Thu. Jun 30th, 2022

Few prospects are worse for an economy than stagflation. The combination of stagnation with sharply rising prices can not recommend anything. Asset values ​​are rapidly being undermined by inflation, as are returns on capital, but unlike the inflation that high jobs can bring, it is just as miserable for workers as wages fall and jobs are lost.

Fortunately, it is clear that the world economy is not yet experiencing this unfortunate outcome. While inflation rose as economies reopened, so too grow. A slight delay in the rate of expansion should be expected as the economy normalizes after the pandemic. It would be more accurate to describe the recent experience only as reflection. Indeed, over the past two years, market talk has grown from the pre-pandemic forecasts of persistent ‘low inflation’ to deflation during closures and then reflational growth, caused by stimulus and vaccines. The latest talk on stagflation It can also be an extrapolation of temporary trends that may change soon.

However, the combination of supply chain disruption, high oil prices and labor shortages means the risks are serious. Temporary price pressures may be embedded in more long-term expectations and may even continue as the boost to growth fades through reopening. Right now, all that central banks can do is be vigilant for the risks and move forward with their plans to gradually shut down their stimulus programs. Governments need to think creatively about supply-side reforms to alleviate bottlenecks.

Stagflation is indelibly associated with the 1970s, when high post-war growth rates began to disappear and inflation increased, especially after the ‘oil shock’ following the Yom Kippur War in 1973. However, the world today is a very different place. To begin with, organized labor is weaker. The kind of wage price spiral created by workers or their representatives to keep up with the accelerated prices it is unlikely that it will be repeated. These are also central bankers less tolerant of inflation and has enough room to tighten policy, not only by raising interest rates, but also by withdrawing quantitative easing.

But premature tightening could lead central banks to bring about the stagnation they fear: repressing growth just as the economy recovers. Last week, Federal Reserve Chairman Jay Powell said it Problems and problems with the supply chain has only gotten worse, ” the historical record is full of examples of [central banks] underestimate ”and underestimate the need for continued monetary stimulus.

It may be that the period after World War II is a better historical parallel than the 1970s. Inflation in the US and the UK rose at the beginning of the decade, but also fell sharply. As the consultation Capital Economics in a research note On Monday morning, the need for millions of demobbed soldiers in Britain to quickly find new jobs led to labor shortages amid rising unemployment. The end of the pandemic yielded a similar dynamic. Meanwhile, after the Fed made it clear in 1951 that it would not continue its World War II buying program through the Korean War, price growth was built into the US after initially rising at the beginning of the decade.

However, central bankers must now follow a tight pace and at the same time keep a close eye on economic data, qualitative reports on supply chains and surveys of inflation expectations. Historical circumstances never repeat themselves perfectly and will at best be an imperfect guide to the path of the economy over the years to come. However, they give an example of the high cost of taking a wrong step.

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