My Say: Deepening stagflation: Out of the frying pan, into the fire

This article first appeared in Forum, The Edge Malaysia Weekly, on April 11, 2022 - April 17, 2022.
My Say: Deepening stagflation: Out of the frying pan, into the fire
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The world is sailing into a perfect storm as key leaders seem intent on threatening more war, albeit while proclaiming the noblest of intentions. By doing so, they block international cooperation to create conditions for sustainable peace and shared prosperity for all.

Monetarist counter-revolution

The 1970s saw Milton Friedman disciples’ monetarist counter-revolution blaming stagflation on ostensibly Keynesian economic policies. In 1974, Richard Nixon’s replacement, president Gerald Ford, declared inflation “public enemy number one” and the US’s “determination to whip inflation”.

Monetarists wanted tighter monetary policies to fight inflation. Curbing rising prices was deemed urgent, even though it would increase joblessness. They advocated abandoning expansionary fiscal measures for more growth and jobs.

But US Federal Reserve chair Arthur Burns still considered ensuring full employment his top priority. For Burns, addressing inflation “head on” — as urged by his detractors — was too costly for the economy and people’s well-being.

Nevertheless, the monetarist ascendance was confirmed when the 1946 Employment Act was replaced. The successor 1978 Full Employment and Balanced Growth Act is better known as the Humphrey-Hawkins Act for its sponsors, including the Democrats’ 1968 presidential nominee.

In early 1980, Burns’ successor as the Fed chair, Paul Volcker, insisted, “[M]y basic philosophy is over time, we have no choice but to deal with the inflationary situation because over time, inflation and the unemployment rate go together … Isn’t that the lesson of the 1970s?”

Thus, “fight inflation first” became the clarion call in 1980. This was the pretext for sharply raising US interest rates, while claiming that reducing inflation would somehow eventually create many more jobs. The UK and many other industrial countries followed, deepening recessions and raising unemployment.

By post-1950s’ Western standards, the 1980s saw very high unemployment. Unemployment in rich developed Organisation for Economic Co-operation and Development (OECD) countries averaged 7.3% during 1980-1989, compared to just under 5% during 1974-1979, and under 3% during the 1960s.

Debt crises, lost decades

The sharp US interest rate spike triggered debt crises in Poland, Latin America and elsewhere in the early 1980s. Earlier, US commercial banks had enjoyed windfall gains following the two oil price spikes in the 1970s.

The US government had long provided concessional low interest rate loans to allies to secure support during the Cold War. Flush with deposits from Organization of Petroleum Exporting Countries (Opec) members in the 1970s, they pushed loans to borrowing governments, many in Latin America.

With the interest rate spikes, borrowing countries suddenly faced liquidity crises, also creating systemic risks for their US and UK bankers. Successive US Treasury secretaries, James Baker and Nicholas Brady, came up with various debt restructuring schemes to contain the problem, with the latter adopted.

Meanwhile, International Monetary Fund (IMF) and World Bank financial support was tied to short-term stabilisation programmes and medium-term liberalising reforms, packaged as structural adjustment programmes (SAPs) with explicit policy conditionalities.

The liquidity crises were due to the sudden sharp interest rate increases. But instead, these were portrayed as solvency crises stemming from weak “economic fundamentals”, blamed on “overregulation” and protectionism.

Although African countries were generally not able to borrow as much, they too faced problems as commodity prices collapsed with the growth slowdowns. Many were forced to seek financial support from the IMF and World Bank, and thus obliged to implement SAPs as well.

The liberalising and deregulating SAP reforms were supposed to usher in rapid growth. Instead, however, both Latin America and Sub-Saharan Africa experienced “lost decades of development”.

Stagflation in Europe

Stagflation in our times is expected to be initially most severe in Europe. This has been caricatured as fighting for Ukraine until “the last European” as it bears the brunt of Nato-imposed sanctions on Russia. Besides oil and gas, they will pay more for imported wheat, fertilisers and other Russian exports.

But other economic trends will likely make things worse. First, some rich economies — particularly the UK and the US — are weaker now, having lost much of their manufacturing edge. Others have been experiencing declines in productivity growth since the mid-1970s.

Second, low wages — due to labour market deregulation and “offshoring”, that is, relocating production abroad — have meant less productive activities have survived. Very low interest rates — due to “unconventional” monetary policies since the 2008/09 global financial crisis — have allowed unviable “zombie” enterprises to stay alive.

Third, the declining labour income share has increased income inequalities, lowering aggregate demand. But demand has been sustained by rising household debt. Low, if not negative, real interest rates have also encouraged more corporate debt, but with less used for productive new investments.

Fourth, the pandemic has raised all types of debt — household, corporate and government — to record levels. Fifth, countries, especially smaller ones, are now far more internationally integrated — via trade and finance — than in the 1970s.

Therefore, small interest rate increases can have devastatingly large impacts on household, corporate and government finances. Advanced countries are thus likely to see severe economic contractions and rising unemployment.

Meanwhile, more racism and intolerance in recent decades show little sign of receding. Worse, these are likely to worsen as political elites compete in the ethno-populist league to blame Others for their problems. The recent European decision to privilege Ukrainian refugees is a poignant reminder of what is in store.

But impacts on developing countries are likely to be far worse owing to capital outflows, declining development finance and aid, as well as slowing world trade after decades of globalisation. Increasing inequality since the 1980s and declining growth since 2014 — now worsened by the pandemic — will not help.

Thus, instead of striving to ensure sustainable peace, necessary to improve conditions for all, the world seems set for sustained conflict. This has involved easy resort to sanctions, namely war by economic siege, hurting all. We all thus risk the prospect of mutual destruction instead of shared prosperity for all.


Anis Chowdhury, a former professor of economics at the University of Western Sydney, held senior United Nations positions from 2008 to 2015 in New York and Bangkok. Jomo Kwame Sundaram, a former economics professor, was United Nations assistant secretary-general for economic development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

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