Key Takeaways:

  • “Stagflation” is an ugly word for an ugly situation – the unpleasant combination of economic stagnation and inflation.
  • Unlike in the past, stagflation today would occur alongside heightened financial vulnerabilities, including stretched asset prices and high debt levels, which could magnify any growth slowdown.
  • There is also a need to rebuild monetary and fiscal buffers to cope with future shocks.

“Stagflation” is an ugly word for an ugly situation – the unpleasant combination of economic stagnation and inflation. 

The last time the world experienced it was the early 1970s, when oil-exporting countries in the Middle East cut supplies to the United States and other supporters of Israel. The “supply shock” of a four-fold increase in the cost of oil drove up many prices and dampened economic activity globally. 

Stagflation was thought left behind. But now there is a real risk of it coming back, warns the central bank for the world’s central banks.

“We may be reaching a tipping point, beyond which an inflationary psychology spreads and becomes entrenched,” says the Bank for International Settlements BIS in its latest annual economic report.

By “inflationary psychology” it means that expectations of higher prices lead consumers to spend now rather than later, on the assumption waiting will cost more. This increases demand, pushing up prices. Thus expectations of inflation become a self-fulfilling prophecy. 

The danger of stagflation comes from this inflationary cycle becoming so entrenched that attempts to curb it through higher interest rates push economies into recession. 


Global inflation since the 19th century

Graph of global inflation since the 19th century.
BISCC BY

What’s driving inflation

As well as its own expert staff, the BIS brings together expertise from its member central banks, such as the US Federal Reserve, the European Central Bank, the Bank of England and Reserve Bank of Australia. So its views are worth paying attention to. 

Its report makes clear its experts, like most forecasters, have been surprised by the extent of the rise in inflation. 

This is a global phenomenon, which the report attributes to a combination of an unexpectedly strong economic rebound from the COVID-19 lockdowns, a sustained switch in demand from services to goods, and supply bottlenecks exacerbated by a shift from “just-in-time” to “just-in-case” inventory management. 

Then there is Russia’s invasion of Ukraine. 

An apartment building damaged by Russian attacks on the northern Ukraine city of Chernihiv, June 27 2022.
An apartment building damaged by Russian attacks on the northern Ukraine city of Chernihiv, June 27 2022. Kunihiko Miura/Yomiuri Shimbun/AP

The war’s effect in driving up the price of oil, gas, food, fertilisers and other commodities has been “inherently stagflationary”: 

Since commodities are a key production input, an increase in their cost constrains output. At the same time, soaring commodity prices have boosted inflation everywhere, exacerbating a shift that was already well in train before the onset of the war.

The only bright note is that BIS expects these price surges to be less disruptive than the oil supply shock of the 1970s. 

This is because the relative impact of the oil supply shock was greater due to economies in the 1970s being more energy-intensive. 

There is also much more focus now on containing inflation, with most central banks having a clearly stated inflation target (2% in Europe and the US, 2%-3% in Australia). 

Traffic in Los Angeles, 1973. Economies were much more energy-intensive than now.
Traffic in Los Angeles, 1973. Economies were much more energy-intensive than now. Gene Daniels/Wikimedia CommonsCC BY

What are the biggest dangers?

But the current situation is still very challenging, the report says, because increases in the price of food and energy are particularly conducive to spreading inflationary psychology. 

This is because food is bought frequently, so price changes are notable. The same goes for fuel prices, which are prominently displayed on large roadside signs.

There is also the risk in many economies of a wage-price spiral – in which higher prices drive demands for higher wages, which employers then pass on in higher prices. 

Central banks face what Reserve Bank of Australia governor Philip Lowe has called a “narrow path”. 

To achieve a “soft landing” they need to raise interest rates enough to bring inflation down. But not enough to cause a recession (and thus stagflation). 

How to avoid a ‘hard landing’?

The BIS report cites an analysis of monetary tightening cycles – defined as interest rate rises in at least three consecutive quarters – in 35 countries between 1985 and 2018. A soft landing was achieved in only about half the cases.

