A spectre is haunting us - should we be afraid?

In recent weeks, the word "stagflation" has increasingly appeared in the media and usually has negative connotations. Here is our definition: stagflation is a portmanteau of STAGnation and InFLATION and thus describes stagnating economic growth combined with increased inflation. This is a phase that we are already in in Europe and will remain in for some time, but which is not currently prevalent in the USA, although it may be imminent. Europe reported an economic contraction of 0.1% for the past quarter, while the USA reported a surprisingly positive annualized figure of 4.9% (equivalent to around 1.2% in the European calculation logic). In terms of overall inflation, both regions are still above the target of two percent and the less volatile rate of core inflation (excluding food and energy) is even above four percent.

The reason why stagflation has such a negative connotation is that the most prominent period of comparison is the mid-1970s, when inflation rose rapidly and sharply, triggered by the oil price shock in the wake of the Yom Kippur War in 1973, and the central banks had to respond with massive interest rate hikes. This led to a deep economic slump followed by high unemployment. But if Europe is already in stagflation, shouldn't we be afraid too? We think not, because there are fundamental differences to the 1970s.

Five reasons why we need not fear

Firstly, development was slower - the coronavirus pandemic and the Russian invasion of Ukraine tightened supply - and to a lesser extent demand - and caused lasting disruption to production and supply chains.

Secondly, and very significantly, the interest rate level was different: key interest rates in the US were previously around eight percent in the 1970s. This time they came from a historically low zero. This means that the central banks' hikes have not led to a higher interest rate level, as is often said, but actually to a normal interest rate level.

Thirdly, the economy can digest the developments better because it is no longer so dependent on oil (different distribution of economic sectors) and consumption (also due to government support measures) has not suffered a slump in many sectors.

Fourthly, the labor market is much more resilient. This is also due to demographics, as a large number of new workers entered the labor market in the 1970s, whereas today more people are leaving than entering.

And fifthly, the decline in economic development is only occurring with a time lag after the peak of inflation about a year ago and does not coincide with it.

So it is true that we have increased inflation, will experience a longer phase of stagnation and are therefore ad definitionem in a stagflation, but it is not the same as in the 1970s.

So let the spectre roam around, but don't be afraid of it - it doesn't have the mantle of economic depression on.

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