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Stagflation Risk Rises Amid Sharp Slowdown in Growth

Compounding the damage from the COVID-19 pandemic, the Russian invasion of Ukraine has magnified the slowdown in the global economy, which is entering what could become a protracted period of feeble growth and elevated inflation, according to the World Bank’s latest Global Economic Prospects report. This raises the risk of stagflation, with potentially harmful consequences for middle- and low-income economies alike.

Global growth is expected to slump from 5.7 percent in 2021 to 2.9 percent in 2022— significantly lower than 4.1 percent that was anticipated in January. It is expected to hover around that pace over 2023-24, as the war in Ukraine disrupts activity, investment, and trade in the near term, pent-up demand fades, and fiscal and monetary policy accommodation is withdrawn. As a result of the damage from the pandemic and the war, the level of per capita income in developing economies this year will be nearly 5 percent below its pre-pandemic trend.

“The war in Ukraine, lockdowns in China, supply-chain disruptions, and the risk of stagflation are hammering growth. For many countries, recession will be hard to avoid,” said World Bank President David Malpass. “Markets look forward, so it is urgent to encourage production and avoid trade restrictions. Changes in fiscal, monetary, climate and debt policy are needed to counter capital misallocation and inequality.”

The June Global Economic Prospects report offers the first systematic assessment of how current global economic conditions compare with the stagflation of the 1970s—with a particular emphasis on how stagflation could affect emerging market and developing economies. The recovery from the stagflation of the 1970s required steep increases in interest rates in major advanced economies, which played a prominent role in triggering a string of financial crises in emerging market and developing economies.

“Developing economies will have to balance the need to ensure fiscal sustainability with the need to mitigate the effects of today’s overlapping crises on their poorest citizens,” said Ayhan Kose, Director of the World Bank’s Prospects Group. “Communicating monetary policy decisions clearly, leveraging credible monetary policy frameworks, and protecting central bank independence can effectively anchor inflation expectations and reduce the amount of policy tightening required to achieve the desired effects on inflation and activity.”

The current juncture resembles the 1970s in three key aspects: persistent supply-side disturbances fueling inflation, preceded by a protracted period of highly accommodative monetary policy in major advanced economies, prospects for weakening growth, and vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.

However, the ongoing episode also differs from the 1970s in multiple dimensions: the dollar is strong, a sharp contrast with its severe weakness in the 1970s; the percentage increases in commodity prices are smaller; and the balance sheets of major financial institutions are generally strong. More importantly, unlike the 1970s, central banks in advanced economies and many developing economies now have clear mandates for price stability, and, over the past three decades, they have established a credible track record of achieving their inflation targets.

Global inflation is expected to moderate next year but it will likely remain above inflation targets in many economies. The report notes that if inflation remains elevated, a repeat of the resolution of the earlier stagflation episode could translate into a sharp global downturn along with financial crises in some emerging market and developing economies.

The report also offers fresh insights on how the war’s effects on energy markets are clouding the global growth outlook. The war in Ukraine has led to a surge in prices across a wide range of energy-related commodities. Higher energy prices will lower real incomes, raise production costs, tighten financial conditions, and constrain macroeconomic policy especially in energy-importing countries.

Growth in advanced economies is projected to sharply decelerate from 5.1 percent in 2021 to 2.6 percent in 2022—1.2 percentage point below projections in January. Growth is expected to further moderate to 2.2 percent in 2023, largely reflecting the further unwinding of the fiscal and monetary policy support provided during the pandemic.

Among emerging market and developing economies, growth is also projected to fall from 6.6 percent in 2021 to 3.4 percent in 2022—well below the annual average of 4.8 percent over 2011-2019. The negative spillovers from the war will more than offset any near-term boost to some commodity exporters from higher energy prices. Forecasts for 2022 growth have been revised down in nearly 70 percent of EMDEs, including most commodity importing countries as well as four-fifths of low-income countries.

