Slow Growth And Rising Prices

Today's economic environment is reminding investors of the so-called "stagflation" that affected developed economies throughout the 1970s and 1980s. These periods were marked by slowing economic growth, rising inflation and growing unemployment. Today's picture is different but pose a central choice for central banks: should they support slackening growth or combat soaring inflation?

  • Central bankers, who were already trying to defuse soaring inflation at the end of 2021, say the war in Ukraine has increased their uncertainties as energy prices skyrocket and global supply chains are, once again, derailed
  • Central bankers risk having to stifle their economies and raise unemployment in order to keep inflation in check

For the time being, many of the world's major central banks have taken serious action against inflation by tightening monetary policy. However, the path ahead is still unclear.

Additional Errors?

The hope is that the Fed can create a soft landing, in which inflation returns to its target of 2% while the economy remains strong and unemployment does not rise significantly. Jerome Powell and fellow central bankers appear to believe they have a high chance of succeeding, based on their previous statements.

  • However, the Fed may be overestimating its capacity to tame inflation while sustaining growth as it minimises the mistakes it did in 2021 when it stated that inflation was "transitory"

"So there is little basis for confidence in the Fed’s assessment of inflation risks. With extraordinarily tight labor markets getting tighter by the best available measures, and wage inflation running at 6 percent and accelerating, high inflation was a major risk even before the events of recent weeks. We now face major new inflation pressures from higher energy prices, sharp run-ups in grain prices due to the Ukraine war, and potentially many more supply-chain interruptions as covid-19 forces lockdowns in China. It would not be surprising if these factors added three percentage points to inflation in 2022. And with price increases outstripping wage increases, a wage-price spiral is a major risk." by Lawrence H. Summers for the Washington Post

BENCHMARK'S TAKE

  • Uncertainties linked to the war in Ukraine and new rises in COVID cases in China may put additional pressures on the economy and keep inflation higher than expected
  • In the longer run, we also expect U.S.-based and European businesses to be forced to bring their manufacturing activities closer to home in order to protect their security interests
  • These might sustain inflation longer than expected while reshaping global supply chains and progressively increase global manufacturing prices

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Anne Preble on Unsplash.