What is stagflation? Here’s why it matters and what you should know.

Inflation and weakening growth could trap the global economy in a years-long slump,
economists warn

By Jacob Bogage and Jeanne Whalen

June 8, 2022 at 6:00 a.m. EDT

The global economy could be heading for slow growth, rising prices and high unemployment,
economists are warning, a toxic brew that could hamper countries’ recovery from the
coronavirus pandemic.

The World Bank on Tuesday warned that those forces, called “stagflation,” could induce years’
worth of struggles. And persistent challenges — such as supply chain snags, Russia’s attack on
Ukraine and continuing waves of covid-19 cases — could harm consumers and employers alike,
settling world markets into a downturn that they largely avoided when the pandemic first struck.

Here’s what you need to know about stagflation and the risk it presents to the global economy:

WHAT TO KNOW

What is stagflation?

Why is stagflation bad?

Why is stagflation a risk now?

Is it possible to avoid stagflation?

Has stagflation happened before?

Is stagflation different from a recession?

Show all questions

What is stagflation?

Stagflation is a mash-up term combining the words stagnation and inflation. It describes an
economy that is malfunctioning, in which prices keep soaring while economic growth — the rate
of increase in the output of goods and services — slumps. The lack of economic growth over
time can lead to higher unemployment.

Under stagflation, households and businesses begin to worry that inflation will continue to soar
over the long haul, which becomes a self-fulfilling prophecy, causing them to adjust their
economic behavior in a way that ensures inflation will continue.
The term came into use in the 1970s, when economists and central bankers were flummoxed by
an unusual period of high inflation and weak economic growth sparked by twin oil shocks.

Overall, stagflation defines “a macro economy that’s not working very well,” says David
Wilcox, a senior economist at the Peterson Institute for International Economics and Bloomberg
Economics.

Why is stagflation bad?

People are generally happier when the economy is booming and prices are low. “If you’re getting
the opposite of those two things — if things are getting more expensive all the time but you’re
not able to consume more and you may lose your job as well, that is bad,” said Brian Coulton, an
economist in London with the ratings agency Fitch Group.

Stagflation is also hard to fix. The job largely falls to central bankers such as the Federal
Reserve, which exists to ensure a stable economy.

Generally, the Fed aims to keep inflation around 2 percent. Usually, when inflation exceeds that
level, the Fed and other central banks will raise interest rates, making it more expensive for
households and businesses to borrow money, which discourages spending and tamps down price
increases.

U.S. policy makers misjudged inflation threat until it was too late

That all becomes harder when the population is convinced that inflation is here to stay, Wilcox
said. That then forces central bankers to raise interest rates more aggressively to try to bring
inflation under control, which can slow growth even more dramatically.

Why is stagflation a risk now?

The United States and the global economy are experiencing inflation rates not seen in decades.
Those rising prices have largely been caused by disruptions in the supply of goods and shifting
consumer demands. The pandemic forced factories to shut down for weeks or months at a time, a
problem still plaguing the world’s biggest manufacturer, China, where draconian lockdowns to
prevent infection spread have kept ports and manufacturing facilities from operating as normal.

Russia’s invasion of Ukraine has worsened the problem, disrupting Russia’s oil and gas exports
and leading to global energy-price inflation. Russia’s blockade of grain exports from Ukraine,
one of the world’s biggest wheat producers, is also driving up food prices globally and sparking
worries about hunger in the developing world.

Some of those same factors have weakened global economic growth. The World Bank on
Tuesday slashed its annual growth forecast to 2.9 percent from January’s 4.1 percent and forecast
the sharpest slump after an initial post-recession rebound that the global economy has suffered in
more than 80 years.
Is it possible to avoid stagflation?

Avoiding stagflation is difficult, because financial regulators have to balance two competing
interests: inflation and unemployment. Dealing with inflation usually involves hiking interest
rates, making it more expensive to borrow money. That depresses consumer demand and makes
running a business more expensive. Employers often respond by trimming their workforces,
sending unemployment up.

Conversely, central bankers could try to lower unemployment by cutting interest rates, creating
incentive for employers to make large investments, hire and take market risks. But when
employers hire, wages rise. And when wages rise, consumer prices go up (i.e.: inflation). So
regulators are mostly stuck when it comes to stagflation.

The conventional wisdom on solving stagflation is to deal with inflation by raising rates and
sacrificing economic growth and higher unemployment. The rationale is that the market recovers
faster from unemployment than it does from persistently high consumer prices.

“The only known remedy for stagflation is a recession,” Wilcox said. “The Fed would have to
cause unemployment to go up; it would have to cause a recession to convince the public it is
serious about the 2 percent objective, and that they need to reset their expectations, their wage
demands, their pricing behavior so it is consistent with that 2 percent.”

