|Is The World Economy Heading Into Stagflation?|
The traditional definition of stagflation means a stagnation of economic growth and employment numbers coupled with persistently high inflation. It occurs when a nation's prices are increasing but the output is not. For economies a stagnating growth means that fewer jobs will be created, which in turn will restrict consumer spending. This becomes a vicious cycle since declining consumer spending results in lower production and slower GDP growth. All this while, however, prices continue to increase.
There is widening belief that the global economic recovery is losing pace, by weighing first on the sluggish demand and then by fears of sovereign debt. This shift in fundamentals can possibly translate to further loss of momentum.
GDP growth has reached a plateau in most major economies, including the US and Europe. We are also seeing that the labor market continues to remain tight. Job numbers pose much cause for concern, especially in the US, where the most recent data indicates that more people were fired than hired. And this is made worse by the bullish commodities run we've seen, with gold and oil both likely to rise further after taking a momentary breather in the past two weeks. Oil prices have risen more than 24 per cent since the beginning of the Middle East & North African tensions, reaching as high as 113.46 USD/Barrel, while inflationary risk soar further.
Of course governments all over the world are fast to react and curtail any sense of stagflation. Most central banks have remained ahead of the game by tightening monetary policy to choke off inflation. While this has fortunately paid off especially when one sees encouraging expansion continue across these nations, it has also become more expensive to finance economic growth.
Take the case of Europe alone. An interest rate hike risks widening the gap between struggling periphery economies and the stronger ones at the center of the euro zone. A rate hike can thus be a mistake since output in periphery euro zone economies is still contracting and the ECB rate rise will lead to a strengthening of the euro, further affecting competitiveness in the area.
The bottom line is that as long as commodity supply fears keep prices at unsustainable levels most global economies will continue to remain on a knife-edge. This will sustain the uncertainty in equity and currency markets as investors adopt a wait-and-watch approach, till a clear trend emerges.