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Economic Downturn, Soaring Prices, the Arrival of Global Stagflation

  As information and communication technology gradually develops and exchanges between countries become more active, all countries around the world have become more sensitive to the economic situation of other countries. The global economy has been plagued by crises such as the pandemic and the outbreak of war recently. Many factors, including those mentioned above, work in combination, raising concerns about "Global Stagflation." So what is this stagflation, this economic crisis that threatens our society? Let's learn about the principles and past history of stagflation along with the definition of the term, how it affects the global society, and how we can overcome it.

 

Have you ever heard of “Stagflation?”

 Stagflation is a compound of stagnation and inflation, which means a situation in which economic stagnation and inflation occur at the same time. In economics, this word refers to a situation in which the inflation index, which is the degree of inflation, is high, the economic growth index is low, and the unemployment rate stays high. In other words, the word stagflation stands for an economic crisis in which prices rise while the unemployment rate increases and the economy stagnates due to a decrease in transaction volume in the market. The term was first used in 1965 by British politician Iain Norman Macleod during a speech in Parliament. At a time when inflation and unemployment were high, he said, "We are now facing the worst of both worlds. We're in a kind of 'Stagflation' situation." After Macleod mentioned it again in 1970, the year he was appointed British Chancellor of the Exchequer, the word stagflation also emerged in the media. So, what are the causes and principles of stagflation? In a poor economy, households cut back on spending and increase savings, which reduces aggregate demand in the market. According to the traditional economics by the Keynesian school, prices fall when effective demand decreases. They argue that falling prices lead to consumers buying goods at low prices, and that the market economy will naturally improve again, lessening unemployment and increasing wages, leading to higher prices. However, traditional economic theory and the real economy do not always take the same direction. If prices continue to rise rather than fall as aggregate demand decreases, inventories will increase, factories will curtail production, and aggregate supply will decrease. Then prices rise again, Gross Domestic Product (GDP) retreats, resulting in investment contraction, which raises the unemployment rate. A rise in the unemployment rate will lead to a decline in household income, consumption, and production, and as a result, the market will gradually slow and an economic crisis will occur.

 

History of Stagflation

 The most widely known example of stagflation is the Great Depression that occurred in the United States in 1929 and persisted worldwide for about a decade. After World War I, many cases were cited as possible causes, including excessive protection trade, German hyperinflation, the aftermath of the stock market's overheated stock price crash, and the absence of the International Monetary Fund. The stock market, which had been expanding during the booming U.S. economy in the 1920s, peaked in October 1929, and the stock bubble burst and the boom phase ended. The U.S. relied on upper-class consumption by the unfair U.S. income distribution structure, but their consumption was not large enough to revitalize the national economy. The gradually subdued economy and continued unemployment naturally led to poverty and decreased purchasing power. American capitalists refused to make new loans to foreign countries, and foreign debtors who were no longer able to get money were forced to go bankrupt. Due to the Great Depression, investment in the United States plunged by more than half from $7 billion to $2 billion between 1929 and 1933, with approximately 100,000 companies and 6,000 banks going bankrupt. In four years, the rate of unemployment in the US reached 13 million, and U.S. imports and exports plunged as the stock market collapsed. At that time, the U.S. economy, which accounts for 42% of the world's economy, faltered, and the economies of hegemonic countries such as the U.K., France, Germany, and Japan began to wobble with tremendous unemployment rates. Because many countries were heavily dependent on exports to the U.S., the situation worsened as they increases tariffs to reduce imports, causing the entire world to be swept away by the Great Depression.

 We can also come up with the global oil shock that occurred in the 1970s as an instance of global stagflation. This is an event in which the world economy suffered great confusion and difficulties due to the Arab oil-producing countries' policy to weaponize oil in 1973 and the Iranian Revolution in 1978, two oil shortages, and price hikes. International crude oil prices, which were at the $3 level before the first oil crisis, nearly quadrupled in three months to the $12  level. The world was struggling with recession and inflation, with major developed countries and most countries experienced a sharp drop in growth due to oil shortages, and some countries experienced negative growth. In the aftermath of the second oil crisis, crude oil prices, which stood at 12 dollars, surpassed 30 dollars in 1980 and rose to 39 dollars. Due to the two oil shocks, the annual economic growth rate of developed countries decreased from 4.0 percent in 1978 to 2.9 percent, and the world suffered from oil supply problems.