All that said, a major driver of stagflation is high commodity prices — things like oil, wheat,
steel and other foundational market items. As commodity prices rise, everything else in the
economy becomes more expensive, too. One way to tame those prices is deregulating those
industries, more conservative economists say, but it can take months or years for those effects to
reach a producer’s bottom line. Policymakers generally want to address stagflation on a more
accelerated timeline.

Has stagflation happened before?

Yes. The most recent stagflationary period was from 1973 to the early 1980s. Commodity prices
were already high when OPEC, a consortium of oil-producing countries, cut off exports to the
United States, the United Kingdom, Canada and other nations because of their support of Israel
in the Yom Kippur War.

That created a dangerous combination of economic factors. Oil prices skyrocketed 300 percent
within a year. Prices on other commodities jumped, too. Employers, responding to the price
shocks, cut their workforces, leading to high unemployment. The phenomenon baffled
policymakers, who had assumed inflation and unemployment had an inverse relationship.
They were wrong, and the U.S. regulatory framework lacked a playbook to address stagflation.
The crisis dragged on until Western economies were able to build out their own commodity
production capacity to compete with sometimes-adversarial exporting nations.
Is stagflation different from a recession (suy thoái)?

Yes, for a few reasons. One aspect of stagflation is low or stagnant growth in economic output,
whereas in a recession, economic output declines. During stagflation in the 1970s, “the economy
was neither booming nor busting — it was trundling along, not in recession,” Wilcox said.

Another difference: Normally a recession leads to low inflation or even a cut in prices for goods
and services, whereas stagflation comes with high inflation.

But ridding an economy of stagflation may require central bankers to push the economy into
recession to finally curb spending and bring inflation under control, Wilcox said.

What happens if stagflation is here for years?

If stagflation is here for years in developed economies, something has gone horribly wrong. The
main method of dealing with stagflation is eliminating inflation and allowing the market to
naturally repel unemployment. In other words, the goal is to turn a stagflationary market into a
recessionary market, and recessions typically resolve in a little less than a year.

In developed markets like the United States, the euro zone and Japan, that will mean some hard
times for consumers and periods where hundreds of thousands of people probably will lose their
jobs. But on the other side of the recession, wages will be higher — wage growth that tracks with
inflation generally persists after inflation cools — and investment markets will stabilize and
employers will staff up again.

The real long-term risk is in emerging and developing economies, such as Brazil, Russia, India,
China and South Africa. They are all major exporters whose markets rely on importing countries
to sustain growth. If the economy contracts — especially the Western consumer economy —
developing countries will have fewer places to send their stuff. Those economies are also heavily
dependent upon foreign investment, but if international markets are turbulent, businesses are
likely to pull back from developing countries whose economies are more risk-prone. That could
lead to credit crises in developing market nations that could hamper the global financial
recovery.

https://www.washingtonpost.com/business/2022/06/08/what-is-stagflation/

World Bank warns global economy may suffer 1970s-style stagflation

Risks of further deterioration are mounting

By David J. Lynch

Updated June 7, 2022 at 3:34 p.m. EDT|Published June 7, 2022 at 9:30 a.m. EDT
The global economy may be headed for years of weak growth and rising prices, a toxic
combination that will test the stability of dozens of countries still struggling to rebound from the
pandemic, the World Bank warned Tuesday.

Not since the 1970s — when twin oil shocks sapped growth and lifted prices, giving rise to the
malady known as “stagflation” — has the global economy faced such a challenge.

The bank slashed its annual global growth forecast to 2.9 percent from January’s 4.1 percent and
said that “subdued growth will likely persist throughout the decade because of weak investment
in most of the world.”

Fallout from Russia’s invasion of Ukraine has aggravated the global slowdown by driving up
prices for a range of commodities, fueling inflation. Global growth this year will be roughly half
of last year’s annualized rate and is expected to show little improvement in 2023 and 2024.

This will be the sharpest slump after an initial post-recession rebound that the global economy
has suffered in more than 80 years, the bank said. And the situation could get even worse if the
Ukraine war fractures global trade and financial networks or soaring food prices spark social
unrest in importing countries.

“The risk from stagflation is considerable with potentially destabilizing consequences for low-
and middle-income economies,” said David Malpass, president of the multilateral development
institution in Washington. “ … There’s a severe risk of malnutrition and of deepening hunger
and even of famine in some areas.”

If the worst outcomes materialize, global growth over the next two years could fall “close to
zero,” he added.

With few exceptions, the economic outlook is troubled.

Now in year three of the pandemic, the global economy has been hit in 2022 by what the World
Bank labels “overlapping crises” — fallout from the war in Ukraine, recurring coronavirus
lockdowns affecting Chinese factories and the highest inflation rates in decades.

Economy shows resilience despite mounting recession fears

For now, the greatest areas of concern lie beyond U.S. borders. A recession in Europe is a real
possibility, as the continent struggles to accommodate millions of Ukrainian refugees and deal
with upheavals in energy markets. Elsewhere, the interruption of grain exports via the Black Sea
is hurting countries such as Lebanon, Egypt and Somalia. China is suffering from its rigid zero-
covid policies and battling costly property market weakness.

