Risks and Trends

Risks and Trends: how to survive stagflation

Preview 2022-10-20
At the Polityka Insight conference on 24 October, we will talk about what action should be taken in a situation of simultaneously rising inflation and falling GDP dynamics.

Preview

What policies to adopt at a time of stagflation? The rate of consumer price growth in most developed countries has reached dynamics not seen since the early 1980s. In the USA, inflation stood at 8.2 per cent in September, in Germany at 10 per cent, in the United Kingdom at 10.1 per cent, and in Poland at 17.2 per cent. At the same time, the global economy is decelerating sharply. "How to survive stagflation?" - will be the question we will ask the participants of a panel under the same title at the Risks and Trends conference. According to the latest IMF forecasts, global GDP growth will slow to 3.2 per cent this year and 2.7 per cent next year from 6 per cent in 2021. The slowdown will be felt more strongly in the developed countries, where GDP growth will fall to an average of 1.1 per cent in 2023 (some countries such as Germany, Italy, and Sweden will even experience a mild recession). As the World Bank already pointed out in July, such a combination of economic dynamics raises the risk of stagflation, i.e. the perpetuation of high inflation with very low economic growth. It poses a major challenge from the point of view of policymakers, as it requires a good alignment of fiscal and monetary policy.

Is it possible to bring inflation down painlessly? The last time stagflation occurred in developed economies was in the 1970s. For nearly a decade at the time successive energy shocks combined with expansionary fiscal policy and excessively low interest rates translated into sustained elevated inflation, which in turn dampened economic growth, leading to unemployment. Governments sought various, often unorthodox measures to overcome stagflation - from price and wage controls to quantitative limits on lending. However, it was only the strong tightening of monetary policy and the ensuing recession that ended the period of stagflation in the early 1980s. The current actions of governments and central banks resemble those of half a century ago. Interest rates, although rising, are still lower than the rate of inflation, and politicians are introducing one protective measure after another - from additional levies on corporations to price controls and indirect tax cuts. The moves are aimed at protecting citizens from the effects of rising inflation, but in many cases only succeed in postponing the rising prices.

How to prevent fiscal crises? Stagflation hits the state budget as hard as it hits household budgets. Although high inflation initially leads to an increase in tax revenue and a reduction in the public debt-to-GDP ratio, in subsequent years the combination of low economic growth with high interest rates and large claims by groups dependent on the state (e.g. public sector employees, pensioners), leads to an increase in the deficit and overall debt. If this is compounded by turmoil in the currency markets, poorer countries and those with high levels of debt can spiral into fiscal crises and, in extreme cases, go bankrupt. To address this threat, central banks are using increasingly unconventional monetary policy tools. For instance, the ECB has started to raise interest rates at the same time as it has launched an emergency purchase programme for eurozone bonds, which it can use if the fiscal stability of any of the countries in the monetary union is threatened.

Will stagflation stop the energy transition? An additional problem caused by the simultaneous increase in financing costs and slower economic growth is that companies are less willing to make investments, including those to green their operations. At the same time, governments, in order to protect consumers from the rising costs of energy prices and for fear of overdependence on Russia, are liberalising what were previously stricter emissions requirements for the energy fuels used. In Poland, a return to coal is taking place and in Germany, the extension of nuclear power plants is being advocated. In addition, the freezing of gas or electricity prices discourages households from reducing their energy consumption and ensuring the thermal efficiency of their homes. This could lead to a delay in achieving the goals set out in the European Green Deal.

Panelists

The panel "How to survive stagflation" will be attended by Paweł Borys - President of the Board of the Polish Development Fund, who is responsible for financing and implementing a number of programmes supporting the development of the Polish economy, Julia Patorska - expert in the field of economic and environmental analyses, associate partner at Deloitte, Jan Piotrowski - economic editor of the weekly "The Economist", and Gallina A. Vincelette - EU director at the World Bank and economist specialising in research into sources of economic growth.

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dr Adam Czerniak
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