 Another example of stagflation is the Asian financial crisis of 1997. At that time, a currency crisis occurred in Southeast Asia due to the Korean government's reckless over-investment and Thailand's abandonment of the fixed exchange rate system; these actions caused an economic crisis throughout Asia and Northeast Asia. As foreign companies, anxious about the Asian economy, rushed to withdraw their capital, foreign exchange reserves ran out, corporate bankruptcy and mass unemployment occurred in a short period of time. In Thailand, 600,000 foreign workers had to return to their home countries, and in January 1998, the Thai currency hit a high of one dollar to 56 baht. The Thai stock market fell 75 percent, and Finance One, Thailand's largest financial company at the time, went bankrupt. As Thailand abolished the fixed exchange rate of the Thai baht due to the rapid expansion of the current account deficit and the collapse of the real estate bubble, the Indonesian Ministry of Finance also removed the limit on fluctuation in the Rupiah and the value of the currency fell significantly. Companies' debt, heavy selling of Rupiahs, and soaring demand for dollars resulted in a loss of 13.5% of Indonesia's GDP that year. In Korea, all but 11 of the top 30 domestic businesses went bankrupt, and in December of that year, the exchange rate soared to 2,000 won per dollar, causing the nation to fall into ruin. To overcome this, the Korean government received a total of $55 billion in bailout funds from the International Monetary Fund (IMF), and after three years and eight months, they repaid $140 million and broke away from the IMF system.

 

The Cause of Global Stagflation

 We have looked into events of global stagflation that occurred in the past. Recently, prices have risen sharply around the world again, and a global economic crisis is rising. The World Bank (WB) and the Organization for Economic Cooperation and Development (OECD) pointed to Russia's invasion of Ukraine, supply chain instability due to the coronavirus infection pandemic, and monetary tightening policies of many countries as factors that can induce global stagflation. Among them, everyone is probably familiar with the economic damage such as the removal of exchange between countries and the weakening of domestic economies caused by the COVID-19 virus. A number of exchanges between countries have gone down over the past three years due to restrictions on entry and exit due to the pandemic, and a global economic downturn has occurred due to a decrease in consumption demand. A lot of businesses, including the global energy and food resources markets, the aviation and tourism industries, and the self-employed, have fallen, and the lives of people around the world have rapidly become difficult. The International Monetary Fund defines the effect that COVID-19 has had on the world as the Great Lockdown. This is because countries, including China, have pursued trade protection to protect their domestic economy and block many channels of exchange with other countries, which has taken a major hit on the global economy. Кристалина Георгиева (Kristalina Georgieva), the head of the IMF also said, “I've never seen the whole world stop like this in IMF history.” Many scholars around the world also say that the economic impact of COVID-19 will be the third-largest scale global economic crisis, following the Great Depression in 1929 and the global financial crisis in 2008.

 It should also be noted that the global economy is suffering more severely due to the prolonged war between Russia and Ukraine. With the aftermath of the two-year COVID-19 pandemic lingering, the Russia-Ukraine war added to the chaos in the global supply chain and raised inflation to its highest level in decades. These factors have lowered the economic growth rate of major countries and intensified the polarization between developed and developing countries. The war has blocked the supply and logistics of major raw materials and commodities such as crude oil, gas, and wheat, raising the prices of almost all products from fuel to food. The missile that bombed Ukraine, which is so specialized in wheat production that it is called “the bread basket of Europe,” has a great impact on the raw material market, including the global food supply. India is reportedly considering restricting exports of wheat, sugar, and rice, and Indonesia has introduced measures to restrict food exports of domestic food reserves since the outbreak of the war, including restrictions on palm oil sales. In addition, the war has caused energy prices to soar and instability to intensify, accelerating poverty in developing countries due to rising agricultural prices. Compared to developed countries, some states that do not have many usable policy instruments are being directly hit by rising import prices and increased market volatility due to the strong dollar. Food shortages and rising prices can cause political turmoil in poor countries and add to the instability of the international community.

  Rapid inflation in the United States, a country that controls the global economy, is also affecting accelerating stagflation around the world. According to the International Monetary Fund, the U.S. gross domestic product in 2008 was $14.4 trillion, accounting for 23% of the world's gross domestic product (GWP) at the market exchange rate. The U.S. is the world's largest importer of goods, and it is no exaggeration to say that all countries in the world trade with the U.S.  According to the Bank of Korea's "International Financial Market Outlook Webinar for the Second Half of 2022" on June 23 this year, most U.S. investment banks expected economic growth to slow down more than expected due to aggressive interest rate hikes such as the U.S. Federal Reserve. Economists at major U.S. investment banks invited to the webinar expect a 30-40% chance of the U.S. economy slowing down next year or in the following year. The Wall Street Journal (WSJ) also reported a 44 percent economic recession probability within 12 months in a survey of economists in June. As of July 1, the Atlanta Federal Reserve Bank's "GDP Now," which presents the U.S. GDP outlook in real time, announced that the U.S. GDP growth rate in the second quarter to be at -2.1%, lower than the growth rate in the first quarter. The growth rate in the second quarter, which was predicted to be 0.3% a week ago, fell sharply in a week. Daan Struyven, a senior Global Economist at Goldman Sachs, predicted that the U.S. economic growth will gradually fall from 5.7 percent last year to 2.4 percent this year and 1.4 percent next year due to the U.S. Federal Reserve's financial belt-tightening. Larry Summers, a professor at Harvard University who served as U.S. Treasury Secretary, also predicted an 80% possibility of an economic recession in the U.S. in 2023. Experts argue that in order for the U.S. to correct inflation, it should consider fiscal stimulus, not monetary policies such as interest rate hikes. In response, U.S. President Joe Biden is reportedly considering removing trade tariffs and lowering tariffs on some Chinese products.

