1.12 Stagflation

FIGURE 1.12 Stagflation

Rising inflation and slowing growth raise concerns that the global economy is entering a period of stagflation reminiscent of the 1970s. The surge in energy and food prices over the past two years has been the largest and second largest, respectively, since the early 1970s. It has been accompanied by a steep slowdown in global growth that was even more pronounced than the one following the 1975 recession.

A. Energy and food prices B. Slowdown in growth after global recessions

Percentage points 0 i

1970 1983 1996 2009 2022

24 79

World Advanced economies

24 79

EMDEs

Source: World Bank. Note: EMDEs = emerging market and developing economies. A. Percent change in monthly price indices over a 24-month period. This facilitates a comparison of the April 2020 trough with the most recent data (April 2022). Due to data limitations, prior to 1979, the energy price change is proxied using the oil price change. B. Figure shows changes in global growth (in percentage points) between 2021-24 and 1976-79; in both cases covering the rebound following a global recession. Aggregates are calculated using real U.S. dollar GDP weights at average 2010-19 prices and market exchange rates. Data for 2022-24 are forecasts.

the implementation of large-scale trade embargoes. The demonstrated impact of sanctions on the Russian economy may prompt some other countries to self-isolate and protect themselves from similar measures in the future. This could involve raising barriers to free trade and developing parallel payment systems independent of the U.S. dollar. The pace of global economic integration has slowed substantially in recent years, and an outright reversal could result in less specialization, fewer economies of scale, less competition, and the slower spread of innovations. This could slow output and income growth and add to inflation pressures.

Stagflation

The current multidecade high levels of inflation, combined with sharply slowing growth, raise concerns that the global economy is entering a period of stagflation reminiscent of the 1970s (Special Focus 1). In the 1970s, large supply shocks amid accommodative monetary and fiscal policies resulted in prolonged stagflation. The policy tightening in the early 1980s to contain high inflation played a major role in triggering a global recession in 1982 and set off a string of EMDE debt crises.

The current juncture resembles the 1970s in several key aspects. First, supply disruptions driven by the pandemic and the recent supply shock dealt to global energy prices by the war in Ukraine resemble the oil shocks in 1973 and 1979-80. In fact, the increase in energy prices over the past two years has been the largest since the 1973 oil crisis (figure 1.12.A). Second, global growth is decelerating sharply, with the current slowdown even more pronounced than the one following the 1975 recession (figure 1.12.B). Third, then and now, monetary policy was highly accommodative in the run-up to these shocks, with interest rates negative in real (inflationadjusted) terms for an extended period. Fourth, with EMDE debt at multidecade highs now, a rise in global borrowing costs may trigger financial crises, as it did in the early 1980s.3

The stagflation experience of the 1970s is a reminder that there is a considerable risk that inflation will remain high or continue to rise. The supply bottlenecks and rising commodity prices that have contributed to elevated inflation could persist in the near term as a result of renewed pandemic-related lockdowns or continued commodity market disruptions. In the longer term, inflation may remain elevated as many of the factors that have contributed to low inflation in recent decades are slowing or in outright retreat. The growth of global value chains and the global labor force has fallen, the productivity gains from the reallocation of resources away from agriculture have waned, and technological progress has slowed (Ha, Kose, and Ohnsorge 2022). In addition, the commitment among some policy makers to disciplined fiscal and monetary policy frameworks could soften.

3 There are also important differences with the 1970s. Over the past three decades, many central banks have built considerable credibility in their commitment to price stability, which has helped anchor inflation expectations. Disinflation will also be supported by the planned fiscal consolidation underway in many economies. In addition, the 1970s were a time of considerable structural rigidities, including wage, price, and interest rate controls. Economies have become more flexible over time, reducing the likelihood of pricewage spirals that entrench inflation.