The ghost of stagflation is already real
By Isidro Pena (TU and Professor of Business Management Fundamentals at ESI)
In the last few weeks we have been observing that articles warning of the danger of stagflation have proliferated more and more in the economic press. Stagflation is the combination of inflation (continued rise in prices, which affects the purchasing power of families and the competitiveness of companies) and economic stagnation (low and even negative growth). It is a totally atypical situation, which first appeared in the 70s as a consequence of the 1973 oil crisis. To date, inflation and economic stagnation had never appeared simultaneously, since inflation occurred in periods of economic growth and periods of recession were characterized by falling prices.
The increase in prices, together with a possible reduction in sales, will have a direct impact on the profit of the companies and therefore on their valuation.
The invasion of Ukraine by Russia, together with the appearance of new variants of COVID, mean that the economic recovery after the pandemic is slower than initially expected. In addition, the increase in energy prices is causing a shortage of certain inputs and components (steel manufacturers are stopping production due to the increase in the cost of electricity), which contributes to a "brake" in the economy. Added to this situation are inflation levels of over 7%, which will surely reach double digits. It is important to note that when inflation reaches "cruising speed" it is difficult to control. In this sense, Paul Volcker, (director of the Reserve in the period 1979-1987, during the mandates of Carter and Reagan) and hero of Wall Street for his way of fighting inflation (he took interest rates to 22% after that in the year 1980 inflation reached levels of 15%), he compared inflation with toothpaste "very easy to take out of the tube, impossible to put it back once it has come out". In addition, it cannot be ignored that inflation affects, to a greater extent, workers with lower salaries for what is known as the "tax of the poor".
Monetary and fiscal policies are the main tools that allow acting on inflation and growth. In times of inflation, central banks must adopt a restrictive monetary policy, reducing money in circulation and increasing interest rates. In the current context (with an economy "doped" by large injections of liquidity by central banks and 0% interest rates), these measures would cause a further slowdown in the economy, not to mention a possible debt crisis given the very high levels of indebtedness of families, companies and governments in developed countries. While the Federal Reserve has taken steps in this direction, the ECB has announced reductions in debt purchase programs starting in April and is waiting to see if the existing high levels of inflation are not circumstantial to start raising interest rates .
The situation requires caution in terms of monetary policy, with small steps in terms of withdrawing stimuli and raising interest rates that allow us to gauge the impact of monetary decisions accompanied by a fiscal policy that favors private investment and improvements in the productivity.
In any case, taking into account the current war context in which thousands of people are dying, millions displaced and images of destruction and suffering that will remain in our retinas for many years to come, and despite the negative economic consequences, we would all like to tell: that everything bad that happens is…..stagflation.
