The World Bank has now joined the chorus of economists who believe that a recession is imminent. last week, World Bank President David Malpass also warned about the return to stagflation like in the 1970s.
Which brings the question: what is stagflation? Stagflation is defined as inflation plus stagnant growth. It is described as a time in which there is both inflation and a decrease in the gross domestic product (GDP).
It is characterised by slow economic growth and high unemployment. Generally, the strong bargaining power of trade unions, falling productivity, disruption to supply chains, and a rise in structural unemployment are the main causes of stagflation.
Why is stagflation a hot topic today?
Since inflation has been at record highs in practically all countries since the beginning of 2022, the threat of stagflation has dominated discussions for some time.
The World Bank has weighed in on the stagflation discussion by allocating a whole chapter to the topic in its Global Economic Development report for June 2022. Due to supply chain disruptions and pent-up demand as economies opened, inflation was high in most countries in 2021 as well.
However, the price rise has been worsened by the Russia-Ukraine conflict. In April 2022, the global median headline CPI inflation rate was 7.8%, the highest since 2008. While aggregate inflation in emerging and developing nations was 9.4%, it was 6.9% in advanced economies, which was the highest level since 1982.
Due to the higher risks at this time, the World Bank study has substantially altered global growth as well as growth in practically all countries.
Global growth is expected to decline from 5.7% in 2021 to 2.9% in 2022, with an average of approximately 3% in 2023. Development institutions are waving the red flag for stagflation risk as the world faces a period of high inflation and decreased GDP.
When was the last time the world experienced Stagflation?
Stagflation last occurred in the United States in the 1970s. This signalled the end of the post-World War II boom in the United States and the beginning of a period of de-growth. The US Federal Reserve’s easy monetary policy in the 1950s and 1960s is said to have contributed to this. The Fed attempted to raise employment and output, but this resulted in an unsustainable rise in wages, which pushed demand higher.
The oil shock of the 1970s, when OPEC countries agreed to impose a ban on crude oil exports to the United States, exacerbated inflation and interrupted economic activity. The years between 1975 and 1980 was particularly difficult, with the CPI exceeding 11% and the economy collapsing.
What you should know about the Nigerian economy
- Although a rising oil price is thought to be beneficial to a large oil exporter like Nigeria, the Central Bank of Nigeria (CBN) has stated that the recent increase in oil prices does not correspond to higher revenue or boost the Nigerian economy’s external reserves.
- In the recent Monetary Policy Council, Edward Lametek Adamu, the CBN’s Deputy Governor, also cautioned that oil earnings will be offset by fuel subsidies and higher production costs.
- “Under this condition, the cost of subsidy on PMS will increase, further limiting the fiscal space for supporting growth. Other downside risks to growth emanating from the war in Ukraine include rising gas prices as well as the cost of some intermediate goods. Manufacturing and agriculture could take a hit from this development,” he said.
- Nigeria’s Gross Domestic Product (GDP) grew by 3.11% (year-on-year) in real terms in the first quarter of 2022. However, the oil sector of the Nigerian economy contracted by 26.04% (year-on-year) in Q1 2022, indicating a decrease of 23.83% points relative to the rate recorded in the corresponding quarter of 2021.
- Nigeria recorded an average daily oil production of 1.49 million barrels per day (mbpd) in Q1 2022, lower than the daily average production of 1.72mbpd recorded in the same quarter of 2021 by 0.23mbpd and lower than the fourth quarter 2021 production volume of 1.50mbpd by 0.01mbpd.
- Nigeria’s inflation rose to 16.82% in April 2022, following a similar uptick recorded in the previous month as a result of the increase in energy and food prices. This represents the highest rate recorded since August 2021.
What causes stagflation
Stagflation, according to oil shock theory, occurs when an economy’s productive potential is reduced due to a sudden spike in the cost of oil. The Organization of Petroleum Exporting Countries (OPEC) imposed an embargo on Western countries in October 1973. As a result, the worldwide price of oil skyrocketed, pushing up the cost of commodities and contributing to an increase in unemployment.
Producing things and delivering them to shelves got more expensive as transportation costs increased, and prices soared even as employees were laid off.
Another view holds that the combination of stagnation and inflation is the outcome of weak economic policy. Stagflation is thought to be caused by strict regulation of markets, goods, and labour in an otherwise inflationary environment. Some blame former President Richard Nixon’s policies for the 1970 recession, which some belief was a forerunner to the stagflationary period.
To keep costs from rising, Nixon imposed tariffs on imports and froze wages and prices for 90 days. Economic pandemonium resulted from the immediate economic shock of oil shortages and the quick increase of prices after the limits were loosened.
Other theories suggest that monetary variables may also contribute to stagflation. The Bretton Woods system of international finance was brought down by Nixon, who abolished the last indirect traces of the gold standard.
Since then, the US dollar and most other world currencies have been on a fiat basis, removing most practical limitations on monetary expansion and currency devaluation.
Bottom line
- Stagflation is usually considered complex because slow economic growth may lead to an increase in unemployment but it should not result in rising prices. This is incongruent, which is why it’s bad for the economy. Increased unemployment reduces consumer purchasing power, affecting the demand-supply balance in the country.
- A remedy for stagflation could be to improvement in productivity which leads to better growth without further inflation. Increased aggregate supply (AS) via supply-side measures is another way to combat stagflation.
- The World Bank has recommended that all governments meet down and reach an agreement on how to deal with rising prices. Individual countries’ unilateral policy initiatives to combat domestic price inflation will not alleviate the global supply constraint. More than the government, central banks must be on the lookout for signs of stagflation. They should be prepared to ease up on their monetary tightening if necessary.
