The world is grappling with a sharp deceleration in growth, coupled with rising inflation. Are we experiencing so-called stagflation, what does that mean for people, and what can we learn from comparable situations in the past?
In this episode of The Development Podcast, World Bank forecasting expert Franziska Ohnsorge, Manager of the Prospects Group, one of the lead authors of the Global Economics prospect Report; and debt expert Marcello Estevão Global Director of the World Bank Group's Macroeconomics, Trade and Investment global practice give the big picture on stagflation. While Enrique Cárdenas, a Mexican economist and economic historian, explains what it felt like to experience stagflation during the so-called “lost decade” of the 1980s. Listen now!
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- Franziska Ohnsorge, Manager of the Prospects Group, World Bank.
- Marcello Estevão, Global Director of the World Bank Group's Macroeconomics, Trade and Investment Global Practice.
- Enrique Cárdenas, Mexican economist and economic historian.
[00:00] Raka Banerjee: Hello, and welcome to The Development Podcast from the World Bank Group, coming to you from Washington DC and beyond. I'm Raka Banerjee.
Paul Blake: And I'm Paul Blake. In today's show, what happens when you get a global economic slowdown and rapidly rising inflation? Yes, we're talking stagflation.
Raka Banerjee: The latest data from the World Bank warns of the sharpest deceleration in economic activity in 80 years. So what is driving this contraction and are we really headed for so called stagflation?
Franziska Ohnsorge: Stagflation, weak growth and high inflation is something that really hurts the lower income household, particularly hard.
Paul Blake: The war in Ukraine has compounded economic damage left by the COVID-19 pandemic and pulled harder on the breaks of economic growth, but who's at greatest risk and have we seen this all before? We get the view from Latin America.
Enrique Cárdenas: We had to pay at that point, about 11% of GDP. 10% of the production of the country had to go simply to pay for interest of the debt. Imagine how big that is.
Raka Banerjee: So what does the World Bank forecast for the coming months and beyond?
[01:45] Paul Blake: That's all coming up in the next few minutes here on The Development Podcast from the World Bank Group. So Raka, we've been hearing a lot about stagflation, but I rarely see a clear definition of it. What does it mean exactly?
Raka Banerjee: Well, you've got stag- and you've got -flation. So the stag- is for stagnation. So we're talking about economic growth slowing down, and then the -flation is for inflation, prices going up. And basically when you've got the two together, slowing growth combined with rising prices, you've got stagflation. So it's really an unholy mix of all the things that you don't want in the economy.
Paul Blake: And I often hear there's this vicious cycle aspect to it. Explain that. Is that fair?
Raka Banerjee: Yeah, exactly. When you have stagflation, people could start to adjust their behavior. Assuming that prices are just going to keep going up and up and up. And when they do that, when they adjust their behavior, it tends to contribute to the phenomenon of increasing prices and reduced growth.
Paul Blake: So this isn't a new phenomenon though, it's happened before, when did we see it last?
Raka Banerjee: So it happened before in the 1970s. The so-called Arab Oil Embargo was a key factor among other triggers. Oil shipments were suspended at that time driving up the prices. And so we had less supply and the same demand. And so as a result, the cost of living went way up, at the same time that the global economy was suffering pretty severely.
Paul Blake: And so we're going to be talking in a few minutes to Franziska Ohnsorge from the World Bank. But tell us, you've been looking at some of the data, what do things look like right now? What are some of the facts of the case? So Franziska hopefully characterize it for us, but can we say, do the facts say we're in stagflation right now?
Raka Banerjee: Well, I don't really think I can say whether we are experiencing it or not right now. What I can say is that according to the latest Global Economic Prospect report from the World Bank, global growth is definitely slowing way down. Last year growth was at 5.7%. This year it's expected to be 2.9%. At the same time, inflation rates are currently at levels that we haven't seen for years, as of April global inflation was at 7.8% and in emerging markets and developing economies, it was at 9.4%. That's the highest it's been since 2008. And if you are looking at advanced economies, this is the highest that we've seen it since 1982.
