Concerns about persistently high inflation and slowing economic growth in global markets have become increasingly serious recently. The most significant period of stagflation was the decade of the 1970s in the United States, when major industrialized countries in the West experienced economic stagnation, massive unemployment, and severe inflation, known as stagflation. Regarding the discussion of the causes of that round of stagflation, academics believe that the supply factors of the two oil crises in the 1970s caused most of the inflation shocks. Of course, continued loose monetary policy and stagnant labor productivity also played an important role in promoting stagflation at that time.
Going back to the present, there will be supply shocks in crude oil, natural gas, grain, etc. in 2022. Since the global financial crisis in 2008, the cumulative effect of easing policies in major global economies on inflation, and labor productivity in major global economies has stagnated for nearly a decade. , also makes us start to worry about potential inflation and economic stagnation. History does not repeat, but it rhymes. In the face of the impact of deglobalization on the industrial chain, the follow-up effects of global easing policies, and the impact of the epidemic on the supply side, will there be stagflation similar to the 1970s in the world? Will China face the risk of stagnant inflation and growth? In the medium and long term, this paper attempts to explore possible stagflation risks from the perspective of different supply functions in different economies. In the short term, the inflation risk in the United States shows no sign of easing significantly in the coming quarter, and the job market and economic growth may be at risk of slowing down in 2023 due to the expected tightening of monetary policy and the demand-side factors of economic fundamentals.
1. The causes of stagflation, a comparison of reality
The causes of inflation mainly come from the accelerated expansion of aggregate demand, supply-side shocks, the pull of excess money, and the self-fulfillment of inflation expectations.
The negative aggregate supply shock from the supply side was an important reason for the formation of stagflation in the 1970s. The two oil crises were the direct trigger for high inflation in the United States at that time. Inflation in the United States exceeded 10 percent in 1974, 1979, and 1980, as a result of rising energy prices caused by geopolitical conflicts that increased pressure on industrial oil prices and the accompanying rise in food prices. Although the statistical caliber of the core inflation rate in the United States at that time was constantly revised, monetary policy makers were reluctant to supply shocks such as energy and food to affect the trend of loose monetary policy, but in the middle and late stages, the core inflation in the United States gradually rose, which was in line with the overall inflation. The gap is gradually narrowing. The shock from the aggregate supply pushes up the inflation level from the cost side. Even if the United States implements price controls for some time, the exchange is a retaliatory increase in inflation. The shock on the aggregate supply side is an important reason for pushing up inflation, but it is not the only reason. The deeper stagflation factors come from the demand side and the productivity of the real economy.
Our research finds that aggregate supply shocks are not the only, or even the primary, cause of stagflation. Factors in aggregate demand and labor productivity in the real economy also play an important role. Trend inflation in the U.S. had been rising for some time before the supply shock. In the United States from 1965 to 1970, the inflation rate has increased significantly, mainly due to the continuous expansion of monetary and fiscal policies. Nominal wage growth is equal to labor productivity growth plus inflation, and real wage growth should theoretically be consistent with labor productivity growth. It is not uncommon in real economic operation that labor prices cannot be adjusted according to changes in productivity. The slowdown in the growth of labor productivity in the United States began in the 1960s, and the trend growth rate of labor productivity in the United States in the 1970s was already 1 percentage point lower than the average growth rate in the 20 years after World War II, showing the weakness of labor productivity in the real economy.
Back to reality, the global economy is faced with the supply shock of high crude oil, natural gas, and food prices caused by geopolitics. Since the global financial crisis in 2008, the continuous easing policies of major economies in the world have been driving inflation. A decade of stagnation has also raised concerns about potential inflation and economic stagnation. If the pressure of inflation and economic recession we face is only cyclical, such as lasting 1-2 years, then it cannot be called continuous stagflation pressure; if the pressure we face is structural, inflation and economic growth If the slowdown is with us for a longer period of time, even as in the United States in the 1970s, then we should attach great importance to the current possible signs of global stagflation.
The geopolitical factor is contingent and has a certain inevitability of the times. If it can be ended in a short time, the risk of global stagflation will be greatly alleviated. The fragmentation of the global industrial chain and the poor division of labor brought about by anti-globalization will artificially increase the price center of industrial products and consumer goods, which is not conducive to the mitigation of global inflation. Since 2008, loose monetary and fiscal policies have emerged. If the huge monetary stock and asset price bubbles are carefully digested, and a series of unconventional policy measures are gradually withdrawn, it will also have an important impact on the risk of global stagflation. The control of the epidemic by human beings and the recovery of total demand and supply are of great significance to the pressure of stagflation in the medium and long term. The difficulties and problems faced by the real global economy are similar to those in the 1970s, but we believe in the wisdom of human beings and believe that the difficulties are only temporary. and policy issues will be solved one by one.
