Until recently, central banks ignored soaring inflation by continually arguing that the phenomenon of rising prices was “transitory”. Now the global economies fear that stagflation is more likely. Financial and commodity markets may no longer believe that central bankers can do much to avoid the prospect of a long period of high prices and slow growth.
Russia’s invasion of Ukraine increased inflationary pressures, including for energy, food and other commodities. The response by countries and companies to pull out of Russia will complicate the trade scenario, which was already looking more depressed due to the Trump-Biden commitment to protectionism. No government can now rely on healthy economic growth for long in this context.
Since Russia began its invasion of Ukraine, the price of wheat has skyrocketed, and the price of Brent crude oil hit $ 118. The world’s biggest shipping companies have said they would suspend all deliveries to and from Russia, thereby creating more supply shortages. These moves will exacerbate strains in supply chains and lead to price increases for food, fuel, and more at a time when global central banks are just starting to move to combat pricing pressures.
It is helpful to understand why we are in this unenviable situation without resorting to blaming. For too long, political leaders ignored the World Health Organisation warnings about the seriousness of COVID and the drastic economic impact of its spread in the US and Europe. Central banks reduced interest rates to historically low levels and purchased debt of distressed companies and countries to prevent a significant recession.
A sustained rejuvenation of global economic prospects can only happen on sustained growth, increasing trade flows and more direct investment. Disruptive monetary policy measures added to weakening growth prospects and misguided trade wars will only further derail the chances of economic regeneration.
The management of the present global economic crisis ultimately depends on the decisions taken by central bankers and political leaders. So far, the primary weapons used to stimulate economic growth were massive fiscal support to struggling companies and ultra-light monetary policy. Some argue that these measures favoured more equity markets by avoiding drastic price falls. Still, many ordinary people saw their savings devalued because of rising inflation.
No government can now rely on healthy economic growth for long in this context
Governments have ensured that most businesses, including some no longer economically viable, continued to exist. However, low-interest rates are now dangerously being taken for granted and the mere mention of interest rate rises spooks financial markets. These markets are arguably better at understanding the threats of looming stagflation than business and political leaders.
Global economies now have to deal with a toxic cocktail that can only accelerate the onset of stagflation. The recovery from the COVID pandemic is still not complete. Inflation continues to rise fast and central bankers no longer argue that it is temporary as supply chain blockages persist. The Ukraine war outcome, while still not clear, will continue to put pressure on commodity prices, and this will make every aspect of dealing with stagflation that much more difficult.
When economic policies are misguided – and some of the economic policies adopted in the last few years at a global level were misguided – threats of war and rearmament drives conveniently deflect and distract from the real economic challenges.
Countries cannot continue to borrow to deal with their unresolved economic challenges. US sovereign debt is 131 per cent of its GDP, not far from that of Italy amid the onset of the European debt crisis in 2010. Unlike the US, of course, Italy does not account for a fifth of the global economy. US monetary policy has global repercussions.
Up to some months ago, the European Commission sounded cautiously optimistic that its economic strategy for renewal is producing healthy growth and the greening of the economy.
This outlook is bound to change as the combined effect of old structural economic weaknesses and new geopolitical realities necessitate a rethinking of economic and political strategies.
We may well see old coal-powered electricity generators being recommissioned to deal with the fuel shortage. Nuclear power stations may no longer be an obsolete and an environmentally unacceptable way of satisfying energy needs.
Some economic recoveries end with stagflation often before turning into a recession. The time to worry is when we see the most damaging aspects of stagflation.
This time is when corporate profitability becomes compromised. Companies respond by cutting jobs, leading to an increase in unemployment and the kind of recession that characterised the 1970s in Europe and the US.