Paul Blake: So what happened last time back in the 1970s, what did it take to get inflation, stagflation back under control?
Raka Banerjee: So in the US, in particular, the Central Bank, the Federal Reserve aggressively tightened monetary policy, basically significantly raising interest rates. And this did massively cool the economy and ultimately inflation went down, but the aggressive interest rate hikes came with side effects, recession and rising unemployment. Ultimately the economy did recover in the US, but it was very painful and of course there was a lot of pain abroad as well. Many of the poorer countries, emerging markets, developing economies, tipped into debt crises, especially in the 1980s, but we'll be hearing more about that in a bit.
Paul Blake: So a key risk here is that stagflation and the response to it. And that's the part that's super interesting to me is central banks, their main kind of lever to pull is interest rates. And if they raise them to fight inflation, that puts downward pressure on economic growth. And if they lower them to try to boost economic growth, that makes inflation worse.
Raka Banerjee: You've got more inflation. Exactly.
Paul Blake: And so there's this, yeah, there's this catch 22. And so the risk here is that the response to stagflation can lead to these debt crises in developing countries. And I'm excited to talk to Marcello and Franziska about that in a few minutes. But before we get into that, do things look similar today to what the '70s looked like, is the context similar?
Raka Banerjee: Yeah. I mean, there are definitely similarities. So a big thing that's happening now is supply shocks and that was the same then. Right now it's tied to the pandemic and the war in Ukraine, then it was the Arab Oil Embargo. Another thing is the huge increases in global inflation and we've got severely slowing growth, that was happening then as well. So it's not exactly a repeat of history, but there are definitely similarities. And another really key similarity in my view is that a lot of emerging markets and developing economies have pretty serious debt vulnerabilities right now. And that is really what makes it very difficult for poorer countries to manage an effective response to stagflation, their tools are really limited. So, the debt crisis that we saw in the '80s as a result of the monetary policy, that was what was known as the lost decade in Latin America, it's pretty well known. A lot of countries saw huge declines in their living standards then, and it wasn't just there, it was a global phenomenon.
Paul Blake: Well, thanks for the context Raka. I sincerely hope we're not looking at a repeat of the '70s.
[06:42] Raka Banerjee: What you're hearing is the sound of Mexico City, a huge bustling metropolis. Mexico is the 15th largest economy in the world and the second biggest in Latin America, but Mexico is now experiencing inflation at an almost 21 year high.
Paul Blake: This has led some to cast their minds back to the so-called lost decade we just talked about, where Mexico like others in the region experienced severe economic disruptions. At one point, Mexicans saw inflation climb to almost 180%, that was back in February 1988. Our producer Sarah Treanor, caught up with an economic historian in Mexico, who's been teaching since the 1980s.
Sarah Treanor: Mexico City on a typical weekday afternoon. Tacos are sizzling on a street vendor's store and the center of town is a hub of commerce. But as we've been hearing, inflation is causing many concerns. So when we talk about previous periods of low growth and high inflation, what lessons can we draw from the past? What did happen back in the 1980s in Mexico?
Enrique Cárdenas: My name is Enrique Cardenas. I am a professor in economics and economic history. I run several NGOs called Signos Vitales, engaged with providing accurate data and overall analysis of the country.
Sarah Treanor: I asked Enrique to tell me why global shocks caused a regional crisis. And I asked him how high rates climbed?
Enrique Cárdenas: Really high. I mean, about 70%, 100% a year. We had a slow down of the economy because of the debt crisis. We had to use about five, six, 7% of GDP as interest payments for the debt. So that of course extracted resources from the inside economy, from the internal economy, from consumption, from investment. We had to pull our belt so to speak. Mexico, like many other countries borrowed from foreign banks, which were in abundance of liquidity after the oil catastrophe that we had, in which inflation was high in many countries. And the United States decided to curve inflation, raising interest rates, just a bit like it is happening today, increasing interest rates. So we had to pay, as many other debtors, more and more us debt expenses.
