Global Economy

Stagflation – A Looming Threat to the Global Economy

Stagflation is an unusual and intriguing economic situation that calls traditional economic understanding into question. It is distinguished by a combination of slowing economic growth, rising inflation rates, and high unemployment, presenting policymakers and businesses with a challenging picture. There have been a few times over the years where stagflation has decimated economies while its effects last for years. It is equally hard to get out of stagflation. Stagflation could become a serious issue for emerging economies that are heavily reliant on imports for their consumption. These are vulnerable to the adverse effects of stagflation.
One of the reasons we wanted to pay attention to this particular topic.

Understanding Stagflation

It is an economic state in which an economy experiences slow growth, high inflation and a high unemployment rate, simultaneously. Typically, inflation and unemployment have an inverse connection in economics; when one rises, the other tends to fall. However, stagflation defies this link, making it a tough riddle for economists to solve.

Historical Incidents of Stagflation

The oil price issue caused major stagflation in the United States in the 1970s. Futhermore, Rising inflation, poorer economic output, higher unemployment, financial turbulence, and lower interest rates were all consequences of high oil prices. This time called into question the prevailing wisdom that inflation and unemployment were inversely related. Stagflation challenged this concept, as both inflation and unemployment rose at the same time. The oil embargo, exchange rate volatility, budget deficits, and service prices were all major contributors to this stagflationary phase.

Another significant case of stagflation happened during the reign of Robert Mugabe, Former Prime Minister of Zimbabwe when food production and supply problems were worsened. Mugabe's anti-white farmer policies affected agriculture, resulting in lower food output and scarcity. This incident explains how supply shortages can arise as a result of stagflation. Consequently, This is characterized by decreased economic output, higher unemployment, and higher prices.

Causes of Stagflation

Supply Side Shock

Supply-side shocks are disruptions in the supply of goods and services that cause prices to rise and economic output to fall. Various variables can trigger these shocks, including:

  • Wars, revolutions, and sanctions can all affect the production and delivery of key commodities like oil and natural gas. An example of this could be the Russia-Ukraine conflict which led to supply shock for raw materials prices essential for agricultural uses, crude as well as natural gas.
  • Natural catastrophes like as hurricanes, floods, and earthquakes can cause infrastructure damage and disrupt supply chains, resulting in shortages and price rises.
  • Strikes, pandemics, and demographic changes can all cause labor shortages, forcing businesses to boost pay and contribute to inflation.

Cost Push Inflation

Cost-push inflation occurs when production costs rise, causing enterprises to raise prices to retain profit margins. Also, The circumstances that cause this include:

  • Increases in the cost of oil, natural gas, or electricity can have a knock-on impact, raising the prices of transportation, manufacturing, and other goods and services.
  • Labor unionization: When labor unions are stronger, they can bargain for better pay and benefits, which employers may pass on to customers in the form of higher pricing.
  • Environmental regulations, safety standards, and minimum wage laws can all increase firm production costs, contributing to cost-push inflation.

Demand Deficiency

Stagflation can also occur when consumer and company expenditures fall significantly, resulting in slow economic growth and excessive unemployment. Also, This can be caused by a variety of circumstances, including:

  • Economic downturns: Recessions and economic crises can reduce consumer confidence and expenditure, resulting in a fall in demand for products and services.
  • High interest rates make borrowing more expensive, which might deter firms from investing and individuals from making large purchases.
  • Financial crises, trade wars, and other global economic events can have an impact on consumer and company spending around the world, adding to a demand deficit.

Past Policy Reactions

Addressing stagflation is a difficult task, but there are few policy options government and central banks have used in the past in order tackle the challenge of stagflation:

  • Supply-Side Reforms: Governments have conducted supply-side reforms to lower manufacturing costs, boost efficiency, and promote economic growth.
  • Monetary Policy: Central banks have managed inflation by using monetary policy measures such as hiking interest rates to lower demand and cool the economy.
  • Fiscal Policy: Governments have utilized fiscal policy in the past to boost economic growth and counteract high unemployment, such as by lowering taxes or increasing government spending.
  • Long-term structural reforms, like as investments in education, technology, and infrastructure, have assisted in enhancing economic productivity while mitigating the effects of stagflation.

Future Implications

Since mid-2020, Global inflation had been on the rise, owing to a combination of reasons. These are recovering global demand, supply chain disruptions, and increasing food and energy costs, particularly since the commencement of the conflict in Ukraine. Market expectations predicted that inflation would peak in mid-2022 and then gradually drop. However, It was still expected to remain elevated long after the immediate shocks dissipated and monetary policies tightened. In contrast, global economic growth has been declining since the beginning of last year and is expected to continue below the 2010s average for the foreseeable future. Additionally, These trends have increased the possibility of stagflation, a scenario characterised by high inflation and slow economic growth.

Past Emergings Markets and Developing Economies Reaction

To combat inflation after the 1970s stagflation, major advanced-economy central banks raised interest rates sharply. This, in turn, prompted a global recession and a succession of financial crises in emerging markets and developing economies (EMDEs). If present stagflationary pressures develop, EMDEs will confront comparable issues due to less anchored inflation expectations, heightened financial vulnerabilities, and declining GDP fundamentals.

Projections

Although, Recent projections suggest that the Middle East and Europe remain susceptible to stagflationary risks. Asia and North America may be less vulnerable to these threats. However, it is crucial to recognize that even a localized risk can have significant repercussions within the interconnected global economy.

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References: Global Economic Prospects, June 2022, World Bank | World Economic Outlook, July 2023, International Monetary Fund

Disclaimer: The report only represents the personal opinions and views of the author. Also, No part of the report should be considered a recommendation for buying/selling any stock. Thus, the report & references mentioned are only for the information of the readers about the industry stated.

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