The storm that could be seen on the horizon is taking the form of stagflation: inflation without growth
Almost a year ago we announced storm clouds related to inflation.
Unfortunately, in addition to the storm of rising prices caused by a combination of a shock in energy and commodity prices and strong demand in the months following the pandemic, we now have to add the increasingly pessimistic growth forecasts made by the main international organizations for the world economy and in particular for the European economy.
If a slowdown in the economy is added to inflation, if not a decline in growth, we are dealing with a scenario of stagflation or stagnation inflation.
Stagflation is not a new phenomenon. Western economies experienced it during the energy crises of the 1970s, due to the rise in oil prices.
This situation poses a major dilemma for economic policy authorities, both monetary (central banks) and fiscal and income policies (governments).
The dilemma lies in the fact that, despite the fact that the causes of inflation lie in the rise in costs (energy and raw materials in the first round), the tools available to curb prices in the short term only affect demand . That is, they serve to curb overall spending in the economy. This brake is achieved by raising interest rates, taking spending out of the economy with fiscal policies, or through an income pact that distributes the losses from inflation among workers, businesses and retirees. Very difficult thing.
When we find ourselves in a situation of stagflation, the first dilemma lies in how to formulate astringent measures – essentially raising interest rates – without going overboard. That is, without affecting growth too much, without triggering a recession. And that is very complex, because, moreover, the individual leeway of the central banks is scarce and that translates into a synchronized rate hike: first the Federal Reserve and then the European Central Bank.
International capital movements do not allow for much difference in this area, if we do not want to see how the currencies of the economies that lose investment depreciate sharply as rates in other areas start to rise more, as happens with the euro against the dollar. This movement is reflected in a depreciation of the currency (euro), exacerbating inflation problems, as the depreciation makes imports more expensive, especially energy imports (paid in dollars).
But what causes the rise in rates in the economies’ internal demand is an increase in consumption and a brake on investment, the two main factors explaining economic growth. So it is quite a challenge to raise rates without going overboard so as not to cause a recession.
The challenge of raising rates to the appropriate degree is compounded when the policies to complement monetary policy either do not exist (the income pact) or are of the opposite sign, as they contribute to rising demand, the fuel that remains feed the flame of inflation.
Many governments take actions that try to compensate for the loss of purchasing power due to inflation: they speak aid to the population as a whole, subsidize goods that do not sufficiently reduce their consumption – such as fuels – or agree significant income increases in groups, especially sensitive to electoral arithmetic. –read pensions–.
Governments face their own dilemma: recognize the loss caused by the inflation shock and try to absorb this loss between groups, or adopt a policy of higher spending to mitigate the loss, which can exacerbate existing imbalances.
This scenario of two demand policies – fiscal and monetary – that are far from coordinated is becoming more and more likely. And it justifies interest rates either continuing to rise (to compensate for spending caused by fiscal expansion) or remaining relatively high, which would especially hit the most indebted economies.
This article was published in ‘Het Gesprek’.
Source: La Verdad
I’m Wayne Wickman, a professional journalist and author for Today Times Live. My specialty is covering global news and current events, offering readers a unique perspective on the world’s most pressing issues. I’m passionate about storytelling and helping people stay informed on the goings-on of our planet.
