Is the world heading towards stagflation?

The world economy is reeling under a crisis due to COVID-19 and Russia-Ukraine war. The production capacities of countries and the global supply chain have been affected severely. As a result, the economies across the globe are facing various challenges such as high inflation, unemployment, food shortage, and depleting foreign reserves. In these circumstances, the debates around stagflation and recession have gained prominence in the daily news media. So, let’s try to understand what exactly the meaning of stagflation is in our economic lexicon and how the world is reacting to it.

What is Stagflation?

The term stagflation reflects a situation of economic slowdown when both inflation and unemployment are very high. Earlier, in the economic theory of the Phillips Curve, it was believed that stagflation is impossible as inflation was directly linked to the demand in the economy. And, more demand means more production and more employment.

However, the onset of stagflation during the 1970s led to the demise of several economic theories that linked inflation with employment. During stagflation, the reason for inflation can be unprecedented and different from the general demand-supply mismatch.

For example, if the Gulf or OPEC restricts the supply of oil to increase prices in the market, it is bound to bring inflation in all countries that run their economies on the fuel supplied by the Gulf or OPEC. Now, with rising inflation, there will be an increased level of unemployment as the production capacities will be affected negatively, leading to a situation of stagflation.

Besides sudden economic shock due to disruption, the economic and monetary policies of the countries may also lead to a situation of Stagflation.

Is the world economy entering the phase of stagflation?

We will need to look at the recent inflation data of various countries and the reasons behind the high inflation. The International Monetary Fund (IMF) in its recent World Economic Outlook says, “War-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7 per cent in advanced economies and 8.7 per cent in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January.” Clearly, inflation is rising across the world.

According to the Pew Research Center analysis, inflation rates have doubled in 37 of 44 advanced economies over the past two years. Turkey and Israel are countries where inflation has seen a several-fold increase. Turkey has an inflation rate of 54% as of January 2022.

Source: PEW Research Centre

Major economies of the world such as the United States, China, India, France, and Russia are facing high rates of inflation. The reasons are as follows;

  • Supply chain disruption due to pandemic and war in Ukraine
  • Food shortage due to war in Ukraine and protectionist policies of several countries to ensure domestic food security.
  • Higher prices of oil

Growth forecast and risk of stagflation

According to the Global Economic Prospectus report by World Bank, global growth may slump from 5.7 per cent in 2021 to 2.9 per cent in 2022— significantly lower than the 4.1 per cent that was anticipated earlier. This raises the risk of stagflation, with potentially harmful consequences for middle- and low-income economies alike, the report says.

In the current scenario, most of the economic indicators of the world economy are indicating a higher chance of stagflation in near future. To avoid 1970-style stagflation, there is a need to counter the rising prices of oil and food grains. Immediate relief should be given to the developing economies that are particularly facing the worst economic crisis and the Ukraine war needs to be stopped.

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