Enrique Cárdenas: So that took even more dollars from us. So we had to borrow and borrow and borrow just in order to pay those interests. And that has strained the balance funds to the point where we just simply didn't have any reserves to sustain the exchange rate. So it had to be devalued. So that was really the start of the lost decade of the 1980s. But it meant that we had to pay, at that point about 11% of GDP, 10% of the production of the country had to go simply to pay for interest of the debt. Imagine how big that is.
Sarah Treanor: With inflation through the roof, debt spiraling out of control and an economy in a free fall, what did people actually experience?
Enrique Cárdenas: Well, not every income was indexed to inflation and therefore those who weren't suffered even more, because they couldn't cope with inflation as it evolved. So what it entails for people, for common people, ordinary people, is that they have less resources to live on. And with that scarcity, with not enough incomes then of course, life becomes much more difficult. In terms of recession, just people had general lower incomes, they were not very happy. You went into the underground in the subway in Mexico City, you would see pale faces and not very happy faces, not happy faces. It implied a tremendous flow of Mexicans crossing the border to the north, to the United States. I remember talking to my students in class where I would ask them, "Do you have anybody you know that lives now in the United States?" So in the early '80s, just one or two would say, "Yes, I do have somebody." As time passed by, I asked the same question semester after semester. And the number of people that knew somebody in the US, simply expanded and expanded.
Raka Banerjee: Thanks so much to Enrique for those reflections.
Paul Blake: Well, to give us the complete picture on where we are and where we might be headed, and those comparisons to the 1970s and 80s, we're joined now by Franziska Ohnsorge, Manager of the Prospects Group here at the World Bank. One of the lead authors of The Global Economics Prospects report, which we talked about earlier. As well as Marcello Estevao, Global Director of the World Bank Group's Macroeconomics Trade and Investment Global Practice. Welcome to you both. Thanks so much for taking the time to be here.
[11:47] Raka Banerjee: Welcome, and Franziska, let's start with you. Your team just released the latest edition of the Global Economic Prospects, that's the bank's flagship economic forecast. We went through some of the top line figures earlier, but I want to hear from you, how significant is the slowdown right now?
Franziska Ohnsorge: Yes, we are in the midst of a very steep global growth slowdown. It's in fact, it's the steepest global growth slowdown after any rebound from any global recession in the last half century, since the 70s. So to put some numbers to this, in our recently released Global Economic Prospects report, the one that you mentioned, we forecast global growth to almost half from a very strong 5.7% last year to 2.9% this year and then it'll stay around that level. It's not just in advanced economies, in emerging markets and developing economies as well. There we are expecting growth to slow from 6.6% to 3.4%, again, half the 3.4% this year. And by our estimates that's well below the long term sustainable potential growth for emerging markets and developing economies. That's much worse than we had thought six months ago. We've downgraded forecast for 70% of the countries and emerging markets, advanced economies, commodity importers has commodity exporter, you name it, and that was four weeks ago. And since then, if anything, the outlook has deteriorated. Conditions have deteriorated.
[13:09] Raka Banerjee: Oh my goodness. Okay, so given all of that, it sounds very bad. How real is the risk of stagflation? Is it inevitable, are we already there?
Franziska Ohnsorge: Well, stagflation is a contentious term. So just to start with a definition, that's one definition, weak growth, high inflation. And by that definition, yes. I mean, 2022 looks very much like stagflation, because of the growth slowdown we just talked about, anti-inflation, high inflation. So just let me just illustrate the high inflation. Inflation is globally running now at a 14 year high in emerging markets as well. Advanced economies, you have to go back 40 years to get this kind of inflation. In all advanced economies and in 90% of emerging markets and developing economies that are inflation targeting, inflation is now running above target. So inflation is high. Now the big question is, how long will this continue? How long will weak growth and high inflation continue?
