In this month’s instalment of our visual series on topical themes, we look at whether the global economy is heading towards stagflation.

Read this article to understand:

  • The latest economic growth projections
  • The knock-on effects of inflation on emerging markets
  • How the current scenario compares to the stagflation experienced in the 1970s

The lingering after effects of COVID-19 and Russia's invasion of Ukraine have exacerbated supply chain pressures and fuelled inflation, causing a slowdown in the global economy.

Some market commentators fear we could be about to enter a prolonged period of stagflation, characterised by high inflation and stagnant or slow economic growth. This would replicate the 1970s, where oil price shocks saw inflation remain elevated for much of the decade, hurting household finances and the economy more broadly.

There are eerie parallels to today, particularly with the surge in the price of energy and other commodities. But is a return to 1970s-style stagflation really on the cards?

Growth is not growing

As Figure 1 illustrates, global growth is projected to slow significantly this year and in 2023, with advanced markets suffering most. According to our latest House View, the risk of recession has risen to close to 50 per cent.

Figure 1: Global growth projections (per cent)
Source: Aviva Investors, Macrobond. Data as of June 28, 2022

Figure 2 shows a global macroeconomic projection model featuring three different scenarios that could result in substantially weaker growth.

In the first, the Federal Reserve will accelerate monetary policy tightening in response to surging wage inflation and rising inflation expectations. In the second, Russia responds to sanctions by announcing an immediate ban on all energy exports to European countries. In the third, China experiences a resurgence in COVID-19 across the country and, in an effort to contain the spread, enforces lockdowns across several major cities.

Figure 2: Growth under alternative downside scenarios (per cent)
Source: World Bank, June 20221

Inflation increasing social inequality

Inflation has come to dominate dinner table discussions as food, energy and housing costs have increased. But that might not persist for much longer.

Inflation has come to dominate dinner table discussions

According to the Bank of England, inflation is forecast to keep rising this year, slow down in 2023 and be close to two per cent in around two years.2 As Figure 3 shows, and according to our projections, inflation should peak this year before falling sharply next year.

Figure 3: CPI Inflation projections (per cent)
Source: Aviva Investors, Macrobond. Data as of June 28, 2022

It helps to understand the drivers of inflation. Figure 4 shows the contributions to the Consumer Price Index (CPI) are different in developed and emerging economies. Food is the main contributor in emerging markets, while for developed markets housing and transportation are the biggest items.

Figure 4: Sectorial contributions to CPI (percentage point)
Source: World Bank, June 20223

This helps explain why inflation is having a disproportionate impact  on middle-and-low-income economies, as well as lower-income households in developed countries.

Figure 5 shows how the food terms of trade – the change in the price of food exports/the change in the price of food imports, weighted according to exports’ and imports’ respective shares of GDP – have worsened for 80 per cent of emerging market countries.4

Figure 5: Higher food prices leave most countries worse off
Higher food prices leave most countries worse off
Source: Goldman Sachs. Data as of May 2022

Now and then

The last time the world experienced stagflation was in the 1970s, when oil-exporting countries in the Middle East hiked prices and restricted supplies to the US and other developed countries. Figure 6 compares food and energy prices between 1970 and now.

Figure 6: Food and energy prices (per cent)
Source: Aviva Investors, Macrobond. Data as of June 2022

While the chart shows the 1970s period of inflation was worse overall, natural gas prices are significantly higher today, as Figure 7 reveals.

Figure 7: Real energy prices during price spikes (US$/bbl equivalent)
Source: World Bank, June 20225

But even if inflation is brought under control in the next year or so, according to the World Bank the slowdown in growth is projected to be more severe this time around (Figure 8).

Figure 8: Slowdown in growth after global recessions (percentage points)
Source: World Bank, June 20226

A quick response

Central banks are making a rapid reassessment of monetary policy

The rapid rise in inflation has led central banks to make a rapid reassessment of monetary policy – the Federal Reserve raised rates in June by 75 basis points, the largest increase since 1994, with further hikes likely before the end of the year. Other central banks are also moving quickly, or intend to do so, including the European Central Bank which has not raised rates in over a decade (Figure 9).

Figure 9: Policy rates (per cent)
Source: Aviva Investors, Macrobond. Data as of June 28, 2022

If the Fed and other central banks are effective in putting inflation back in its box, it will be interesting to see how quickly financial markets speculate on when monetary policy will return to a more accommodative state – a condition they have become accustomed to since the global financial crisis. But that is a question to be answered another day….

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