2. Stagflation risks in different global economies in the medium and long term
Historically, the correlation between China's inflation level and currency growth rate has not been strong, and has a slight lag. Relatively speaking, some countries have also implemented relatively loose monetary policies, releasing a large amount of currency, but it has brought hyperinflation, such as some economies such as South America. Judging from the practice of various countries in the past ten years, loose monetary policy does have a positive correlation with inflation, but it does not necessarily bring about hyperinflation. This section presents recent reflections on the different responses of different supply functions across economies to inflation and economic growth. Whether the loose monetary policy will bring persistent inflationary and economic stagnation pressure depends on the overall production and supply capacity of the economy. We divide the production supply of the economy into two sectors: the low-productivity sector and the high-productivity sector. From the perspective of the monetary quantity equation, the classical theory holds that monetary policy easing has no significant impact on production, so the increase in money supply is mainly reflected in an increase in prices, that is, inflation. In fact, monetary policy easing has an impact on production, and the impact varies across industries.
Sectors with low production efficiency (such as sectors with low capital deepening) have weak supply capacity when faced with monetary easing and cannot rapidly expand supply in a low interest rate environment, so the loose monetary policy can easily be reflected in the rise of product prices. High production efficiency sectors (such as sectors with high capital deepening) have strong supply capacity when faced with monetary easing, and can rapidly expand supply in a low interest rate environment, so the loose monetary policy will not be reflected in the rise of product prices. When the supply increases rapidly, the loose monetary policy stimulates the supply, which may be reflected in the decline of product prices, that is, the loose monetary policy coexists with deflation in some industries.
The production efficiency of low-efficiency sectors is weak, and it is difficult for loose monetary policy to increase supply and output:
F"low-k (K, L, etc.) < 0
The production efficiency of high-efficiency sectors is relatively strong, and loose monetary policy is easy to increase supply and output. Out:
F"high-k(K, L, etc.)>0
Then, why do loose monetary policies respond differently in different economies? The main reason is that the proportion of low-productivity sectors and high-productivity sectors in each economy is not the same. For example, when the proportion of high-end manufacturing (higher capital deepening, similar to high-productivity sectors) in an economy reaches a certain threshold, loose monetary policy, although manifested as product inflation in low-productivity sectors, but in high-productivity sectors The sector is showing deflation. When the proportion of highly productive sectors in an economy exceeds the threshold, loose monetary policy may not bring about a higher overall inflation level, such as China with strong manufacturing and a wide range of industrial sectors, and Vietnam in the future. Vice versa, in economies dominated by inefficient sectors, loose monetary policy is likely to bring inflation, such as some economies in South America. The U.S. monetary policy has spillover effects. From a global perspective, as long as there are enough high-productivity sectors in the world and their proportion is large enough, even if the Fed continues to ease, it will not bring significant inflationary pressure.
To sum up, loose monetary policy has different effects on different economies. China's manufacturing industry is strong, the industrial sector is relatively broad, and it has a relatively high proportion of high-productivity sectors. There is also a large space to implement a moderately loose monetary policy without worrying about more sustained and significant inflationary pressures. Even if the price of raw materials from the supply side rises, through the hedging of higher production efficiency in the industrial sector and other real economic sectors, there will be no sustained upward pressure on the actual price increase of final products. Some economies with a large proportion of low production efficiency, because of weak supply capacity, loose monetary policy may soon be reflected in inflation. Therefore, in the medium and long term, the risk of stagflation in different economies around the world mainly depends on the production efficiency of the real economy of each economy.
3. In the short term, the inflationary pressure in the United States will remain unabated, and the United States will face the risk of recession next year
Our U.S. inflation model is based on factors such as excess U.S. money demand, commodities, and inflation expectations. According to our model results, US headline inflation is unlikely to ease significantly in the coming quarter. Due to seasonal factors such as summer travel and base effects, U.S. inflation may remain at 7%-8.5% in the third quarter. At the same time, under the neutral assumption of oil prices, U.S. inflation may remain at 6%-7% by the end of 2022, and the Fed’s tightening monetary policy process will continue.