Franziska Ohnsorge: So start with growth. All the fundamental drivers of growth point to a growth slowdown over the 2020s. 2020s, long term, sustainable growth will be slower than the 2010s. That's baseline, that's expected, that is the most likely scenario, that's not a risk. But with inflation, it's more a question of a risk. We do expect inflation to come down by the middle of next year from around 8% now, to around 3% next year. That's still a percentage point higher than 2019. So we don't know whether that's enough to get inflation back within targets, but it's a considerable inflation slow down ahead of us. So there is a very real risk that next year inflation will not come down the way we have anticipated and growth will remain weak as well, but it's not the most likely scenario.
[14:57] Paul Blake: So Marcello, let me get you to jump in here. As someone, myself, who isn't an economist, I'm trying to wrap my head around this. The main tool that central banks have to respond to slowing growth or to rising inflation, is interest rates, they can adjust those, but there's kind of a Catch-22 here with stagflation. Can you explain that a little bit?
Marcello Estevão: Yeah, indeed. But first of all, thanks for inviting me to participate in this conversation. This is a key topic that we are facing right now. Indeed, I mean, what you see happening, is that many central banks have fighted inflationary shock by raising policy interest rates. So in advanced economies, especially the United States, an important part of the inflationary push comes from the fact that economic activity is very strong and unemployment rates are very low. Raising rates helps control the aggregate demand, and also helps anchor inflation expectations in the United States. But most emerging markets in developing economies do not have booming economies right now. Actually, most of them are facing lack luster economic activity. And you just heard from Franziska that the outlook is not great in terms of growth rates certainly compared to previous decades. But many are still raise interest rate for instance, to keep exchange rates from devaluing too much, as this has an impact on inflation and inflation expectations.
Marcello Estevão: So here we have a set of countries that need to hike rates. This has an impact on several economic variables, but has an impact also on growth through investment, through lower investment rates. In this world of higher interest rates, also, it becomes expensive to issue that in finance public accounts, so countries that already face a large debt overhang, will be in a worse debt dynamics path again, because that will rise faster and growth will be lower. And that's a recipe for debt crisis. There will be side effects of this rise in interest rates that is needed, but countries need to tread carefully.
Paul Blake: And I definitely want to pick your brain about that, the debt implications, but I think Raka wants to just jump back real quick on the short-term effects with Franziska.
[17:24] Raka Banerjee: Yeah. Well, I'm just wondering if you could speak a little more Franziska too. It sounds like also from Marcello said, this is going to be really difficult for people in emerging markets and developing economies. Can you speak to what does this mean for the average people, just the people on the street in emerging markets, developing economies, facing this combination of rising inflation and slow growth.
Franziska Ohnsorge: So stagflation, this weak growth and high inflation is something that really hurts the lower income households, particularly hard. Because slow growth means less employment and lower wages, but high inflation means at the same time that it erodes the real value, the purchasing power of especially lower income households, that rely on wages of their household incomes. And it also erodes the real value of their assets because they tend to be not able to protect their savings against inflation as much. So that's one angle.
Franziska Ohnsorge: But the other angle is that this stagflation is very crisis prone. What Marcello said just now is really important. And just a reminder of the 1970s. In the 1970s, it took a doubling of global interest rates to 14% over six years to bring inflation back within targets. A nine percentage point increase in US monetary policy rates within two years. That, yeah, it did end inflation, but it also triggered a global recession in 1982 when global per capita incomes fell by a percent. And that then set off the string of debt crisis. More than three dozen of debt crisis in emerging markets and developing economies. So if that were to materialize a financial crisis on top of the real income losses that are anyways embedded in stagflation, household, especially in emerging markets and developing economies will really suffer.
