Stagflation: the new risk facing the economy

BarcelonaThe combination of slowing economic activity and widespread price rises – a phenomenon known to economists as stagflation – is the main risk to global economic growth, the World Bank warned on Tuesday. The war in Ukraine is the main source of the slowdown in economic activity around the world, which has led the international organisation to revise its growth prospects downwards.

Thus, the World Bank has slashed growth forecasts for world gross domestic product (GDP, the indicator that measures economic activity) for 2022 from 4.1% advanced last January to 2.9%. It also predicts that in the years 2023 and 2024 the growth rate will remain at this same level, according to World Economic Outlook report presented on Tuesday. Among advanced economies, growth will fall from 3.8% to 2.6% this year, but will increase from 2% to 2.2% in 2023, according to the institution.

The figures are similar for the Eurozone, where GDP will increase by 2.5% and 1.9% this year and next year, respectively, while emerging economies will increase by 3.4% and 4.2% this year and next year. Per capita income in developing economies will remain 5% below 2019 levels in 2022, before the outbreak of the pandemic

Inflation – the growth in prices of consumer goods and services – is of particular concern to the Bank, because of the danger of it being combined with a slowdown in the economy and occasionally with recession in some countries, which is the situation that defines stagflation. However, the study forecasts a moderate rise in prices in 2023, although it could still remain, on average, above main central banks' targets, which is normally around 2% per year.

As a result of this mix of inflation and cooling activity, "for many countries recession will be difficult to avoid", said World Bank President David Malpass, who called for "changes in fiscal, monetary, climate and debt policies to counteract the misallocation of capital and inequality".

The Russian invasion of Ukraine is the great source of instability for the world economy because of its impact on the price of energy, which in turn affects the rest of the production chain. Europe's dependence on Russian natural gas has allowed Moscow to continue selling this fuel to many European Union states, but this is not the case with oil, whose sales have been sanctioned by the EU and the United States. In addition, the war also endangers the supply of cereals such as wheat and corn, which can lead to shortages and price increases for staple foods in developing countries, especially in Africa.

Supply-driven inflation

War is thus the main source of instability, but not the only one, the institution notes. "The war in Ukraine, lockdowns in China, disruptions in supply chains and the risk of stagflation are all impacting on growth," added Malpass. In this sense, the shortage of raw materials and intermediate industrial goods is another element pushing up prices. Also, bottlenecks in the industry's supply chains due to port closures in China have also contributed to inflation.

The World Bank study compares the current inflationary situation with the stagflation of the 1970s. The organisation points out that both then and now, inflation was not rooted in excess demand –for example, prices rising because of an increase in household consumption thanks to wage increases– but rather on the supply side: there are shortages of certain products or problems in supplying them, or instability in the energy markets, and all this makes fuels more expensive, which makes all the other products in the shopping basket more expensive.

On the other hand, the dollar is currently very strong, which allows the U.S. –the world's economic engine– to maintain a high level of imports that helps other economies to grow, while price increases of raw materials are proportionally lower than those recorded almost 50 years ago. Moreover, the World Bank welcomes the fact that most central banks have a clear mandate and necessary tools to contain price increases, which was not the case over four decades ago.