One of the reasons why the Federal Reserve and other institutions have underestimated inflation pressure before is that the inflation forecast model follows the traditional output gap model, which is prone to misjudgment about inflation trends in the context of the global epidemic severely affecting aggregate supply. Due to the impact of the global epidemic, the aggregate supply function of some producers in the world has contracted, which has seriously affected inflation forecasting models that rely on output gaps.
Our inflation forecasting models rely primarily on factors such as excess money demand, commodities and inflation expectations. With the liberalization of interest rates and the development of financial markets, the role of aggregate monetary data in predicting inflation and asset price bubbles is declining. A large number of credit currencies make monetary statistics and definitions of aggregates very difficult. The guiding significance has declined. However, if the total monetary data excludes the real transaction part of the real economy, it will have a better leading role in forecasting inflation (two quarters in advance) and credit expansion in the capital market. Money supply statistics in the traditional sense do not necessarily all enter the real economy for trading and circulation in the current period, and some currencies may be idled by micro entities and enter the financial market or other virtual economy asset fields. In order to further explore the relationship between inflation and the amount of money, we redefine and use the econometric model to measure the amount of money that actually enters the real economy circulation and production, which is called the real amount of money in this paper. According to the definition of the formula: the
real amount of money = the amount of money announced by the monetary authority - the amount of idle money - the amount of money in the virtual economy
In the short term, we found that the real money volume in this part leads inflation by about two quarters, that is, the real money volume entering the real economy can indeed affect the inflation level after a quarter or two. When there are many capital inflows into the asset field, although the monetary aggregate growth rate announced by the monetary authorities is relatively high, many of them have not flowed into the real economy (or although they have flowed into the real economy at the beginning, the funds of the real economy will not be reinvested and produced, and the funds will not flow into the real economy. idling and then flowing into the asset field), the inflation level of the real economy can still remain stable. When there are more real inflows of funds into the real economy and the monetary authorities' money supply is larger, inflation may be pushed to a higher position by this part of real liquidity.
Sensitivity risk of short-term U.S. inflation to supply shocks: If the geopolitical-induced crude oil prices and food prices can be eased in the short term, crude oil prices will gradually fall, and return to $85-95 per barrel by the end of 2022, then the U.S. inflation will be at the end of 2022. May be reduced to the level of 6%-7%; if geopolitics does not ease in the short term, and crude oil prices only fall back to around $110/barrel by the end of 2022, then US inflation may remain at 7.5% by the end of 2022. Of course, if crude oil prices continue to rise due to various factors, the impact on global inflation will be more significant and far-reaching.
To sum up, due to seasonal factors such as summer travel and base effects, U.S. inflation may remain between 7.5% and 8.5% in the third quarter. At the same time, under optimistic assumptions, U.S. inflation may remain at 6%-7% by the end of 2022, and the Fed’s tightening of monetary policy will continue. Meanwhile, data on the U.S. housing market, business equipment investment and finished goods inventories, as well as recent purchasing managers' index (PMI) data and consumer confidence, suggest that persistently high inflation is weighing on economic growth. At the same time, the Fed's next policy of raising interest rates and shrinking its balance sheet will also begin to affect the cost of capital and labor market for companies' productive investment in a quarter or two. There are various signs that the United States may face the risk of slowing economic growth in 2023. Globally, the supply and demand shocks in Europe are stronger than those in the United States, and the pressure on economic growth is more pronounced under the expectation of tightening monetary policy.
Will China face the risk of stagnant inflation and growth? In the medium and long term, among the major economies in the world, China's labor productivity in the real economy is relatively high. Although it has shown a downward trend in recent years, the horizontal ratio is still much higher than that of some developed economies. Therefore, in the face of the same pressure of high global commodity prices, the real economy has achieved a hedge against rising prices of end products through higher productivity, and China's inflationary pressure in 2022 will not be significant. In terms of growth trends, although China's potential output has been declining slowly in recent years, structural opportunities for China's economic growth have emerged in an endless stream. The economic structure has changed, and the intra-industry structure has changed rapidly. It is still the most dynamic economy in the world. With the easing of the epidemic and the efforts of easing policies, we believe that the Chinese economy does not encounter the risk of stagnant economic growth. In the short term, China may be subject to the cost transmission of bulk commodity prices and the slow transmission of pork, grain and other prices, and inflation may rise slowly, but the magnitude and duration are significantly lower than those of other major economies in the world. On the whole, how to get rid of the risk of stagflation, the world should reduce the impact on the supply side, follow the trend of globalization, and do a good job in strengthening the real economy.
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