Stagflation, inflation, and recession are economic terms that have taken the center stage in recent times due to their crucial role in shaping the global economy. Central banks worldwide are making efforts to formulate strategies to moderate inflation in some advanced economies, including the U.S., to prevent triggering a recession. Experts are wary about the potential rise of stagflation in the future. This article explores these concepts and explains why they are significant in the current economic system.
Understanding Stagflation
Stagflation refers to a unique situation characterized by concurrent increases in prices and stagnation of economic growth. The term was first coined by Iain Macleod, a Conservative Party MP in the United Kingdom, in November 1965. An economy undergoing stagflation experiences slowed growth, high unemployment, and high inflation simultaneously. Typically, central banks and governments attempt to stimulate low-growth economies through increased public spending and low-interest rates. However, these measures also tend to raise prices, leading to inflation. Therefore, these instruments cannot be employed when inflation is high, complicating the resolution of stagflation.
Historical Case of Stagflation
The early and mid-1970s witnessed a significant incidence of stagflation when the Organisation of Petroleum Exporting Countries (OPEC), operating like a cartel, decided to cut oil supply. This move resulted in soaring oil prices worldwide. On one side, this caused constraints on the productive capacities of oil-dependent western economies, thereby impeding economic growth. On the other hand, the hike in oil prices led to inflation as commodities became more expensive.
The Recent Emergence of Stagflation Concerns
Concerns about stagflation have surfaced recently due to a mix of geopolitical events and policy measures. The Covid-19 outbreak and the resulting containment measures led to a worldwide economic slowdown. The ensuing fiscal and monetary measures, including substantial liquidity increases in most advanced economies, triggered a sharp inflation rise. Furthermore, the ongoing war in Ukraine following Russia’s invasion and subsequent Western sanctions on Moscow have caused a fresh ‘supply shock’ that is difficult to quantify.
Impact of Supply Factors
Prices of commodities ranging from oil and gas to food grains, edible oils, and fertilizers have surged sharply due to the conflict, posing challenges for authorities to contain inflation. Inflation has now become less controllable through credit regulation due to its dependence on supply factors rather than demand.
The Way Forward
Long-term policy support may be required for a sustained and inclusive economic recovery. The focus is set on normalizing prudential policies and strengthening insolvency frameworks and restructuring mechanisms. This strategy includes dealing with the overhang of public and private debt.