensions and conflicts within countries increase, fiscal policy is ineffective at promoting the investment needed to resolve near-term energy supply–demand imbalances. Central banks raise interest rates further in an attempt to bring inflation under control. As political pressure in the face of economic challenges mounts, central bank independence is compromised, and central banks abandon their low-inflation targets. This “regime change” allows inflation to settle at a higher level of around 7 percent per year (Exhibit B).
The fracturing global order and lack of investment lead to continued supply shortcomings. The transition to permanently higher inflation proves costly, as many existing stabilization policies (such as tax structures and social transfers) are not designed to cope. As inflation outstrips wage growth, real wages and household incomes decline, deepening the downturn. This not only leads to a severe recession, but limits growth post-2025. The US economy delivers no more than 1 percent annual real GDP growth and the eurozone’s GDP stagnates.
In the C2 scenario, individuals, businesses, and governments determine that the costs of global cooperation outweigh the benefits. Interregional flows stagnate amid disagreement over new rules to address the effect of outsourcing on local economies, the vulnerabilities of concentrated dependence on raw materials, and the system’s lack of resilience. The conflict in Ukraine continues to reinforce these vulnerabilities.
Amid this more difficult international environment, central banks in the eurozone and the United States move more aggressively against inflation, tipping these economies into recession in 2023. Despite the purposeful slowdown, inflation comes down only gradually, forcing central banks to abandon their 2 percent targets to avoid a prolonged downturn. Inflation persists at 3.5 percent or higher while growth in the short term recovers to about 2 percent in the United States and the eurozone (Exhibit 9).
The combination of stagnating global economic cooperation and more restrictive economic-policy choices create poor long-term incentives and slow the rates of investment and innovation. This weakens productivity growth and makes it harder to produce the technology required for an affordable energy transition. In this scenario, investment in energy technology and renewables is insufficient to scale new technologies, creating more reliance on fossil fuels, so global oil prices reach $130 a barrel (Exhibit 10). Slow growth after 2025 makes it harder to deliver on the promise of inclusivity. The US economy experiences only about 1.7 percent annual real GDP growth, while growth in the eurozone is stuck below 1 percent.
Scenario-informed perspectives help build strategic insight, commitment, execution, and resilience
Management teams can thrive rather than merely survive in this volatile environment by building both resilience and boldness in their organizations (see sidebar “Embracing uncertainty, embedding resilience, and enabling growth”). Leaders who are both prudent and bold hone their organizational performance edges in three ways: in being sharper on insights, deepening their commitment, and accelerating their execution.
Business leaders can use scenarios to sharpen insights by analyzing longer-term success factors before zeroing in on the near term. McKinsey’s new scenarios show a wide range of potential GDP growth rates for 2025–30, and leaders need to understand whether alternative growth outcomes require a fundamental change in where and how they choose to compete. Consider two real-world examples, the first of which highlights a company for which strategy hinges on macroeconomic outcomes, and the second which demonstrates the opposite.
- A container shipping terminal operator is emerging from the pandemic surge in container volumes, which produced never-before-seen operational challenges along with record profits. This record volume won’t continue, but there is a fundamental question about whether the terminal operator will see a permanent increase in volume momentum relative to the slowdown experienced since the financial crisis. How volumes are expected to play out will be critical to determining strategy for 2023 and beyond.
- A polyethylene manufacturer faces the prospects of an accelerating energy transition, carbon taxes becoming a reality, and increasing consumer demand for green products. How strong that demand will be is certainly a question, but the real strategic challenge is that the fundamental technologies to compete in this new world are still on the R&D bench. The critical question is whether the executive team and their stakeholders have real conviction that green plastics are the future.
Individual industry growth matters and will be influenced by overall GDP, but the moves a company chooses to make and how it responds to trends make the biggest difference to performance.20 These scenarios can help provide the foresight that can improve the odds of success. Working with these scenarios can also help executive teams build shared conviction about their operating and competitive environment and, consequently, act more decisively when it’s time to commit, be bold, and accelerate execution; or hold back, remain agile, and preserve optionality.
We believe that the effort to build commitment and resilience around scenarios and scale execution should be planned in a separate effort that reports directly to the CEO and by design avoids disrupting current operations. This plan-ahead team must also evaluate what new infrastructure and people may be needed to execute against multiple scenarios in existing business processes recognizing that key capabilities (for example, financial planning and analysis) may require additional resourcing. With the right prioritization, leadership commitment, and shifts in organizational incentives in place, the new plan-ahead initiatives can be executed with confidence and speed.
Many business leaders see 2023 as a continuation of the most challenging environment management teams have ever faced—and for good reason. The scenarios we have shared can help give you the insight into the range of operating environments you could face, the opportunities and risks of the commitments you make, and where you need the discipline and strength to accelerate execution and build resilience. They can help you set your top priorities and prosper in a 3 × 3 world where uncertainties are multiplied.
