Today’s global economy looks eerily similar to that of the 1970s, but governments can still escape an episode of stagflation
The global economy is in the midst of a sudden slowdown accompanied by a strong increase in power global inflation to multi-decade highs. These developments raise concerns about stagflation – the coincidence of low growth and high inflation – similar to what the world experienced in the 1970s. This experience should warn of the damage this could cause. to emerging and developing economies (EMDE). The stagflation of that era ended with a global recession and a series of financial crises in EMDEs. In light of the lessons of this episode of stagflation, these economies must quickly rethink their policies to deal with the consequences of rapidly tightening global financing conditions.
Inflation and growth: developments in opposite directions
In May 2022, global inflation (8.1%) and EMDE inflation (9.4%) were at their highest levels since 2008. Inflation in advanced economies reached its highest level recorded in the last four decades. As recent energy and food price shocks fade, supply bottlenecks ease and financial conditions tighten, global inflation is expected to decline to around 3 % next year. But that would still be around 1 percentage point above its average in 2019, before the pandemic upended the world.
After collapsing during the 2020 global recession, global growth rebounded to 5.7% in 2021, supported by unprecedented accommodative fiscal and monetary policy. However, growth is now expected to slow to 2.9% in 2022 with little change in 2023-24 due to the war in Ukraine, diminishing pent-up demand and withdrawal of policy support amid high inflation. Looking beyond the near term, global growth is expected to remain subdued over the 2020s, reflecting a trend weakening of fundamental drivers of growth.
The slowdown in growth is more pronounced, inflation is rising less (again)
The current conjuncture resembles the early 1970s in three key respects:
- High inflation and low growth. The global economy is emerging from the pandemic-related global recession of 2020, just as it did during the period of stagflation that followed the global recession of 1975. Global inflation from 1973 to 1983 averaged 11 .3 percent per year, more than three times higher than the average of 3.6 percent per year during the period 1962-72. While the rise in inflation since the 2020 global recession triggered by the COVID-19 pandemic has been less steep than after the 1975 recession, the expected slowdown in growth is much more pronounced. Between 2021 and 2024, global growth is expected to slow by 2.7 percentage points, more than twice as much as between 1976 and 1979 (Chart 1).
- Supply shocks after prolonged monetary policy easing. Supply disruptions caused by the pandemic and the recent supply shock world energy and food prices by Russia’s invasion of Ukraine resemble the oil shocks of 1973 and 1979-80. Energy price increases in the 1970s and over the period 2020-22 were the largest price changes in the past 50 years. Then and now Monetary Policy has generally been very accommodative on the eve of these shocks, with negative interest rates in real terms for several years.
- Significant Vulnerabilities in Emerging and Developing Economies (EMDE). In the 1970s and early 1980s, as now, high debt, high inflation, and weak fiscal positions made EMDEs vulnerable to tighter financial conditions. The stagflation of the 1970s coincided with the first global wave of debt accumulation over the last half century. Low global real interest rates and rapidly developing syndicated loan markets have encouraged an increase in EMDE debt, particularly in Latin America and many low-income countries. The 2010s marked the fourth (and current) wave of global debt accumulation involving the largest, fastest and most widespread increase in public debt by EMDEs in the last 50 years. A number of LICs are already over-indebted or close to over-indebted. The scale and speed of debt accumulation increases the associated risks.
Figure 1. Developments in the 1970s and 2020s: similarities
A. Slower growth after global recessions
B. CPI inflation
VS Real interest rates
D. Evolution of food and energy prices
Sources: Federal Reserve Economic Data; Haver Analytics; World Bank.
