What Is Stagflation? Why Is It A Cause For Worry For Major Economies Of The World | EXPLAINED

The double whammy of Covid-19 pandemic-induced lockdowns and ongoing conflict between Ukraine and Russia have added to stagflation worries for the entire globe

The finance ministry has said that Indian economy faces a lower risk of stagflation than other countries, however, there is an upside risk to gross budget deficit due to cuts in excise duties.

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The economic order of the world is facing serious threats of inflation. But economists worldwide aren’t just only worried about inflation; they are more concerned about another economic peril, stagflation, which may take a serious toll on the financial parameters of the world. They have cited every possible reason why stagflation is a major reason for worry.   

The double whammy of Covid-19 pandemic-induced lockdowns and ongoing conflict between Ukraine and Russia have added to stagflation worries for the entire globe. Countries witnessing surging inflation, demand slump, and unemployment may encounter stagflation. 

Is the Indian economy also on the verge of stagflation? According to some analysts, stagflation may hit the economy if the inflation graph doesn’t bend down at the earliest. However, both the central government and the Reserve Bank of India (RBI) are trying to allay fears over stagflation.

The finance ministry in its monthly economic report on Monday said that the Indian economy faces a lower risk of stagflation than other countries. Though the government in its report mentioned that there is an upside risk to gross budget deficit due to cuts in excise duties.

The central bank also categorically said there are no fears of stagflation in India as of now and the RBI doesn’t see inflation going over 6 per cent in FY22-23. However, the prospect of stagflation is alarming as many countries are staring at economic imbalances.

What is stagflation?

Stagflation is a combination of two words – stagnation and inflation. Stagflation occurs when an economy experiences high unemployment, little or no growth, and soaring inflation. However, all the three categories will not lead to stagflation all the time as experts see it as a peculiar economic condition.

The term stagflation was first coined by Iain Macleod, a British politician, in 1965.

Several economists once doubted stagflation was possible, as unemployment and inflation typically move in opposite directions. Analysts are of the view that price levels are usually driven by an economy’s level of demand, while unemployment generally declines when demand rises.

How stagflation happens?

Stagflation usually occurs when a country faces supply shocks. The Covid lockdowns, which disrupted the global economy, followed by the current war between Ukraine and Russia could put the last nail in the coffin. Experts have termed the supply disruption due to the ongoing geo-political crisis as the largest commodity shock the world had experienced since the 1970s.

The world economy could be in the doldrums if the conflict between two nations continues for a longer period, with additional harsh sanctions on Russia. These will only make the matter worse as demand will gradually fall and prices of goods and services stagnate.

The Organisation of Petroleum Exporting Countries (OPEC) in the mid-1970s decided to cut the supply of crude oil which resulted in surging oil rates by nearly 70 per cent in the world. This move had impacted the western countries mostly as they were heavily dependent on crude oil. That time inflation in the US almost reached double-digits.

Stagflation may also occur when central banks print excessive currency notes, hence creating inflation as supply of money rises, and certain policies for industry could lead to supply constraints resulting in slow economic growth. 

Overseas stagflation woes

A potential threat of a recession in the US is making headlines after an over 8 per cent inflation rate was registered which crossed 40-year highs. The US Federal Reserve has raised key interest rates to record high to tame the soaring inflation. According to economists, stagflation has not yet hit the US, but if the current situation prevails for a longer time, the US might experience another stagflation after 1970.

Countries at risk

Economists are of the view that chances of possible stagflation are higher in the US, the UK, and the other European countries where economic recovery after the pandemic had been stronger, as reported by Bloomberg.

Inflation in the Euro zone hit 8.1 per cent in May. The OECD predicted that the UK would be the slowest-growing member of the G-7 countries in 2023. According to a Bloomberg report, in June, the World Bank cut its global economic growth forecast and issued a warning that the danger of stagflation was “considerable.” David Malpass, World Bank’s president, wrote, “Even if a global recession is averted, the pain of stagflation could persist for several years — unless major supply increases are set in motion.”

How to tackle stagflation?

Experts opine that there is no absolute remedy available to tackle stagflation. However, economists suggest a rise in production to the level leads to high growth and a surge in demand that could eventually help to control stagflation.