A key factor in the hard landings was the extent of financial vulnerabilities, particularly debt. Economies with hard landings on average had double the growth in credit to GDP prior to the interest-rate rises. 

This factor contributes to BIS concerns now. As the report notes:

Unlike in the past, stagflation today would occur alongside heightened financial vulnerabilities, including stretched asset prices and high debt levels, which could magnify any growth slowdown. 


https://datawrapper.dwcdn.net/wlAjv/2/

Furthermore, the slowdown in China’s labour productivity is removing an important boost to global economic growth and restraint on global inflation. 

But a key lesson from the 1970s is that the long-term costs of doing nothing outweigh the short-term pain of bringing inflation under control.

This means governments must curb handouts or tax cuts to help people with cost-of-living pressures. Expansionary fiscal policy will only make things worse. Assistance must be strictly targeted to those who most need it.

There is also a need to rebuild monetary and fiscal buffers to cope with future shocks. This will require raising interest rates above inflation targets and returning government budgets (close) to surplus.

Contributor

Recently Published

Key Takeaway: DeepSeek, a Chinese AI lab, disrupted the artificial intelligence industry by developing a model rivaling OpenAI’s ChatGPT-4 at a fraction of the cost. Founded by a former hedge fund manager, DeepSeek focused on efficiency and optimized algorithms for less powerful hardware. The company’s open-source approach has forced Chinese competitors to lower their own […]
Key Takeaway: Quantum computing, a groundbreaking idea over 40 years ago, aims to process information using quantum mechanics. Qubits, which can embody 0, 1, or a blend of both, enable quantum systems to explore vast arrays of solutions simultaneously. Quantum entanglement, a phenomenon where qubits become intertwined, allows quantum computers to perform intricate calculations that […]

Top Picks

Key Takeaway: Attosecond science, a field that earned the Nobel Prize in Physics in 2023, uses ultra-short laser pulses to observe and manipulate matter on timescales previously thought impossible. This breakthrough has implications across various sectors, including computing, renewable energy, medicine, and beyond. Attosecond science harnesses the energy of laser light to emit rapidly moving […]
Key Takeaway: The blue sky is a result of Rayleigh scattering, a process where shorter wavelengths of light scatter more than longer wavelengths. The atmosphere is composed of nitrogen and oxygen molecules, which interact with sunlight to create a spectrum of colors. This scattering process, which is governed by physics and chemistry, is the primary […]
Key Takeaway: South Korea’s cultural exports have surged to unprecedented heights, with the latest season of “Squid Game” solidifying its position as a global entertainment powerhouse. The “Korean Wave” or Hallyu, which includes TV series, movies, animation, and music, has generated approximately US$3.7 billion annually for South Korea through exports, consumer spending, and tourism. The […]
Key Takeaway: A study published in Nature Astronomy found a strong consensus among scientists that extraterrestrial life exists in the universe. The survey, which involved 521 astrobiologists and 534 non-astrobiologists, found that 86.6% agreed or strongly agreed that some form of extraterrestrial life exists. The study also found that 67.4% of astrobiologists and 58.2% of […]
Key Takeaway: Researchers are using genome-scale metabolic models (GEMs) to study the complexities of microbial life, offering innovative solutions to climate change and space challenges. GEMs simulate the vast network of metabolic pathways within living organisms, allowing scientists to test and predict microbial behavior across diverse environments. They provide a detailed framework for understanding organisms’ […]

Trending

I highly recommend reading the McKinsey Global Institute’s new report, “Reskilling China: Transforming The World’s Largest Workforce Into Lifelong Learners”, which focuses on the country’s biggest employment challenge, re-training its workforce and the adoption of practices such as lifelong learning to address the growing digital transformation of its productive fabric. How to transform the country […]

Join our Newsletter

Get our monthly recap with the latest news, articles and resources.

Login

Welcome to Empirics

We are glad you have decided to join our mission of gathering the collective knowledge of Asia!
Join Empirics