Stagflation stalks - are we reliving the 1970s?

Stagflation stalks – are we reliving the 1970s?

Fuel prices are soaring. War rages outside Europe’s threshold. ABBA is also back on tour – albeit in avatar form.

With unrest for workers rising against the backdrop of rising living costs, some are wondering – are we reliving the 1970s?

Another look back from the disco era came last week when the World Bank raised what it believes is the very real prospect of “stagflation” – a term we have heard with greater regularity and will likely do so even more in the coming months.

The Washington-based department, along with a number of other stores, issued updates over the past two weeks.

They all say about the same thing – the global economy is heading for slower growth amid further sharp price increases along with higher interest rates.

“The global outlook faces significant downside risks, including intensified geopolitical tensions, a prolonged period of stagflation reminiscent of the 1970s, widespread financial stress caused by rising borrowing costs and worsening food insecurity,” the World Bank wrote in its report.

“For many countries, the recession will be difficult to avoid,” the bank concluded, adding that it expected “virtually no recovery” next year.

What is stagflation?

Originally coined in the 1960s and attributed to British MP Iain Macleod, “stagflation” is an amalgamation of words, stagnation and inflation.

And that’s basically what it is – a situation where economies are shrinking but prices continue to rise.

It’s a toxic mix, often called a “double whammy” for consumers who pay higher prices for goods and services against a background where wages are likely to remain static – and it is for those lucky enough to have a job that unemployment inevitably increases.

For decades, economists did not believe that such a potent combination of circumstances was even possible. They believed that inflation would only be high when the economy was strong and unemployment was low – which sounds logical.

But the oil crisis of the 1970s changed all that. Economists and central banks were surprised at how they would handle a period of high inflation and weak economic growth triggered by commodity and supply shocks.

Back to the Future

It looks a lot like the scenario we are facing now – a parallel that the World Bank pointed out in its latest outlook, where it identified three key ingredients for a stagflationary environment.

The first, “persistent supply-side disturbances that favor inflation”, is basically what we have seen in the aftermath of the pandemic when economies reopened and supply chains adapted to a decline in demand.

When “preceded by a prolonged period of highly accommodative monetary policy in large, advanced economies”, the outlook for stagflation intensifies.

The recent fuel shortage in the UK is reminiscent of the 1970s

Such policies were introduced by all the major central banks for much of the last decade with bottom-up (or even negative) interest rates and billions of euros, dollars and pounds spent every month on buying bonds to keep government and commercial borrowing costs. low.

The third characteristic is the “prospect of declining growth” in the midst of monetary tightening, which is essentially the situation in which the global – and especially the euro area – economy has found itself in recent times.

As interest rates are rising in the euro area (and are already rising in most major economies), it coincides with a period of economic challenge intensified by the war in Ukraine.

Is stagflation here?

The “Flation” part is really here, but “stag” has not yet appeared.

Right now, things are still going relatively well for most advanced economies – albeit in an environment where storm clouds are gathering – and, more importantly, unemployment is low.

However, there are vulnerabilities, especially in Europe.

The German economy – the largest in the euro area – avoided a recession by showing growth in the first quarter of the year after shrinking in the last quarter of last year.

A recession is defined as at least two quarters of back-to-back economic downturn.

Figures from the UK Office for National Statistics this week concluded that the UK economy had shrunk by 0.3% in April, which together with a 0.1% pullback in March was the first time the economy had shrunk two months in a row since Covid struck.

The Bank of England has warned of the prospect of recession and inflation rising above 10% – together they are the raw materials for stagflation.

The OECD was relatively bullish on the outlook for the UK economy this year, expecting growth of 3.6% before falling next year.

Overall, the Paris-based institution is reluctant to draw too many parallels to the oil shock of the 1970s and considers that the risk of stagflation is limited.

“Global growth will be significantly lower with higher and more sustained inflation,” said OECD Secretary-General Mathias Cormann, adding that the organization does not foresee a recession even though there were many downside risks with the outlook.

The OECD points out that economies are less energy-intensive now, central banks have more robust mandates and frameworks, and consumers still have a lot of pandemic savings that are something of a buffer for domestic economies.

It believes that it should be enough to ward off stagflation – for now.

Interest rate mystery

It is against this precarious background that the European Central Bank has had to make its monetary policy decisions.

Some argue that the ECB has been slow to act in the face of rising prices and should have pulled the trigger for interest rate hikes by now.

The Bank of England and the US Federal Reserve have been raising interest rates for a few months.

However, the ECB is following a monetary line and balancing the need to bring inflation under control while not hampering economic growth.

This has signaled an interest rate increase of 0.25% next month, followed by a potentially larger step in September, if inflation does not cool down.

The Nixon era marked the end of America’s long period of prosperity after World War II

It has left plenty of room for maneuver should circumstances change, but opinions are divided on whether it is on the right track.

“The fact that the ECB raises interest rates sharply and quickly can prevent an inflation spiral, but at the cost of stifling economic activity,” Patrick Honohan, former governor of the Bank of Ireland, wrote in the Irish Times last week.

“It must be acknowledged that while monetary policy can bring inflation under control, the recession costs of doing so can quickly become high,” he added.

Which begs the question, is recession an inevitable when inflation is so high and the measures required to bring it down are so severe?

And must the central banks then make a quick turnaround to strengthen the economies again?

The ECB is paying too much attention to the last two occasions when it raised interest rates (2008 and 2011) and had to turn the course shortly afterwards.

Are we likely to see stagflation in Ireland?

Given the distortive effect that multinational companies tend to have on our GDP, it is unlikely that we will technically end up in a recession any time soon.

In fact, stockbroker Davy recently upgraded its outlook for GDP growth this year to double-digit percentage growth based on the stronger-than-expected 10.8% decline in the first quarter of this year.

However, there was a slight fall in domestic demand during the quarter with consumption declining marginally, after a further slight decline at the end of last year.

“This is a little puzzling,” said Davy’s chief economist Conall MacCoille.

“The weak spending data is difficult to compare with the more lively output data,” he added, pointing to credit and debit card spending that showed a clear increase in spending on hotels and restaurants and other tourism-related activities.

So, are we seeing the beginning of a decline in consumption spending and is it likely to intensify?

“If wages do not rise as fast as inflation, there will be a soft spot in consumption,” he said.

He warned that it was not time to go and try to deal with it with tax cuts or provide broad welfare support.

The government, he said, should instead target the most vulnerable households.

“You can not chase higher prices here. If we pay more for oil and energy, it is ultimately bad news in one way or another,” he explained.

How bad the news is largely depends on how long the war in Ukraine lasts and how much energy prices must rise further.

The recession in Ireland looks unlikely at this time, but the picture can change quickly.

Do not rule out a return of a broad kind yet!

#Stagflation #stalks #reliving #1970s

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