Global Economic Outlook (G.E.O)
Inflation the Trigger, Stagflation the Consequence. Vol. 94. June 20, 2022.
Dear readers, welcome to another edition of the Global Economic Outlook (G.E.O) - our weekly newsletter providing insights on the local and global economy. Today, we will be discussing how the attempt by countries to control inflation is possibly going to lead to another challenge: stagflation.
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Inflation the Trigger, Stagflation the Consequence
Inflation has become the major challenge for many economies around the world with prices rising at an astronomical rate. A combination of high energy cost, disruption to the global supply chain and the increase in the prices of food triggered by the Russia-Ukraine conflict has helped to aggravate issues that countries were already dealing with in the aftermath of the coronavirus pandemic.
Central banks have already started responding with interest rate increases as they look to tighten the economy to prevent prices from spiraling beyond control. The United States (US) Federal Reserve recently raised interest rate by 0.75 basis point last week, which is the highest increase since 1994, while the Bank of England has done the same, albeit an increase of 0.25 basis point. Even in Nigeria where the Central Bank has been trying to stimulate the economy by keeping rates low, there has been an increase of 150 basis points in recent times.
Inflation by itself is not an issue but Central Banks seek to keep it within a certain threshold to ensure that it does not disrupt economic growth. For instance, the inflation target in the US, United Kingdom (UK) and many of the developed nations is about 2% while in Nigeria, the target is to keep it in the single-digit territory. Tightening the economy through interest rate is normally the response to inflation rising beyond the target. However, there is another issue that can be triggered by the tightening of the economy and that is Stagflation.
Stagflation is a concept coined in the 1970s which denotes a situation whereby an economy is experiencing high inflation, slow economic growth and high unemployment at the same time. Prior to the 1970s, Economist A.W. Phillips had introduced an economic model called ‘Phillips Curve’ which states that there is an inverse relationship between inflation and unemployment, and also that economic growth comes with inflation. Stagflation is certainly a major departure from that and violates this model.
Many people are starting to think that we are not far from what was experienced in the 1970s. The inflation rate in the US is currently high at 8.6% and the economy contracted in the first quarter of 2022 by 1.5%. The only variable holding the US back from stagflation is the low unemployment rate at 3.6%. The UK might be farther away from stagflation as their high inflation of 9%, high economic growth of 8.7% in the first quarter of 2022 and low unemployment rate of 3.7% seems to be consistent with Phillips Curve but the question now is for how long they can keep it that way.
Nigerians have every right to believe that their economy is already in a state of full-blown stagflation. This is because the inflation rate in the country was at 17.71% in May 2022 while economic growth slowed down to 3.11% in the first quarter of 2022 from 3.98% in the last quarter of 2021. If we consider the last unemployment statistics released by the National Bureau of Statistics (NBS) which stands at 33.3%, we will see that all the variables required for stagflation which are high inflation, slow economic growth and high unemployment rate are already present in the country.
Taking Nigeria’s case into consideration, it is clear that the only reason why many believe that stagflation of the 1970s is still months away is because the developed markets are yet to fully experience it. In Nigeria, it is already the reality and it will take a combination of strategic moves by the Central Bank and the government to keep it in check.
The US and the UK are already taking steps to prevent stagflation and only time will tell if their approach will prove effective. The major task is in tightening the economy (by controlling inflation) through interest rate increase without plunging the economy into recession. It is certainly not an easy time to be the Central bank Chief.
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Please share your thought on how you think countries can prevent stagflation.
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The Central Bank of Nigeria (CBN) has raised the interest rate for the first time in six years. Watch this video to learn what the effects might be on individuals and businesses.
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If you have any questions or you need help on how to manage your personal finance, please send us an email at info@ecofinar.com.
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