The term ‘stagflation’ was coined 50 years ago when many global economies experienced long periods of double-digit inflation and interest rates, high unemployment and sluggish economic growth. Economists are now asking whether the global economy is once again reliving the 1970s or whether rising inflation and slow growth are a temporary phenomenon that will soon fizzle out.
The majority of economists seem to agree that the present phase of stagflation is nothing like that experienced half a century ago. One big difference between now and the 1970s is that today organised labour strength remains weak.
In 1970, about 38 per cent of workers across the more advanced economies were covered by union wage agreements. Today, this figure has declined to just 16 per cent, the lowest on record. Despite spiralling food and fuel prices, it is unlikely to lead to labour unrest with severe damage to economic growth and further pressure on wage inflation.
However, the consensus view on the temporary nature of the present rise in inflation may be too optimistic. Global food prices have risen by roughly a third over the past year. Gas and coal prices are close to record levels. Oil has reached $80 per barrel, a price not seen for some years.
The surge in consumer demand following the perceived lower risks of the pandemic has put immense pressure on supply chain dynamics. Shipping rates are soaring as consumers spend more on manufactured goods. Ports are congested. Today, a global shortage of semiconductors, an essential element in most devices, threatens consumer spending. Workers, especially lorry drivers, are in short supply in specific industries, putting pressure on wage increases.
Today’s generation of central bankers has quite a different mindset from those of the latter part of the last century. In the 1970s, governments and central bankers were not unduly worried about high inflation as they prioritised low unemployment over stable prices. But the negative experience of stagflation ensured that a new generation of central bankers was determined to keep inflation in check.
One lethal risk is that central banks caught between opposing pressures may act on the monetary front too slowly
The financial crisis of 2008 weakened the solid resolve of central bankers to keep inflation in check. An extended period of loose monetary policy helped western economies avoid a period of depression. Governments focused on preserving employment. Interest rates were kept at historically low levels. Fiscal discipline was relaxed, and when COVID hit the global economies, governments flooded their economies with liquidity to preserve jobs and help stimulate growth.
However, some economists, who are not so convinced about the short-term nature of current inflationary pressures, see various risks on the horizon. Stagflation is a toxic cocktail.
It could lead to a protracted recession in some countries.
One lethal risk is that central banks caught between opposing pressures may act on the monetary front too slowly. Industry has become addicted to low interest rates. Whenever central bankers indicate that an interest rate rise may not be too far away, stock markets react badly. The ECB is arguably the most dovish on the prospect of rising interest rates. It fears that the already sluggish EU economic growth may be extinguished as and when interest rates are raised.
However, central bankers can do very little to ease adverse supply shocks. Central bankers do not help in the recruitment of more heavy vehicles drivers. They can also do nothing to avoid congestion in busy ports. Monetary policy has lost most of its effectiveness in maintaining price stability.
Other risks are equally worrying. The trend towards deglobalisation and increasing protectionism is gaining strength. The reshoring of supply chains and the demographic ageing of most advanced economies will not help to stimulate economic growth. Tighter restrictions on immigration are a political reality that will do nothing to help the workforce rejuvenation in countries suffering from demographic pressures.
Geopolitical risks are today higher than they were in the last two decades. The Cold War climate that seems to have gripped China and the US will not help strengthen the trade globalisation process that is already under severe stress.
Problems linked to climate change are becoming more tangible. Failed harvests will continue to cause spikes in food prices. Cybersecurity is disrupting production and it remains very costly to control. The growing income gap is forcing politicians to tighten fiscal and regulatory measures that might strengthen labour unions’ bargaining power and fuel wage inflation.
Stagflation will always be a toxic cocktail. Today’s economic threats can no longer be kept at bay by loose monetary policies and fiscal laxity.
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