SYDNEY, Apr 21 (IPS) – The global economy is on the brink of “stagflation” – slowing growth and high inflation – due to a shock in energy prices following the illegal US-Israeli war on Iran. The International Monetary Fund (IMF) recently described it as “textbook negative supply shock“. For the first time since the 1970s, the possibility of stagflation looks real.
What can central bankers learn from the stagflation of the 1970s?
Possibilities of global stagflation
The IMF simulated three possible macroeconomic scenarios depending on the duration of the conflict and the extent of damage to energy infrastructure in the region. These range from a slight decline in this year’s projected global growth rate – from 3.4% to 3.1% – to a moderate decline of up to 2.5% and a sharp decline of up to 2%. The projected increase in “headline inflation” – which covers all goods and services, including volatile goods, such as energy and food – ranges from 4.4% to 5.8% in 2026.
The IMF doubts whether monetary tightening can prevent inflation without causing a substantial increase in unemployment. But this does not provide any solution; “Instead it advises central banks to be prepared.”Acting decisively to maintain price stability“.
The IMF’s overall policy advice is conservative. However, it acknowledges the need for monetary and fiscal policy to support economic activity if financial conditions tighten sharply and global activity declines significantly.
Inflation fears and policy over-reaction
Ben Bernanke and his co-researchers found that the recession in the 1970s was not caused by oil-price shocks but by monetary policy tightening. Bob Barsky and Lutz Kilian found that “oil price rises were not as essential a part of the causal mechanism causing the stagflation of the 1970s as is often thought”. ed nelson Blamed the “flawed principles” of central banks for the stagflation of the 1970s.
So, it was not inflation that led to a decline in output, but inappropriate and harsh efforts to curb inflation that essentially suppressed growth, and produced the world’s first stagflation. This could happen again if central bankers overreact and tighten financial conditions to eliminate the current “textbook supply shock” inflation.
The problem is the intransigence of central bankers groupthink Despite empirical evidence to the contrary. For example, expectations of uncontrolled inflation and fears of wage-price spirals have no empirical basis as stated in the report. imf research and this Reserve Bank of Australia.
Nevertheless, central bankers and the IMF favor monetary tightening due to fears of “uncontrolled” inflation expectations and the risk of wage-price spirals.
Revisiting the inflation target
The group-think bias of central bankers insists on an inflation target of 2% – a figure “pulled out of the air“Still it became”global economic gospel“. don brashThe acclaimed former Governor of the Reserve Bank of New Zealand, who was the first central bank governor to adopt a 2% inflation target, admitted that it was based on “a casual comment by Roger Douglas, then New Zealand’s Finance Minister, during a television interview”. This “became a mantra that was constantly repeated” as Brash and his colleagues “devoted enormous amounts of effort” to preaching their new gospel to “everyone who wanted to listen – and some who were reluctant to listen.”
olivier blanchardThe former chief economist of the IMF questioned the wisdom behind a 2% inflation target and argued for a higher, for example, 4% target after the 2008–2009 global financial crisis. imf research Also advocated a long-term inflation target of 4%. Such high inflation should lead to an expansion of the policy space.
Joe Gagnon and Chris Collins Argued that “the case for raising the inflation target is stronger than is generally thought”. Their research showed that “the benefits (of a higher inflation target) clearly outweigh the costs”.
In such a situation, no one should be surprised The Financial Times Says, “Now is the time to revisit the 2% inflation target”.
Rethinking inflation
Almost all central bankers view inflation as the result of excess demand, caused by either an increase in aggregate demand or a decrease in aggregate supply at a given price. Prices rise to eliminate excess demand.
A common view is that higher prices lead to demand for higher wages which in turn leads to higher prices, creating a wage-price spiral. Therefore, central bankers focus on controlling demand by raising interest rates regardless of the sources of inflation.
On the other hand, the optimal policy-mix is different when inflation is viewed as the result of distributional conflict or disagreement. Guido Lorenzoni and Ivan Werning Analyzed the effects of supply shocks arising from “non-labor” inputs, such as energy under different relative bargaining powers of labor and firms where non-labor input prices are perfectly flexible, and goods prices are more flexible than wages.
They found that the optimal policy response to supply shocks coming from scarce non-labor inputs is to “overheat the economy”, that is, to allow demand to exceed supply capacity and higher inflation. Their findings suggest that it would be more efficient to reach adjustment with the help of high price inflation than low price inflation and deep wage deflation by creating high unemployment.
David Ratner and Jay Sim The trade-offs of anti-inflation measures were analyzed considering inflation as the result of distributional conflict. They found that restrictive anti-inflation measures are more costly in the case of unemployment.
Interestingly, their finding confirms the IMF’s observation that the aggregate supply curve is rising making restrictive anti-inflation measures more costly in the context of higher unemployment. Unfortunately, the anti-inflationary group bias of central bankers tends to dismiss high unemployment or declines in growth caused by restrictive policies as “short-term pain for long-term gain.”
recent imf research The recession’s lasting scars were revealed, including those resulting from external shocks and macroeconomic policy mistakes; They all “cause permanent losses in production and welfare”. The Lancet Reported “substantial impact on suicide rates”. Physiological Economic: Why Austerity Killsexamined the human cost of austerity policies during the economic crisis to highlight that health indicators could worsen significantly.
optimal policy response
In light of the above, central bankers should reconsider their aggressive anti-inflation policy-making.
Governments around the world are trying to mitigate the effects of fuel price through fiscal measures such as fuel excise duty, subsidies and temporary reduction in price caps. Mainstream commentators, including International Monetary FundThey argue that if the crisis continues these measures could have significant fiscal costs and would place additional burden on central banks, which are focused on controlling inflation.
It is noteworthy that the optimal policy mix should include measures to increase tax revenues. Governments should consider increasing tax progressivity. In particular, beneficiaries of high interest rates and fuel prices, such as banks and fuel companies, should be imposed an additional profits tax to fund the cost of living support measures.
Dr. Ken HenryAustralia’s former Treasury Secretary recently argued that a 100% tax on windfall profits from gas would be “socially optimal”. organized by tony wood “Wind profits tax could be least-bad solution to gas crisis”.
Research based on US data shows that excess profits tax Reduces existing racial and ethnic disparities and disparities between groups with different educational attainments. It could also accelerate the renewable energy transition when increasing geopolitical tensions and climate impacts threaten continued instability in fossil fuel and gas markets.
Anees ChaudharyEmeritus Professor, Western Sydney University (Australia). He held senior UN positions in Bangkok and New York and served as Special Assistant to the Chief Adviser on Finance (with the status and rank of Minister of State) in the interim government led by Professor Yunus. E-mail: (email protected)
IPS UN Bureau
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