What is stagflation?
Stagflation is a jargon derived by combining stagnation and inflation. This is a period marked by prices in the economy rising sharply even as growth stagnates and unemployment rises. Past episodes of stagflation indicate that possible causes could be price shock in commodities and bungled monetary policies.
Stagflation could therefore be among central bankers’ worst nightmares. What would a central bank do to fight surging inflation? It would hike interest rates with the objective to control demand and thus bring down the prices in the economy. That is what the RBI is doing currently.
But when prices refuse to subside despite rate hikes, and the monetary policy of the central bank along with high inflation kills growth, the result could be stagflation. The central bank runs out of options here, leading to a long period of economic de-growth or recession.
Why are development institutions talking about it now?
The spectre of stagflation has been dominating conversations for a while now because inflation has been at record highs in almost all countries since the beginning of 2022. The World Bank has added to the debate on stagflation by dedicating an entire chapter in its June 2022 edition of Global Economic Development report to this subject. Inflation had been high in most countries in 2021 too, due to supply chain disruptions and pent-up demand as economies unlocked.
The Russia-Ukraine war has exacerbated the price increase. Global median headline CPI inflation reading was 7.8 per cent in April 2022, the most since 2008. While aggregate inflation in emerging and developing economies was 9.4 per cent, it was at 6.9 per cent in advanced economies; the highest since 1982. The World Bank report has sharply revised global growth as well as growth in almost all countries due to the elevated risks at this juncture.
Global growth is projected to slow from 5.7 per cent in 2021 to 2.9 per cent in 2022 and average around 3 per cent in 2023. With the world facing a period of high inflation and lower growth, development institutions are raising the red flag for stagflation risk.
When was the last time the world experienced it?
The most recent episode of stagflation was in 1970s in the US. This brought the post-world war II boom in the US to an end and ushered in a period of de-growth. The easy monetary policy of the US Federal Reserve in the 1950s and 1960s is reported to be partly responsible for this. The Fed tried to boost employment and output, but this led to an unsustainable increase in wages, pushing demand.
The oil shock in the seventies as the OPEC Nations decided to embargo crude oil exports to the US further contributed to inflation and disrupted economic activity. The period between 1975 and 1980 was especially challenging with CPI crossing 11 per cent and economy contracting.
What is causing a fear of stagflation now?
The conditions that exist currently across the globe are quite similar to that in the seventies. There is a commodity price surge led by crude oil and inflation is at multi-decade highs. Central banks are vigorously tightening monetary policy to rein inflation and growth is beginning to decelerate due to this potent combination.
But many economists also point out that the magnitude of price shock now is much lesser now and that many of the emerging and developing economies are in far better fiscal position now to face price shocks.
How does a government tackle it?
The World Bank has advised that all countries should sit together and arrive at a consensus to tackle price increase. Unilateral policy measures by individual countries to tackle domestic price inflation will not address the issue of the shortage in global supply. More than the government, the central banks need to stay watchful about stagflation rearing its head. They should be ready to go slow with their monetary tightening if required.