[19:19] Paul Blake: Well and Marcello on that point, setting off those debt crises. We heard about earlier in the podcast about the experience of me Mexico, but I want to hear from you, how can stagflation lead to debt crises?
Marcello Estevão: If you think about Latin America, that is the region that I grew up in, we are very concerned about low growth and high debt in Latin America. Both issues are structural problems. Low growth has deep underlying causes in the way those economies are structured with some, like Brazil and Argentina being very close to international trade, thus facing little competition for abroad and small incentives to innovate and be more productive. In addition, when importing needed capital goods they do so at large cost. Others say maybe Peru face large level costs in formality. The Caribbean is very sensitive to recent shocks given it's the dependence on tourism and commodity importing. The list goes on, including relatively bad business conditions and political instability. All this hurts growth.
Marcello Estevão: But this low growth problem is a structural problem. And structural reforms are badly needed. What happened is many governments in the region have tried to solve the low growth problem by jacking up fiscal spending, also boosted by expensive social programs that are often badly targeted, causing the public debt to balloon. And this a big circle to then come to your question that taking these features as given, so low structural growth and high and growing debt in the region. The recent shock's a big problem, as I said before, high interest rate to make harder for these economies to grow and finance programs.
Marcello Estevão: The silver lining for regions like Latin America is that financial systems and monetary policy frameworks are much more robust than in the 1980s. And by the way, the Global Economic Prospect goes over some of these redeeming facts. And oil price have not risen as much in real terms as they did in the 1970s and Latin American economies are less oil intensive as in the 1970s, with many having become self-sufficient about the oil supply needs, or even have become net oil exporters. I think the comparison with the serves in the eighties so far is still positive on what's happening right now. It does not mean that's not a big problem. What means is that we are facing a forecast that has very low growth and inflation that is above what is being targeted at least for two years. Let's see what's going to happen.
Paul Blake: Some reasons for optimism there. Franziska, the recent addition of the Global Economic Prospects though, does highlight this risk that debt crises could come. How could that unfold? And I know we want to be careful about speculating, but how could a stagflation situation lead to debt crises in the current context?
Franziska Ohnsorge: Well, the scenario we explore a bit, that we flag in the Global Economic Prospects Report is very much what happened actually, a repeat of the 1970s. That central banks realize inflation's just not coming back within targets with the plan to currently expected monetary policy tightening. They realize it takes more to bring inflation back into target. Otherwise inflation expectations will deanchor and once they come adrift these expectations, it gets incredibly costly to bring inflation back into target. So the scenario is that central banks tighten, since debt is at record highs, so Marcello has already touched on that, debt is almost 70% of GDP for emerging market sovereigns now. That is the highest since 1987, right in the middle of those debt crisis after the stagflation period ended. So debt is very high. And when growth slows and interest rates rise, it's going to be difficult to service that debt or to roll it over, it's at that point, that there is the risk that there is going to be the sovereign debt distress.
[23:31] Raka Banerjee: And Franziska, what is creating this toxic mix of slow growth and inflation? I'm wondering if the factors that are creating it could be addressed, then we could minimize how long the stagflation is going to go on.
Franziska Ohnsorge: Yeah, of course, most immediately the food and energy price spikes that were caused by the war in Ukraine, they've raised inflation and they've also lowered growth, but that war was a compounding factor. Two thirds of the energy price increase and food parts increase over the past two years, already happened before Russia's invasion of Ukraine. It was simply the result of this very strong, or at least initially very strong rebound from the pandemic while supply disruptions took a while to unwind.
Franziska Ohnsorge: So if you combine that effect of the pandemic rebound and the war, this two year increase in energy price and food price, really very, very large. Just to give you a comparator, it's the largest two year increase in energy prices since the seventies and the second largest two year increase in food prices. Since the seventies, high inflation is really the result of supply shocks and strong demand. And that also then points to what can be done like you said. So the first order of businesses, of course, is to stock the supply shocks, end the pandemic and find a way to end the war. And the World Bank is actively engaged in ending the pandemic and mitigating the impact of the war.
