STAGFLATION: ENEMY OF THE PAST OR WORRY OF THE PRESENT?

By Ritika Yachna, Kalindi College

As the time to say goodbye to 2021 is nearing, traders are saying hello to the anxiety of dealing with ‘stagflation’. A word that hasn’t been heard since the late 70s, an enemy that the world had long forgotten, is making a comeback. A massive increase in energy prices across the world, crimps in the supply chains, and rising unemployment has made the matters worse.

‘Stagflation’, a portmanteau of two words, ‘stagnation’ and ‘inflation’ refers to a sluggish economic period of low growth and increased inflation. Stagflation was first experienced in the United States in 1971 when President Richard Nixon made a major decision to take the US off the gold standard. This decision coaxed the decline of the dollar against other currencies, escalating the domestic inflation rate. The authorities went on to impose both wage and price control which contributed to the increasing spiral of tension. In 1973, the Arab members in OPEC seized the oil supply to the countries that supported Israel in the war. This ban led to the skyrocketing price of oil and gas in the United States. These events intertwined to increase the scarcity, thereby giving a supply shock and increasing inflation. The fall in production led to a rise in unemployment. In 1975, the ‘Misery Index’, a collective sum of the inflation and unemployment rates rose to 19.9% before reaching its peak of 22% in 1980.

The reason why economists are fearing a return of Stagflation is the global post-pandemic recovery. Every country in the world struggled with the deadly virus for over two years, by strictly imposing wide economic shutdowns and social distancing. The aftermaths can be analyzed by the crimped supply chains in comparison to the increased consumer demands post-vaccination drives in major economies. Initially, the US Fed had anticipated that the economies will recover from the pandemic period in a transitional phase and that the price increases were a part of this transitional phase, however, the delta variant spoiled this prediction. The prolonged lockdowns further reduced the supply of the goods and led to a labor shortage in nearly every major industry, thus, further aggravating the supply shortage across the world. Furthermore, this shortage led to rising food and fuel prices across continents, which diminished the lamp of optimism initially carried by the Fed.

There’s still a school of thought which believes that the economies are in the recovery phase and as the growth rate expands, the worry of stagflation will leave our minds. Even though the inflation rates subside, the other side of the equation i.e., the ‘stagnation’ side will not be worrying us.

A Deutsche Bank AG Survey shows that a ‘fairly strong consensus’ has developed and the market professionals believe that some kind of stagflation is likely to take place. The stagflationary setup has proven to hit the technology stocks the hardest, while the healthcare and energy stocks are seen to be outperformed.

To comprehend the stagflationary talks in India, the debate is growing rather strong in India, after the release of GDP data for the first quarter of 2021. The data shows an overall contraction of 23.9% in Q1FY21. Adding to the woes of low output, the inflation measured through CPI (Consumer Price Index) reports inflation level crossing the upper band of 6% for the fifth consecutive month, at 6.69% in August 2021. A major contributor to inflation is the rise in the prices of food ( 9% in August). The core inflation (inflation excluding food and fuel) has registered a growth rate of 5%. However, the wholesale inflation measured through WPI shows a contrasting picture. In January, retail inflation was reaching an all-time high of 7.5%, while the WPI stood at 3.5%. This distinct image can be explained by the lockdown-induced supply-side restriction.

While the data points towards a stagflation era, only the time and recovery policies of the governments will foretell how soon this inflationary period with low growth can be overcome. As the world is still recovering from the ghastly pain inflicted by the deadly virus, it will be a fair assumption that with time, as wounds of the pandemic are filled, the train of the economy will be back on track and things can take a different turn. After all, it is not only the inflation rate that is rising across the world. A recent report by Google says that worried people all across the world are searching for the term ‘stagflation’.

References:

-Why Stagflation is back on some traders’ radars, By Matthew Boeslor and Emily Graffeo, The Washington Post

-Stagflation is all anyone in Markets wants to talk about now, By Katherine Greifeld, Bloomberg

-Why economists are talking about Stagflation, By John Detrixhe, The Quartz

-Stagflation worry haunt India: What it is and how it really hurts, By Deepthi Mary Mathew, The Economic Times