The spectre of stagflation

Mahmoud Mohieldin
Thursday 21 Oct 2021

Stagflation, a possible threat to the world economy, could be avoided.

When following current global economic developments, recently published reports on the global economy, and often heated discussions on such matters, one term one often comes across is “stagflation.”  

The term was coined in 1965 by the outspoken British politician Iain Macleod, the then Conservative Party shadow chancellor of the exchequer or finance minister. “We now have the worst of both worlds – not just inflation on the one side, or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation,” he told the House of Commons. 

Remedying stagflation is very complicated. Measures designed to address stagnation, as component of stagflation, can fuel inflation, while measures meant to fight inflation can aggravate stagnation. Because of such difficulties, I was not surprised when a number of participants at a conference on global economic development, called for avoidance of using the term “stagflation.”

Keen to rationalise expectations, he denied that what was happening in the economy was a “stagflation” process, preferring instead to describe the situation in terms of supply bottlenecks and temporary price hikes. 

Before this portmanteau word gained wider currency, analysts tended to treat its component parts as inversely proportional. Inflation and stagnation (and consequent unemployment) could not occur in tandem but lowering inflation would mean rising unemployment and vice versa. 

The economic boom experienced by the developed nations from the 1980s to the global financial crisis in 2008 showed that it was possible to sustain economic growth with increased production, low unemployment and inflation rates, and reduced economic volatility. This period, known as “Great Moderation”, was described by former chair of the US Federal Reserve Ben Bernanke in a speech in 2004 as an outcome of structural change, improved macroeconomic policies, and good luck. 

However, four years later, the world was plunged into the worst economic crisis it has seen since the Great Depression in the 1930s. That certainly could not be chalked up to bad luck alone. Subsequent studies and reports of parliamentary hearings have attributed it to poor regulation, manipulation and other fraudulent practices, and the failure of financial markets to play their proper role.  

At the height of the stagflation of the 1970s, inflation had climbed to over 7.5 per cent in the US due to soaring oil prices, and unemployment was at least six per cent. Such figures are extremely high according to the standards of the advanced economies. The repercussions from this crisis and the measures adopted to address it took a heavy toll on the economies of the developing nations, which had increased their external debts and were then hit by a sudden rise in interest rates. 

The result was havoc in developing economies exchange rates, instability in financial flows and an inability to pay back debts. The indebted countries were compelled to adopt an array of stringent measures in order to emerge from what became known as the first global debt crisis.

The past few months have brought successive price increases in a variety of goods and commodities including cotton, timber, semiconductors and readymade clothes. In a blog this month, economists Francesca Caselli and Prahi Mishra observed that food prices around the world have jumped by about 40 per cent during the Covid-19 pandemic, “an especially acute challenge for low-income countries where such purchases make up a big share of consumer spending.” 

As food prices continue to climb, World Trade Organisation (WTO) Director-General Ngozi Okonjo-Iweala has urged governments to abide by the rules of international trade on foodstuffs in particular. She has also appealed to them to abandon policies that distort the rapidly evolving global food market.

The problem of the current scarcity of commodities in the marketplace was the subject of the cover story of two successive editions of the UK magazine the Economist. The articles covered the upheavals in supply chains due to their inability to meet the sudden rise in consumer and producer demands after the pandemic and the havoc in the markets caused by the 95 per cent increase in the prices of oil, coal and gas since May this year. 

It is easy to cast the blame for the problems in supply chains and logistics on Covid-19, but this only makes it easier to overlook the protectionist practices that existed before and after the pandemic and that continue to hamper the movement of trade, drive up prices and reduce supply. 

At the same time, ad hoc and extemporaneous measures taken in response to political pressures and posturing have distorted policies for managing the transition to reduced carbon emissions.

Investments in new and renewable energy are still less than half their required level and fossil-fuel exit strategies are too poorly managed to attain the zero-carbon emissions targets by 2050 or 2060 to which the signatories to the Paris Climate Agreement have committed themselves. 

Disruption in the markets combined with public pressures, fears of legal action and concerns over regulatory measures have precipitated a 40 per cent drop in investment in fossil fuels, still the main source of more than 80 per cent of the world’s energy needs, since 2015, according to the Economist.

Moreover, as the UK city of Glasgow prepares to host the COP26 Summit meeting on climate change against the backdrop of rising geopolitical tensions and high gas prices in Europe, some European countries have been forced to put their coal-fired power plants back into operation after years of closure and pledges never to reopen them. 

Mounting inflationary pressures and the looming spectre of recession come as little surprise. In March, an article of mine on this question appeared in the pan-Arab newspaper Asharq Al-Awsat, in which I observed that the easing of Covid-19 restrictions would trigger a sharp rise in the prices of goods and services due to the inability of supply to keep pace with the surge in demand after the period of partial or total lockdowns. 

I also cautioned that middle income economies should be on guard against sudden rises in global interest rates targeting short-term securities in order to contain inflation expectations because of the consequences of this on their currency exchange rates and the real costs of debt-servicing, especially if the countries in question have had their credit ratings downgraded. 

In a previous article that appeared in February last year on the spectre of recession, I suggested that some developing nations might enter an extended period of lower growth rates than the global average. At the time, economists were speaking about “U-shaped” and “V-shaped” recoveries, referring to economies that could bounce back quickly and smoothly to their pre-pandemic baselines. I pointed out that such prospects were contingent on increased public spending and access to low-cost loans, options that are not available to most developing countries. 

   Economist Markus Brunnermeier best describes dealing with inflation and/or stagnation during times of multiple crises in his recently published book The Resilient Society, which is about societies that are able to bounce back from shocks, such as pandemics and economic crises. He likens the decision-maker in times of crisis to someone who has to drive a bicycle across a narrow ridge with a chasm on both sides. The motorcycle rider has to be very careful, for otherwise he might tumble into the stagnation chasm on the right or into the abyss of inflation on the left. Averting either one of these has its own set of economic, monetary and structural tools and instruments to do it. 

As we are still some way away from stagflation and are only looking at its early warning signs, we still have opportunities to avert it. Ignoring it or making generous assumptions about the corrective capacities of the market is not the way to go about it. The rising prices that some economists and policy makers currently classify as temporary could become a more lasting phenomenon unless we take the appropriate monetary measures to confront them. The temporary blockages in supply chains could also evolve into chronic structural problems unless investment is directed to increasing production capacities and developing infrastructure. 

An ounce of prevention is worth a pound of cure. Early remedies to inflation and supply problems will cost little compared to the costs of remedying stagflation which, once it does set in, will not go away by merely not mentioning its name. 

*An Arabic version of this article appeared on Wednesday in Asharq Al-Awsat.

*A version of this article appears in print in the 21 October, 2021 edition of Al-Ahram Weekly

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