EcoTVWeek du 25/06

The origin of the word stagflation is the  combination of “stagnation” and “inflation”. It represents a period of above-average inflation and slow or even negative economic growth. The 70s have become characterized as being the era of  stagflation but recently there is a  renewed interest in the concept because some  analysts argue that  inflation nowadays  – which has been accelerating –  could remain high  for longer, whereas growth which is very strong at the moment will eventually start to  slow down. Before analyzing this matter in greater detail, let’s go back to the 70s and let’s see what happened on that occasion.

In the history of pop culture, the 70s  are associated with disco music but in economic history, the 70s are associated with stagflation. The root-cause which is generally considered to be the reason why we had stagflation are two oil shocks, a massive increases in the price of oil, which had knock-on effects on the price structure in the rest of  the economy and had a detrimental impact on economic growth and pushed unemployment higher and higher. Upon closer inspection however, it also turns out that other reasons are to blame as well. First of all, inflation expectations became completely unanchored  It means that  people were expecting that  inflation was going to increase further and further hence were demanding higher wages, whereas companies were also increasing  their prices expecting that  inflation would continue to rise. Another important reason is that monetary policy in major economies, in particular in the USwas actually not reacting to that trend increase in inflation.

Let’s come back to 2021 now. Are there similarities in the current experience with what we have seen in the 70s? One similarity is that we have gone through a supply shock. Covid-19 meant restrictions put in place and a drop in activity. Then the restrictions were lifted, activity was rebounding. But there has also been a demand shock: restrictions mean drop in demand, lifting of the restrictions : demand is re-accelerating. Interestingly, the rebound in demand has been more important and swifter than the increase in supplies and that is quite understandable, but it  has led to longer delivery times and also in  certain sectors to higher prices: more inflation. Let‘s look at the labour market and there the picture is mixed.  In the US for instance, in certain sectors (think of restaurants etc.) companies are struggling to find people and  they  also have to pay higher wages. At the same time, there is concern that the pace of job creation would be too slow and that would mean that the decline in the unemployment  rate would take more time than one would have expected previously. In Europe, there’s also concern that before declining, the unemployment rate could actually increase when a number of support measures for companies would be stopped.

Does this mean that we are kind of inevitably evolving towards some form of  stagflation? I think that the risk is  pretty low and the reasons are that supply will increase, new companies will be created, productivity  is going to be quite high in the recovery. In addition, you will also observe that  the demand which is growing very strongly will gradually  start to slow down  towards the end of the year and even more so in 2022. Another reason that is important is that  inflation expectations remain well anchored, this is really the  message that is coming from the surveys that are being conducted in that respect. And finally should inflation be too high for too long, very clearly the  central banks would not  hesitate to react appropriately. That is the signal that has been  given  by Fed Chairman Jerome Powell in his latest press conference: should inflation be higher for longer, then the Federal  Reserve would not hesitate to act and would indeed tighten policy. So all in all, it means that the risk of evolving towards stagflation seems pretty low.