Brigitte Granville, Professor of International Economics and Economic Policy, Queen Mary University of London
Stagflation is imminent, so a natural focus for anywhere? discussion should be whether we are headed for an episode as bad as the 1970s or worse. My answer would be that a recession is likely, but the 1970s experience of high inflation persisting despite repeated recessions should be avoided. That said, even a relatively milder dose of stagflation will hurt living standards.
The mildest way out of the current situation would be for inflation to heal itself quickly: by making people poorer in real terms, so they can’t afford to buy that much. In this scenario, inflation would decline and central banks could help the downturn in the economy by reversing their current rate hikes.
However, there are several obstacles to such a rapid turnaround: the context of the post-COVID recovery and the labor market.
The main inflationary impulse comes from two factors on the global supply side. First, supply chains are struggling to cope with the collapse and rebound in demand during and after COVID, exacerbated by China’s zero-COVID policy. Second, supplies of energy and other natural resources have been limited by the Russian war in Ukraine and Western sanctions.
The inflationary effects of these problems are being extended by pent-up demand from Western businesses and consumers as a result of COVID stimulus packages in the UK and especially the US, as well as unspent revenue accumulated during lockdowns. In the UK, for example, household deposits were still well above the pre-COVID level in April.
It doesn’t help that the financial markets have been driven to such heights by loose monetary policy. Although the bubbles have popped recently, valuations will need to fall a lot further before people start to feel poorer and less willing to buy things.
As for the second obstacle to a rapid reversal of inflation, ie the labor market, the main problem again comes from the supply side. Corporate labor demand has normalized post-COVID, but there are too few workers. This is partly due to the fact that more over-50s are choosing to leave work, but the UK has the added problem of Brexit interrupting the flow of quality workers from Central and Eastern Europe.
Underemployed, companies are forced to pay people more Wages in the UK are rising at around 4% a year and have to pass costs on to customers in the prices of goods and services. The Bank of England is alert to the threat of a 1970s-style wage-price spiral and has raised interest rates.
But leading indicators suggest that the threat of the wage-price spiral is not that serious. The closely watched Purchasing Managers’ Index, which measures UK companies’ optimism about the economy, shows that services in the services sector will turn gloomier in the coming months.
You don’t keep raising prices if you think people will stop buying. And while we may have seen faint echoes of haulage workers’ militancy in the 1970s, pessimistic companies in general are more likely to cut workforce scheduling and production rather than succumbing to hefty wage demands if they don’t open the store. close completely.
It seems to me that this will be more decisive in determining the course of inflation, as it is a long-term structural issue, while the post-COVID issues must ultimately be resolved. So overall, I expect the current sluggishness of the UK economy, which is very likely to slip into a mild recession, to push inflation back towards the 2% target. In the US, where underlying demand and credit are stronger, sharper rate hikes may be needed to achieve the same goal.
The biggest danger, I think, is that central banks will become too dogmatic about their inflation target of 2%. In my book Remembering Inflation, I discussed compelling research findings that inflation levels of up to 5% do little or no harm to growth in the long run, especially if inflation is stable rather than volatile. So once inflation slows down a bit, central banks should stop raising interest rates to avoid doing more harm than good.