Will the world economy avoid an inflationary fall?
High inflation today is compared to that of the 1970s. However, robust consumer spending, fueled by pandemic-related savings, creates a different set of circumstances.
Memories of the 1970s were evoked when the price of Brent crude oil temporarily soared above $139 a barrel following Russia’s invasion of Ukraine. It was a period when skyrocketing oil prices and high rates of consumer price inflation pushed some of the world’s major economies into recession.
Using the National Bureau of Economic Research (NBER) definition of recessions, there have been seven such downturns in the United States since the 1970s.
The first four were all preceded by a rise in inflation and interest rates (see chart below). The US Federal Reserve’s (Fed) decision to raise interest rates amid mounting inflationary pressures in the United States – as they did in the 1970s – has further brought to light the parallels with the past.
Around $2 trillion in savings in the US and Europe
Could this “business cycle” play out like those of the 1970s, 80s and 90s, when economic conditions were apparently closer than those seen in the past two decades? The business cycle, sometimes referred to as the business cycle, is the period during which an economy moves from a state of expansion to a state of contraction, before expanding again.
Certainly, recessions before the 2000s followed the Fed raising its core borrowing costs, or the federal funds rate to cool economic activity and lower inflation. This time, however, economists expect consumer spending to hold up.
They expect this resilience as people deplete savings accumulated during the Covid-19 pandemic, despite tighter monetary conditions – in addition to raising interest rates, central banks are adjusting other policies monetary instruments such as quantitative easing (QE).
QE involves injecting money directly into the financial system through asset purchases (mainly bonds) to support activity since the global financial crisis. These unconventional policies have again been deployed in response to the fallout from the pandemic.
Keith Wade, chief economist at Schroders, says: “Households still have considerable firepower, and the consumer will likely be the mainstay of economic growth in 2022.
“They have a cushion to absorb the impact of rising energy costs with the excess savings accumulated during the pandemic, which we estimate at around $2 trillion in the United States and a similar figure in Europe.”
Russia’s shock invasion of Ukraine – with the consequent impact on energy and food prices already seen – has certainly added a new dimension to the inflation picture.
Schroders now expects global consumer price inflation of 4.7% this year (from 3.8%) as the impact of the war ripples through global markets, although it remains a level high level of uncertainty about the economic implications of the conflict. These are consumer inflation forecasts based on year-on-year (y/y) movements in consumer price indices (CPI).
Inflationary pressures, however, had already been building following the sharp global economic recovery, as Covid-19-induced restrictions were gradually eased. The easing had led to shortages of materials, energy and transportation. This has been accompanied by very strong demand, especially for goods, given the restrictions in the service sectors.
Pressure in global supply chains has led to sharply rising costs for producers of goods, which in turn have raised prices for consumers of their end products. Even before Russia invaded Ukraine, CPI inflation was at its highest level in decades in the US, Europe and the UK.
Stagflation is the most likely outcome
Wade says, “We are optimistic that supply chains will gradually return to normal in 2022 and we can see the possibility of commodity price moderation if the situation in Ukraine stabilizes.”
As inflationary pressures ease, Wade expects annual global CPI inflation to fall sharply to 2.8% in 2023, up only marginally from the 2.7% projected before the invasion of Ukraine.
That said, the broadening of inflationary pressures seen in some major economies, and notably the United States, is concerning, especially if it translates into a “wage-price spiral”, where inflation expectations become self-prophecy. -director.
“Initially, the rise in inflation in 2021 was led by the reopening of sectors such as airlines, hotels and restaurants, but more recently we have seen a recovery in cyclical areas such as housing. in the United States where housing prices have accelerated sharply,” says Wade.
“Overall, 80% of the components of the US CPI basket are now up more than 4% year-on-year. This suggests that it is not just one-off supply bottlenecks that are at risk. origin of the acceleration in inflation, with cyclical prices also reflecting excess demand.
“The broadening of inflation to cyclical areas of the US economy is concerning, as trends in this area may persist and fuel a wage-price spiral.”
The fear of wage-price spirals is seen as further justification for parallels with the inflation of the 1970s. This was a period when oil prices were highly volatile (initially due to an embargo imposed by oil producing oil following the Yom Kippur war and later following the revolution in Iran) for a long time and where wages were rising in the West.
“Stagflation,” a combination of slowing growth and accelerating inflation, has consequently turned into outright contraction and recession for many of these economies.
The risk of recession has increased
Covid-19-induced supply chain disruptions had already put the global economy on a stagflationary path before the Russian invasions of Ukraine. The war amplified these tendencies.
Along with raising its inflation forecast, Schroders has cut its global growth expectation for 2022 (to 3.7%, from 4.0% previously) and now sees the risks of a further slowdown in growth and of higher inflation for longer. Again, there remains a high level of uncertainty around these forecasts as the economic implications of invading Ukraine become clearer.
Spiraling wage prices or an escalation of the Ukrainian crisis are some of the main dangers in this regard.
Wade comments: “We have a risky scenario where Russia continues to occupy Ukraine and turns its attention to its new neighbors causing tensions with Eastern Europe (Poland, Romania, Hungary, Slovakia) and the Baltic States.
“Rising commodity prices are pushing inflation even higher, which is putting a lot of pressure on consumers and businesses. Economic activity is slowing down significantly. The result is an even more stagflationary outcome with weaker global growth and higher inflation this year and next.
There are also other risks, for example the recession in the world today, Wade believes, could result from a collapse in consumer spending due to other factors: “There are two risks to this view. The first is simply that bottlenecks prevent spending from taking place.
“Expensive items such as cars are in short supply and travel is still restricted in many regions, especially in Asia. This could create another air pocket for the economy where activity plunges until supply can respond.
“The second is that people choose not to spend their savings after all.”
For now, however, pandemic saving appears to be a key difference from past business cycles where higher inflation and aggressive monetary policy tightening triggered a consumer slump and recession. Economists expect consumers to be a mainstay of the global economy as they deplete their savings as the world continues to reopen.
Originally posted by Simon Keane, Equity Specialist, Schroders