The U.S. and global economies might be embarking upon a new era of “Great Stagflation Instability,” according to famed economist Nouriel Roubini, nicknamed “Dr. Doom” for correctly predicting the 2008 financial crisis.
Roubini, a professor of economics at New York University’s Stern School of Business, wrote an opinion piece for Time magazine, in which he warned that the inflationary pressures that have popped up worldwide over the past year are unlikely to be a short-term challenge.
He thinks that the shocks hitting the economy could originate from the supply side rather than from evolving demand, much like what occurred during the 1970s amid two negative oil shocks. When this occurs, energy and production costs skyrocket, resulting in lower economic growth for countries that import fuel and food, triggering an environment of high inflation and a possible recession.
“If the response to this negative supply shock is loose monetary and fiscal policy—banks setting low interest rates to encourage borrowing—to prevent the slowdown in growth, you feed the inflation flames by stimulating rather than cooling demand for goods and labor,” he wrote. “Then you end up with persistent stagflation: a recession with high inflation.”
Many economists and market analysts have been warning about such an economic climate of high inflation and anemic growth.
During the cost-of-living crisis of the 1970s and early 1980s, inflation problems were addressed by a double-dip recession in 1980 and 1981–82 and then-Federal Reserve Chair Paul Volcker approving double-digit rate hikes. This eventually led to the Great Moderation for about 30 years: low inflation, stable growth, appreciating values, low bond yields, and short and shallow recessions.
Is the United States now transitioning from the Great Moderation period to an era of the Great Stagflation? The answer to this question might depend on how other questions are answered, Roubini notes.
For example, will inflation be persistent? Will central banks blink and reverse their tightening efforts? Will the next recession be “short and shallow” or “severe and protracted”? How will the financial markets react to stagflation?
Meanwhile, Roubini writes, a hard landing for the national and international economies is increasingly becoming the baseline scenario for market observers, effectively abandoning the soft landing projections earlier this year. But while a recession might be inevitable, the founder of Roubini Global Economics thinks there could be “a severe stagflationary debt crisis” following the economic downturn.
“As a share of global GDP [gross domestic product], private and public debt levels are much higher today than in the past, having risen from 200 percent in 1999 to 350 percent today,” he wrote. “Under these conditions, rapid normalization of monetary policy and rising interest rates will drive highly leveraged households, companies, financial institutions, and governments into bankruptcy and default.”
In addition, all the usual tools to mitigate a recession or diminish the effects of a downturn are limited, particularly because “public debts are becoming unsustainable.”
In the end, Roubini believes the next crisis will be some combination of 1970s stagflation and the debt crisis of 2008–2009. When these are put together, “the decade ahead may well be a Stagflationary Debt Crisis the likes of which we’ve never seen before.”
Stagflation Alarm Bells
Roubini hasn’t been the only prominent individual to sound stagflation alarm bells or generate concern over global debt risks.
In September, World Bank Chief Economist Indermit Gill, for example, told the press during a briefing in Washington that the spillover effects of the Ukraine–Russia conflict have altered the institution’s outlook, emphasizing concern over “generalized stagflation.”
“Six months ago, we were really concerned about a slowing recovery and very high prices of some commodities, and now I think we are much more concerned about a generalized stagflation, which brings back really bad memories of the mid-1970s and the lost decades,” he said.
While speaking at Stanford University last month, World Bank President David Malpass echoed these concerns as he discussed how it could take years for international energy production to diversify away from Russia following its military conflict in Ukraine. As a result, that could prolong the risk of stagflation and lead to an extended period of high inflation and low growth.
“The developing world is facing an extremely challenging near-term outlook shaped by sharply higher food fertilizer and energy prices, rising interest rates and credit spreads, currency depreciation, and capital outflows,” Malpass said. “A pressing danger for the developing world is that the sharp slowdown in global growth deepens into global recession.”
After the Bank of England temporarily paused its quantitative-tightening cycle to purchase bonds and the Reserve Bank of Australia approved a smaller-than-expected quarter-point rate hike, there has been growing expectation that the Fed and other central banks would limit their inflation-busting activities. But backing away from this fight could exacerbate stagflation risks, former Treasury Secretary Larry Summers says.
“History records many, many instances when policy adjustments to inflation were excessively delayed, and there were very substantial costs to that,” he recently told Bloomberg.
The annual September Consumer Price Index came in hotter than expected at 8.2 percent, and the core inflation rate, which excludes the volatile food and energy sectors, rose to 6.6 percent year over year.
Later this month, the Bureau of Economic Analysis will release the third-quarter GDP data, and the market is forecasting a 2 percent growth rate.