[24:59] Raka Banerjee: As an expert on all of this, we of course want to avoid stagflation and the long term effects of debt crises, what would you say that governments should be doing now to promote growth and tame inflation? What are your recommendations?
Franziska Ohnsorge: Yeah, already central banks and governments they're acting to tame inflation. Central banks are raising rates. Fiscal consolidation is underway, pretty much around the world. So inflation should come down. The problem of course, with high inflation is that the remedy to high inflation, which is exactly what governments are doing now, tightening policy and central banks, the remedy to high inflation causes a side effect of low growth, as you said. So what needs to be done and Marcello touched on this already, it really needs structural reforms, growth enhancing reforms, and they tend to be very country specific.
Franziska Ohnsorge: So for example, in some countries state-owned enterprises are distorting the allocation of resources and that reduces productivity, or in some countries learning losses from the pandemic were so large that there's a risk that there's a whole generation of kids whose productivity or earning potential is going to be lower over the next few years, over their lifespan. In some countries, it's just so difficult to access markets and inputs that a large part of the economy has to operate in the informal sector and unproductively. Or in some countries there's a simmering conflict that prevents or even completely disrupts economic activity and especially investment. So what is needed are measures at boost productivity growth, but what these specific matters are really depends on the country.
Paul Blake: And Marcello, some of those countries, I know you've written about countries facing, a large number of countries facing debt vulnerabilities. As we enter into this potentially stagflationary context. If an official from one of those countries that's facing debt vulnerabilities were to phone you up and say, "What do we need to be doing now?" What would you tell them, adding on to Franziska's advice there?
Marcello Estevão: Yeah, I mean, that's the issue of my professional life. I've been involved in many crisis before, but I would say that, and the answer depends on the particular case, but in general, I would say that the answer is simple to give, but hard to implement. Countries need credible fiscal frameworks, private investors love to lend to countries. They have one of those frameworks as the fixed income they get from such lendings. In general, much better than they would get by lending to developed economies. So countries with credible fiscal frameworks are insulated because there will not be lack of funding for them, even in a situation of crisis episodes, but how to get there and often the list comes out of the first law of holes. When you are in one, stop digging, I mean, adopting good fiscal and structural policies now, can still repair a lot of the damage and help countries send this good signal to private investors.
Marcello Estevão: I mean, the debt overhang can be dismantled, if governance improved debt management procedures and public expanding while strengthening the living environment for debt contracting, is speeding up that restructuring could play a role. I mean, many of the countries in trouble today are set to fail if they cannot get help and the international community must help them by improving global initiatives that facilitated that restructure.
Marcello Estevão: Policy makers should also explore every opportunity to encourage different types of creditors to come quickly to an agreement that provides relief if you are over indebted, they're moving away from purely fiscal and debt measures. The best way to escape that trap is to grow out of it, measures to improve business conditions, better location of resources and healthy market competition, we talk about opening up of closed economies, are essential policy actions to boost productivity growth. So governments should take advantage of this crisis to move faster on these structure reforms. The point here is that crisis also bring opportunities. I mean, the overlapping crisis we are seeing today, governments have an opening to plant the seeds for my stable and prosperous future, and they should definitely not pass up the opportunity.
[29:21] Raka Banerjee: Thanks to Franziska Ohnsorge and Marcello Estevao for taking the time to run through all of that with us, fascinating insights.
Paul Blake: Well, that's about it for this episode of The Development Podcast. For me, Paul Blake and from Raka Banerjee, thanks so much for taking the time to be with us. We'll be keeping a close eye on the numbers and bring you more on the health of the global economy soon.
Raka Banerjee: Thanks for joining us. And as always, please send us your questions, comments, suggestions, reach out to us by email. We are at the email@example.com
Paul Blake: Until next time, goodbye.
Raka Banerjee: Bye.
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