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Stagflation concept starting point: Global growth and ınflation paradox

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Sources and causes of global stagflation concerns… The combination of stagnation in the economy with inflation is called “stagflation”. In the context of distinguishing it from terms that are close, but differ conceptually; While “stagnation” differs from stagflation when the economy grows at a slower rate than the average or does not grow, the difference between “slumpflation” and “stagflation” is “inflation remains high while the economy shrinks”. Stagflation has been effective in certain periods as an economic disease throughout the history of modern economics. Today, although the views on growth and inflation prioritization differ from each other, the prevailing view is that it is necessary to reduce inflation for sustainable growth dynamics. In this respect, it is considered a rational practice to bring price stability to the desired level by suppressing demand and secondary effects through the control of monetary policy instruments, then normalizing the conditions and paving the way for growth. However; The response time of growth, inflation and employment dynamics to the policy toolkit application may vary.

 

Historical development of global growth and inflation… (Source: Bloomberg, IMF)

 

In terms of the elements included in the conceptual terms of the economy; stagnation, stagflation and slumpflation can be thought of as successive supersets and subsets. That is, while every slumpflation is also an example of stagflation and stagnation; The concept of slumpflation is used specifically for shrinkage and inflation. In stagflation, low, stagnant or slowing growth and inflation are intertwined. Stagnation simply represents the concept of economic growth and refers to low or stagnant growth. If we think on the basis of the global economy; The global supply problem, which came into play as an aftershock effect in the recovery process after Covid, brought out the concerns of growth again, and the “stagflation” comments increased as the supply shortage was also subject to inflation. This is also historically; It has an important reflection in the economy of the 1970s, when the damaging effect of oil prices was felt. However, just like the high inflationary period of the 70’s, since supply problems are not seen as the only source of inflation today, it leads Central banks to go backwards from reflationist policies. The main factor underlying the new policy adjustments of major central banks, especially the Fed, called tapering, is the need to be protected from the toxic effects that reflationary policy may now be more harmful than beneficial. Therefore, despite the rough economic recovery, inflation pressure may lead Central banks to a more normalized policy.

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Policies against stagflation… It would not be correct to base the output factors of stagflation on a single factor. At this stage, we can talk about the relevance of inflation pressures arising from supply-based factors, both on a micro basis and with policies that are aimed at growth, but that can accelerate inflation at the same time. The factor that feeds the demand at the micro scale is the deteriorated pricing behavior due to inflation and the income increase effect in the short term due to the firms forced to increase their wages more. This factor leaves its place to the withering effect in demand once again as the effect of the increase in inflation disappears within a few months. However, low interest policies that minimize financing costs keep the private consumption demand alive. While an increase is observed in loans, we also observe pricing behavior that deteriorates due to both cost and demand factors. Since the deterioration in pricing behavior means inflation uncertainty, the warming effect continues.

 

On a macro scale; When governments focus on increasing growth and employment for popularity, demanding lower interest rates can disrupt price stability. In terms of this factor, it is necessary to reduce inflation in order to apply low interest rates. The easing created without this condition being met causes an increase in exchange rates and consequently an increase in import costs. This effect is felt to a greater extent, especially in countries with a high import weight and a need for external financing. Add to the global input prices the rising inflation associated with the depreciation of the local currency. At this stage, if we consider that import dependency is concentrated on resources such as energy with inelastic demand; An increase in inflation will be an inevitable result. Which will also be reflected in the form of a greater balance of payments deficit as there is a heavier import bill incurred. An increase in the balance of payments deficit means that the country’s foreign exchange balance will have more deficit.

 

The money supply is increased by broad policies applied for growth. As the cost of money falls, the demand for loans increases. As the demand for loans increases, aggregate demand increases, it increases inflation. At this point, the fact that the Fed kept interest rates low on the implementation leg brought high inflationary pressure in the 1970s. In the recycling phase of this, the later you give the policy response, the higher the cost you have to inflict on the economy, and you will cause a hard landing in growth while reducing inflation. As a matter of fact, when Paul Volcker became the head of the Fed, he had to apply a bitter prescription and increased interest rates sharply, and while normalizing inflation in this way, a shock drop in growth had to be endured. Normalization of balances may take place at different times depending on the resilience of the economy, cyclical factors and the element of confidence in money management. The normalization of the macroeconomic balances of the countries that are below the norms in the factors we have mentioned takes longer.

 

Therefore, toxic effects should be avoided by considering the balance point in policy making. Monetary and non-monetary factors in the increase in inflation should be evaluated together and analyzed within the source effect. In the context of supply-based factors, central banks’ compliance with economic management in the primary effect; In the secondary effect, there should be a strategy based on the effect of the inflation outlook on the pricing behavior. In terms of the demand factor, funding conditions should be determined according to the conditions of the market, avoiding the policy width that will warm the inflation even more. Since inflation and growth are not economic targets in line with each other under normal conditions, all conditions, including cyclical economic factors, should be analyzed in order to find the equilibrium point. In the simplest terms; To increase growth, you lower interest rates (slack), and to reduce inflation, you increase interest rates (tightening). In the process of reducing inflation, the more acute the situation, the less popularity of policy makers may decrease in the recycling process. For this reason, it is important to implement good economic policy on a broad level and to analyze the needs and priorities of the economy in the right order. In a properly managed economy, shocks are also easier to manage.

 

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