Notes: CPI = consumer price index; EMDE = emerging and developing countries. A. The figure shows the evolution of world growth (in percentage points) between 2021-24 and 1976-79; covers three years after a rebound from a global recession; B. Annual averages of headline inflation and core CPI for the United States and the world (average of 66 countries). 2022 is based on averages from January to May 2022; C. The figure shows nominal and real (CPI-adjusted) short-term interest rates (treasury bill rates or money market rates, with a maturity of three months or less). Global interest rates are weighted by GDP in US dollars. The sample includes 113 countries, although the sample size varies by year; D. Percentage change in monthly energy and food price indices over a 24-month period. Due to data limitations, prior to 1979 the energy price change is approximated using the oil price change.
Critical differences with the 1970s
Although the similarities described above are concerning, there are important conjunctural and structural differences between the 1970s and the current situation. This means that the global economy could still escape a repeat of this episode of stagflation.
- Small bumps. At least so far, the magnitude of commodity price increases has been smaller than in the 1970s. So far, global inflation in 2022 is even less broad-based than it was. in the 1970s, and core inflation has remained subdued in many countries, although it has recently picked up.
- More credible monetary policy frameworks. Monetary policy frameworks have become increasingly focused on price stability over time. In the 1970s, central banks were often faced with competing goals, aiming both for high output and employment, as well as price stability. By contrast, central banks in advanced economies and many EMDEs now have clear price stability mandates, usually expressed in the form of an explicit inflation target (Chart 2). Thanks to improved policy frameworks and better anchoring of inflation expectations, inflation, especially core inflation, has become much less sensitive to inflationary surprises.
- More flexible savings. The 1970s were a time of considerable structural economic rigidities, many of which have since evolved. Today’s greater economic flexibility, with less centralized wage setting and less financial repression, allows for faster response of supply and demand in sectors where prices are rising particularly rapidly and reduces the likelihood that price spirals – wages take root. Moreover, the energy intensity of GDP has fallen significantly since the 1970s, making economies more resilient to energy price shocks (World Bank 2022a).
- Less tax accommodation. The 1960s and 1970s were marked by expansionary fiscal policy. On the other hand, a tightening of fiscal policy is expected in the coming years, as governments withdraw the unprecedented fiscal support provided during the pandemic.
Figure 2. Evolutions in the 1970s and 2020s: differences
A. Number of countries with inflation targeting
B Labor market flexibility
VS Inflation expectations in the United States
D. World energy intensity
Notes: TOE=Tons of Oil Equivalent. A. Based on clarifications from the IMF’s Annual Report on Exchange Rate Regimes and Exchange Restrictions and country-specific sources; B. Collective bargaining rates indicate the percentage of employees with bargaining power. Unionization rates show the number of union members as a percentage of the total number of employees. The aggregation is based on the median of a balanced set of 25 economies; CUS consumer inflation expectations based on University of Michigan April 2022 survey; D. Energy includes coal, natural gas and petroleum. TOE stands for tons (metric tons) of oil equivalent. Aggregates calculated using GDP weights at average 2010-19 prices and market exchange rates.
A slow response to serious risks
Concerns about persistently above-target inflation have already prompted central banks in most advanced economies and many EMDEs to tighten monetary policy amid a sharp slowdown in growth. Despite this tightening, in May 2022, real policy rates (adjusted by real inflation) remain deeply negative in the average advanced economy (-5.2%) and in the average EMDE (-3.2%).
If inflation expectations become unanchored, as they did in the 1970s, due to persistently high inflation and repeated inflationary shocks, the interest rate hikes needed to bring inflation back to objective in advanced economies will be higher than those currently anticipated by the financial markets. This raises the specter of the sharp interest rate hikes that brought inflation under control, but also triggered a global recession in 1982. This global recession also coincided with a series of financial crises and marked the beginning of a long period of weak growth in many EMDEs.
If the current stagflationary pressures intensify, EMDEs would likely face economic danger again due to their less anchored inflation expectations, high financial vulnerabilities and declining growth prospects. It is therefore urgent that their governments strengthen their fiscal and external reserves to avoid possible contagion, strengthen their monetary policy frameworks to reduce political uncertainty and implement structural policies to revive growth.