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What’s the truth about stagflation?

Stagflation occurs when growth stalls, inflation surges and unemployment stays stubbornly high. It’s unsettling when the term starts getting global attention, as it is now, but are we really facing the first resurgence of stagflation in 40 years?

If ‘stagflation’ talk is referring back to the oil shocks of the 1970s – when the US fell into recession as inflation rose sharply – we’re only there metaphorically. In other words, the US, and the global economy more broadly, currently seem far from recession.

In the 1970s the US suffered five quarters of negative real gross domestic product (GDP) growth in 1974 and 1975, and while ‘supply shocks’ are hitting us now as they did then, the comparison only goes so far.

First, while the global economy is suffering simultaneous downward pressure on activity and upward pressure on prices, economic activity in advanced economies remains well-supported, even if growth forecasts are vulnerable to the downside.

Second, to the extent the 1970s contains some lessons, it is possible that that decade reinforces the ‘transitory’ effect of supply shocks on inflation, since inflation did fall meaningfully in the US after the first oil shock in 1973-74.

Finally, while the US has a bigger ‘flation’ problem than a ‘stag’ problem, we continue to underline the risks to global activity coming from China, where ‘stag’ seems to be the dominant risk now, holding out the possibility that China is in for a deeper and longer slowdown than the market is currently braced for.

Trade growth looks particularly vulnerable

Breaks in global transport network supply chains are increasingly apparent, and power shortages in China may put downward pressure on trade growth as a result of the widespread hit to Chinese manufacturing that’s currently occurring.

Simultaneous upward pressure on prices and downward pressure on activity are especially clear now in Europe and the US.

Growth remains strong, but ‘stagflation’ headwinds to the Eurozone economy are blowing ever stronger, and in the US where job growth has proved disappointing. In the Eurozone, supply shortages which had already triggered a decoupling of production from orders are now aggravated by a huge spike in energy prices.

While energy accounts for only 3% of firms’ production cost on average across the EU, some sectors such as land and air transport or power generation will suffer significantly, and rationing could affect others.

This increases risk of business closures and insolvencies, with knock-on effects to the wider economy. Households spend 5% of the consumption basket on energy, and although we expect government intervention to cushion some of the impact of rising energy prices, we still expect 10% to 20% price increases, cutting disposable incomes by 0.5-1%.

Falling energy prices later in 2022 will then drive the reverse effect but shift growth from 2022 to 2023. Yet with GDP growth next year expected to be close to 4% both in the Eurozone and in the US, we remain far from ‘stag’ risks in economies whose potential growth is below 2%.

‘Stagflation’ in a metaphorical sense has been evident for months

As markets are forward looking, the potential for inflation and economic surprises has already been priced into market indices, reducing the risk of shock and policy intervention.

‘Stagflation’ also implies recession, and as we have noted, we see this as a remote risk on current data.

While there is no formal definition of stagflation, the term entered public consciousness in the 1970s against a background of a genuine collapse in economic activity as inflationary pressures simultaneously surged.

What makes the 1970s especially interesting as a historical parallel is that, as today, the proximate cause was a negative supply shock, in the form of a sharp increase in food prices and, especially, in energy prices following OPEC’s announcement in October 1973 that the posted price of oil would rise from US$3.01 per barrel to US$5.11.

This was followed by a decision a few days later to cut off oil shipments to the US, causing a further surge in the price. In the US at least, the inflation problem was accentuated by the end of the wage-price controls that the Nixon administration had introduced after suspending the dollar’s convertibility into gold in the summer of 1971.

The result of these actions caused chaos in the global economy, as world GDP growth fell from 6.3% in 1973 to 1.2% in 1975, and the US itself suffered five consecutive quarters of negative year-on-year GDP growth starting in Q2 1974.

What are the parallels to the 1970s?

The real price of energy has risen sharply recently, but its impact is less significant than it was 50 years ago. It is clear that while real oil prices are still quite low compared to historical pressure points, the real price of gas is indeed a concern on the face of it, reaching historically high levels.

Yet the macro impact of elevated energy prices isn’t what it used to be; diversified supply, alternative energy supplies, country fuel stockpiles and lessons learnt from previous shocks has led to the decline of energy’s impact on GDP over the past 50 years.

It would take a near-unimaginable rise in energy prices to induce a global recession, unless high energy prices shock financial markets.

To illustrate how far we are from recession, it is worth referring to an exercise based on simulations in the Oxford Economics Model. In order to get that model to predict near-zero global growth next year, a US$500 a barrel oil price is needed to shock the current baseline scenario.

In our view, while energy has the potential to create shocks the larger risk to lower growth lies with China, particularly as Chinese authorities seem determined to change the nation’s growth model and wean the economy off its dependence on real estate.


David Lubin is Head of Emerging Markets Economics for Citi, a sponsor of Firstlinks. Information contained in this article is general in nature and does not take into account your personal situation.

For other articles by Citi, see here.



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