 

Global Economic Outlook and Trends

 With an export-dependent economic structure that is greatly affected by the overseas economy, Korea's difficulties will inevitably be greater. The Chinese financial data analysis company, WIND, reported China's annual economic growth forecast to be at 4.2 percent this year. This economic situation in China, the country with the highest proportion of Korea's exports, is expected to have a significant impact on the Republic of Korea. According to statistics from the Korea International Trade Association (KITA), Korea's export to China was 25.3% last year, and if China's growth rate falls by 1%, Korea's export volume will fall by 0.35%. While the ratio of exports to China is decreasing, prices and interest rates in the domestic market are on the rise. This year, the benchmark interest rate has also jumped sharply and consumer prices have soared to around 6% due to reduced supply due to infectious diseases and war. According to the International Finance Association, the ratio of corporate debt to the gross domestic product in the first quarter of this year was 116.8 percent and the ratio of household debt was 104.3 percent, the highest among 36 major countries in the world. This means that the level of debt owed by Korean households and companies is larger than the GDP, and that debt increases faster than money is being made, making it progressively difficult to pay off debts.

 This year, the World Bank (WB) announced its "World Economic Outlook" and significantly lowered its global economic growth forecast for this year from 4.1 percent in January to 2.9 percent in June. World Bank President David Malpass warned that the global economy is likely to enter a period of weak growth and prolonged high inflation, warning that there is a high risk of stagflation. He then expressed concerns about continuing low growth over the next 10 years due to weakening global investment, saying the economic growth rate will be close to zero over the next two years in the worst-case scenario. According to this announcement, the pace of global economic growth will fall by 2.7 percent by the year after next, and it will be twice as severe as the oil shock, which was a notorious economic crisis. In order to overcome the economic slowdown, Malpass suggested that governments should eliminate trade barriers and increase production. The OECD also released its "economic outlook" on June 8 and predicted global growth at 3.0 percent this year. This is 1.5 percentage points lower than the forecast released in December last year, which is the result of a larger decline than the World Bank. The OECD also raised the average inflation forecast of member countries to 8.8 percent this year, which is twice the figure predicted in December last year. According to their data, Korea's economic growth forecast for this year fell from 3 percent to 2.7 percent, and the inflation forecast rose from 2.1 percent to 4.8 percent. The European Central Bank (ECB) also raised its forecast for consumer prices in the eurozone to 6.8 percent for the first time in three months and lowered its GDP growth rate from 3.7 percent to 2.8 percent.

 Experts are also seriously warning of the risk of stagflation. Sung Tae-Yoon, an economics professor at Yonsei University, said the current situation is similar to stagflation caused by the oil shock in the 1970s, comparing the current situation with stagflation that hit the world at the time. He stressed the need to prepare for the future based on his experience of overcoming stagflation in the 1970s regarding the global economic crisis in 2022, which has more factors than in the past. In addition, Nouriel Roubini, a global economist who predicted the 2008 global financial crisis, anticipated a U.S. recession later this year, and predicted that inflation would continue for quite a long time. In an interview with Bloomberg on June 22, 2022, he said "The U.S. economy is not yet in recession, but it is getting very close," adding that, "The U.S. economy will fall into recession later this year." Moreover, he explained that U.S. inflation, which has risen to its highest level in 40 years, suggests the possibility of 1970s-style stagflation. Concerned about bankruptcy in developing countries, WB Director M. Ayhan Kose emphasized the need to strike a balance between securing fiscal sustainability and easing the impact of the current situation on the poor.

 

  In the face of this tremendous stagflation, we can recall the success of U.S. President Roosevelt's economic stimulus during the Great Depression in the 1930s. Through the New Deal, the U.S. government intervened in the market, increased the money supply directly, implemented public projects, set up effective income redistribution, and succeeded in relieving unemployment. As a policy suggestion for the current situation, the World Bank has suggested refraining from policies such as price controls, subsidies, and bans on exports that could worsen inflation. They also emphasized the need for support policies for vulnerable groups that could be hit directly by inflation, low growth, and fiscal austerity policies. The joint response will not be easy as countries are strengthening protective barriers to trade to protect their domestic markets. Nevertheless, we must keep in mind that the world should be actively involved in international economic cooperation and we must work together to overcome the crisis of stagflation by looking at the economic crises that occurred in the past and the various policy responses that overcame them.

김진아  82_j@inha.edu

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