The report highlights the need for decisive global and national policy action to avert the worst consequences of the war in Ukraine for the global economy. This will involve global efforts to limit the harm to those affected by the war, to cushion the blow from surging oil and food prices, to speed up debt relief, and to expand vaccinations in low-income countries. It will also involve vigorous supply responses at the national level while keeping global commodity markets functioning well.

Policymakers, moreover, should refrain from distortionary policies such as price controls, subsidies, and export bans, which could worsen the recent increase in commodity prices. Against the challenging backdrop of higher inflation, weaker growth, tighter financial conditions, and limited fiscal policy space, governments will need to reprioritize spending toward targeted relief for vulnerable populations.


Source : World Bank


Read the Global Economic Prospects report . . . . .

Worry About Stagflation, a Flashback to ’70s, Begins to Grow

Paul Wiseman wrote . . . . . . . . .

Stagflation. It was the dreaded “S word” of the 1970s.

For Americans of a certain age, it conjures memories of painfully long lines at gas stations, shuttered factories and President Gerald Ford’s much-ridiculed “Whip Inflation Now” buttons.

Stagflation is the bitterest of economic pills: High inflation mixes with a weak job market to cause a toxic brew that punishes consumers and befuddles economists.

For decades, most economists didn’t think such a nasty concoction was even possible. They’d long assumed that inflation would run high only when the economy was strong and unemployment low.

But an unhappy confluence of events has economists reaching back to the days of disco and the bleak high-inflation, high-unemployment economy of nearly a half century ago. Few think stagflation is in sight. But as a longer-term threat, it can no longer be dismissed.

Last week, Treasury Secretary Janet Yellen invoked the word in remarks to reporters:

“The economic outlook globally,” Yellen said, “is challenging and uncertain, and higher food and energy prices are having stagflationary effects, namely depressing output and spending and raising inflation all around the world.”

On Thursday, the government estimated that the economy shrank at a 1.5% annual rate from January through March. But the drop was due mostly to two factors that don’t reflect the economy’s underlying strength: A rising trade gap caused by Americans’ appetite for foreign products and a slowdown in the restocking of businesses inventories after a big holiday season buildup.

For now, economists broadly agree that the U.S. economy has enough oomph to avoid a recession. But the problems are piling up. Supply chain bottlenecks and disruptions from Russia’s war against Ukraine have sent consumer prices surging at their fastest pace in decades.

The Federal Reserve and other central banks, blindsided by raging inflation, are scrambling to catch up by aggressively raising interest rates. They hope to cool growth enough to tame inflation without causing a recession.

It’s a notoriously difficult task. The widespread fear, reflected in shrunken stock prices, is that the Fed will end up botching it and will clobber the economy without delivering a knockout blow to inflation.

This month, former Fed Chair Ben Bernanke told The New York Times that “inflation’s still too high but coming down. So there should be a period in the next year or two where growth is low, unemployment is at least up a little bit and inflation is still high.”

And then Bernanke summed up his thoughts: “You could call that stagflation.”

WHAT IS STAGFLATION?

There’s no formal definition or specific statistical threshold.

Mark Zandi, chief economist at Moody’s Analytics, has his own rough guide: Stagflation arrives in the United States, he says, when the unemployment rate reaches at least 5% and consumer prices have surged 5% or more from a year earlier. The U.S. unemployment rate is now just 3.6%.

In the European Union, where joblessness typically runs higher, Zandi’s threshold is different: 9% unemployment and 4% year-over-year inflation, in his view, would combine to cause stagflation.

Until about 50 years ago, economists viewed stagflation as a near-impossibility. They hewed to something called the Phillips Curve, named for its creator, economist A.W.H. “Bill” Phillips (1914-1975) of New Zealand. This theory held that inflation and unemployment move in opposite directions.

It sounds like common sense: When the economy is weak and lots of people are out of work, businesses find it hard to raise prices. So inflation should stay low. Likewise, when the economy is hot enough for businesses to pass along big price hikes to their customers, unemployment should stay fairly low.

