Is stagflation the future? Depends on your definition

At the end of February, just after the start of the war in Ukraine, it began to look as if inflation in the West could move into double digits. The war in Ukraine was a negative to the already-strained global supply chain and would negatively affect price developments.

Two months on inflation in the Eurozone (7.5%) and the US (8.5%) is yet to reach double-digit level.

But with the ongoing supply chain disruptions, China still experiencing Covid problems and the fall out around commodities because of the war in Ukraine, those levels could still be on the horizon.

The war in Ukraine has led to a significant loss of momentum in the European economy and the ECB does not want to be seen pushing the Eurozone into stagflation.

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With stagflation now the watchword of economic analysts and the media alike, it is worth digging into what it actually means in practice.

What is stagflation?

Unlike a recession, ultimately there is no uniform definition of stagflation.

The so-called Misery Index is often used to measure the degree of distress in an economy by looking at unemployment and inflation developments. A significant increase in the index can be seen as a proxy for stagflation.

Indeed, the current levels of the Misery Index in both the Eurozone and the US are roughly comparable with levels seen during previous crisis periods (although admittedly depending a bit on which index you use).

Here the similarity between the two periods end. There are significant differences between the current pandemic-initiated crisis and previous crises.

During the Global Financial Crisis inflation was not an issue in either the Eurozone or the US, while unemployment became a big problem. Europe also had to deal with the Sovereign Debt Crisis. Inflation even dipped below 0% in both economic blocs in 2009.

Currently in 2022 the opposite is the case.

In both regions unemployment is low or declining, while inflation has increased very sharply.

The same Misery Index developments – but for quite different economic reasons.

While inflation is a big problem, unemployment creates far swifter distress for households than just inflation.

With Eurozone unemployment falling to a record low of 6.8% in February it means that people who find a job see a boost in their nominal income, a positive in the current environment, as it dampens somewhat the negative effect of inflation.

In this respect the current increase in the Misery Index has a totally different connotation to high levels of unemployment seen during the previous crisis.

If the current development in the Misery Index is different compared to previous episodes – making a direct comparison and interpretation difficult – this could also hold for other developments in the economy.

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This is especially possible with areas such as the labour market which derailed during the pandemic.

But the dynamics were quite different on each side of the Atlantic. This derailing had, of course, a very special reason – governments paused economies to fight off the virus.

Labour market developments are considered a lagging indicator, but during the pandemic it preceded other developments because of the abrupt pausing.

This changing in the sequencing of economic developments greatly influenced the underlying economic dynamics.

In the end, defining what stagflation is – which in current circumstances looks like very low economic growth in combination with very high inflation – can help to indicate what to expect from central banks.

It seems most are willing to accept significantly lower economic growth rates to tame inflation. However, we may never know how those central banks would have reacted if the economic outlook was bleaker to start with.

Serdar Kucukakin is a senior research analyst at Aegon Asset Management

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