Though the U.S. economy shrank in the first three months of the year during the omicron variant
surge, growth is expected to rebound in the current quarter, according to economists’ estimates.
Financial market gauges of future inflation rates have declined since late April, easing — though
not eliminating — fears of a prolonged price spiral.

Nathan Sheets, global chief economist for Citigroup, called the chance of a significant stagflation
outbreak in the U.S. “remote,” in a recent client note.

Policymakers must act quickly to mitigate the Ukraine war’s consequences, help countries pay
for food and fuel, and accelerate promised debt relief, while avoiding “distortionary policies”
such as price controls and export bans, the bank said.

The World Bank’s Malpass said the global economy is being hampered by inadequate
production capacity for key goods. “It’s very important to increase supply massively to really try
to get at inflation directly by more production. Unfortunately, there aren’t signs of that very
much yet,” he said.

Russia’s invasion of Ukraine has disrupted global energy markets, threatening Europe with
recession and straining the budgets of countries that import large quantities of oil, natural gas,
coal and fertilizer, the bank said.

As Europe weans itself from Russian energy products, its purchases from alternative suppliers
compete with orders from existing customers, limiting available supplies.

Malpass said that to help offset surging prices, investments in additional energy production were
desperately needed, especially to address a shortfall of natural gas supplies, which are used to
produce electricity and fertilizer. Even announcements of future capacity could lower current
prices, he said.

“Announcements of major production increases will be essential for restoring noninflationary

growth,” he said.

The global stagflation threat could have particularly dire effects in the developing world, where
per-person income this year remains nearly 5 percent below pre-pandemic levels, the bank said.

Persistent inflation raises the chances that the Federal Reserve and other central banks will
sharply increase interest rates to cool off demand, as happened in the late 1970s. That could lead
to a more punishing global slump and financial crises in some emerging markets, the bank said.

In the 1970s, Latin American countries, in particular, borrowed heavily from U.S. banks, taking
advantage of low inflation-adjusted interest rates. But when central banks in the United States
and Europe turned to fighting inflation and hiked borrowing costs, 16 Latin American countries
stopped making their debt payments, according to the Federal Reserve.

Major banks cut off financing as they sought to negotiate new payment plans, plunging the
region into a “lost decade” of anemic growth.
Today, developing countries as a group owe a record amount to foreign banks and other financial
institutions. One-quarter of the typical poor country’s debt burden now carries variable interest
rates, up from 11 percent in 2010. So as inflation-fighting central banks tighten credit, repayment
costs will rise for cash-strapped borrowing nations, the bank said.

Sri Lanka last month defaulted on its foreign debts for the first time, and Malpass said he expects
other highly indebted countries will do the same.

But the world’s top economies will not escape damage. Bank economists now expect the United
States to grow this year by just 2.5 percent, down from the 3.7 percent rate they projected in
January.

China, the world’s second-largest economy, will fall short of the government’s annual growth
target, expanding by 4.3 percent. That would be Beijing’s worst full-year figure since 1990,
excluding 2020 when the pandemic depressed activity.

Investors also could take a beating from a repeat of ‘70s-style stagflation. The S&P 500 stock
index, already down more than 13 percent this year, could lose an additional 20 percent or more,
according to a recent client note from Bank of America.

Led by the United States, the world roared out of the pandemic downturn with its fastest growth
since 1973, a 5.7 percent gain. The global economy was expected to struggle this year as it
adjusted to the loss of pandemic-era government spending and ultralow interest rates. But
Russia’s invasion of Ukraine — and continued coronavirus flare-ups — have made the situation
tougher.

The price of a barrel of Brent crude oil has jumped to nearly $120, up about 50 percent this year.
And wheat has staged a similar rally, leading the bank to call for urgent action to ease
“worldwide food shortages.”

The World Bank’s downbeat forecast adds to concerns about global weakness. Most major stock
markets, including those in the United States, are in the red so far this year. And the bank’s sister
institution, the International Monetary Fund, lowered its global forecast in April.

With the U.S. and most other major economies suffering the highest inflation in 40 years, many
economists in recent months have cited the danger of a 1970s rerun.

After enjoying robust growth for most of the previous decade, the global economy toppled into a
prolonged slump in the 1970s. By 1982, global growth hovered near zero even as worldwide
inflation surged into double digits, according to the World Bank.

Still, today’s global economy differs from the 1970s in important ways, the bank said. The run-
up in commodity prices, though painful, pales alongside what happened almost five decades ago.
Oil prices quadrupled in 1973-1974 before doubling again in 1979-1980 amid the overthrow of
the shah of Iran.

Adjusted for inflation, today’s oil prices are one-third below their 1980 level, the bank said.

https://www.washingtonpost.com/business/2022/06/07/world-bank-global-growth-forecast-
stagflation/