Somehow, reality hasn’t proved so straightforward. What can throw things off is a supply shock — say, a surge in the cost of raw materials that ignites inflation and leaves consumers with less money to spend to fuel the economy.

Which is exactly what happened in the 1970s.

Saudi Arabia and other oil-producing countries imposed an oil embargo on the United States and other countries that supported Israel in the 1973 Yom Kippur War. Oil prices jumped and stayed high. The cost of living grew more unaffordable for many. The economy reeled.

Enter stagflation. Each year from 1974 through 1982, inflation and unemployment in the United States both topped 5%. The combination of the two figures, which came to be called the “misery index,” peaked at a most miserable 20.6 in 1980.

Stagflation, and especially chronically high inflation, became a defining feature of the 1970s. Political figures struggled in vain to attack the problem. President Richard Nixon resorted, futilely, to wage and price controls. The Ford administration issued “Whip Inflation Now” buttons. The reaction was mainly scorn.

HAS STAGFLATION ARRIVED?

No. For now, the stagflation glass is only half-full.

There’s “flation” for sure: Consumer prices shot up 8.3% in April from a year earlier, just below a 41-year high set the previous month.

Consumer prices are surging largely because the economy rebounded with unexpected vigor from the brief but devastating pandemic recession. Factories, ports and freight yards have been overwhelmed trying to keep up with an unexpected jump in customer orders. The result has been delays, shortages and higher prices.

Critics also blame President Joe Biden’s $1.9 trillion stimulus plan of March 2021 for overheating an economy that was already hot. The Ukraine war made things worse by disrupting trade in energy and food and sending prices up.

But the “stag” has yet to arrive: Even though the government reported Thursday that economic output shrank from January through March, the nation’s job market has kept roaring.

Every month for the past year, employers have added a robust 400,000-plus jobs. At 3.6%, the unemployment rate is just a notch above 50-year lows. This week, the Fed reported that Americans are in solid financial health: Nearly eight in 10 adults said last fall that they were “doing okay or living comfortably” — the highest proportion since the Fed started asking the question in 2013.

Still, the risks are accumulating. And so are concerns about potential stagflation. Fed Chair Jerome Powell acknowledged this month that the central bank might not be able to achieve a soft landing and dodge a recession. He told American Public Media’s “Marketplace” that he worries about “factors that we don’t control” — the Ukraine war, a slowdown in China, the lingering pandemic.

At the same time, inflation has been eroding Americans’ purchasing power: Prices have risen faster than hourly pay for 13 straight months. And the nation’s savings rate, which soared in 2020 and 2021 as Americans banked government relief checks, has fallen below pre-pandemic levels.

Europe is even more vulnerable to stagflation. Energy prices there have skyrocketed since Russia’s invasion of Ukraine. Unemployment in the 27 EU countries is already 6.2%.

WHY DID STAGFLATION VANISH FOR SO LONG?

For four decades, the United States virtually banished inflation. In the early 1980s, Fed Chair Paul Volcker had jacked up interest rates so high to fight inflation — 30-year mortgage rates approached a dizzying 19% in 1981 — that he caused back-to-back recessions in 1980 and 1981-82. Yet Volcker achieved his goal: He managed to rid the economy of high inflation. And it stayed away.

“The Fed has worked hard since the stagflation of the late 1970s and early 1980s,” Zandi said, “to keep inflation and inflation expectations closer to its target,” which is now around 2%.

Other factors, including the rise of low-cost manufacturing in China and other developing countries, kept a tight lid on prices that consumers and businesses pay.

The United States has endured periods of high unemployment — it reached 10% after the 2007-2009 Great Recession and 14.7% after COVID-19 erupted of 2020. Yet until last year, inflation had remained at bay. In fact, not since 1990 has the nation faced a year of Zandi’s 5%-inflation, 5%-unemployment stagflation standard.


Source : AP

Chart: Investment Returns in the 1970s During Stagflation

Source : Deutsche Bank

Chart: Global Stagflation Survey

According to 3 different definitions of stagflation.


See large image . . . . . .

Source : Deutsche Bank