The Specter of Global Stagflation

Is the world facing a revival of stagflation, that deadly combination of rising inflation and stagnating growth? Given the need for currency appreciation and monetary tightening in emerging-market economies, a negative supply shock – say, a war with Iran – coupled with a deflationary global demand shock (as housing bubbles go bust) is all that is required.

New York – Will rising global inflation lead to a sharp global economic slowdown? Even worse, will it revive stagflation, that deadly combination of rising inflation and negative growth? 

Inflation is already rising in many advanced economies and emerging markets, and there are signs of likely economic contraction in many advanced economies (the United States, the United Kingdom, Spain, Ireland, Italy, Portugal, and Japan). In emerging markets, inflation has – so far – been associated with growth, even economic overheating. But economic contraction in the US and other advanced economies may lead to a growth recoupling – rather than decoupling – in emerging markets, as the US contraction slows growth and rising inflation forces monetary authorities to tighten monetary and credit policies. They may then face “stagflation lite” – rising inflation tied to sharply slowing growth.

Stagflation requires a negative supply-side shock that increases prices while simultaneously reducing output. Stagflationary shocks led to global recession three times in the last 35 years: in 1973-1975, when oil prices spiked following the Yom Kippur War and OPEC embargo; in 1979-1980, following the Iranian Revolution; and in 1990-91, following the Iraqi invasion of Kuwait. Even the 2001 recession – mostly triggered by the bursting high-tech bubble – was accompanied by a doubling of oil prices, following the start of the second Palestinian intifada against Israel. 

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