Today’s global economy is eerily similar to the 1970s, but governments can still avoid an episode of stagflation.

The global economy is in full swing sudden slowdown accompanied by a sharp rise global inflation to multi-century highs. These developments raise fears of stagflation — a coincidence of weak growth and elevated inflation — similar to what the world experienced in the 1970s. This experience should warn of the damage this could do to emerging market and developing countries (EMDEs). stagflation that era ended with a global recession and a series of financial crises in EMDEs. In light of the lessons of this episode of stagflation, these countries need to quickly rethink their policies to deal with the consequences of a rapidly tightening global financing environment.

Inflation and Growth: Moving in Opposite Directions

May 2022 global inflation (8.1 percent) and EMDE inflation (9.4 percent) were at their highest levels since 2008. Inflation in advanced economies is at its highest level in four decades. As the recent shocks in energy and food prices ease, supply bottlenecks clear, and financial conditions tighten, global inflation is expected to ease to around 3 percent next year. But that would still be about 1 percentage point above the 2019 average, before the pandemic turned the world upside down.

After the collapse during the 2020 global recession, global growth recovered to 5.7 percent in 2021 thanks to unprecedented fiscal and monetary easing. However, growth is currently expected to slow down. to 2.9 percent in 2022 with little change in 2023-24. due to the war in Ukraine, the fading of pent-up demand and the withdrawal of political support amid high inflation. In the near term, global growth is expected to remain subdued in the 2020s, reflecting weakening of the trend fundamental growth factors.

The slowdown is steeper, inflation is not rising as much (yet)

The current phase is reminiscent of the early 1970s in three key respects:

  • High inflation and weak growth. The global economy is emerging from the pandemic-related global recession of 2020, as it did during the stagflation period following the 1975 global recession. averaging 3.6% per annum in 1962-72. While the surge in inflation following the 2020 global recession caused by the COVID-19 pandemic was less dramatic than after the 1975 recession, the projected slowdown in growth will be much more dramatic. Global growth is projected to slow by 2.7 percentage points between 2021 and 2024, more than twice as much as between 1976 and 1979 (Figure 1).
  • Supply shocks after prolonged monetary easing. Supply disruptions caused by the pandemic and recent supply shock The effects of Russia’s invasion of Ukraine on world energy and food prices are reminiscent of the oil shocks of 1973 and 1979-80. The increase in energy prices in the 1970s and in the period 2020-2022 was the largest price change in the last 50 years. Then and now, money-credit policy has generally been highly accommodative in the run-up to these shocks, with negative real interest rates for several years.
  • Significant Vulnerabilities in Emerging Market and Developing Economies (EMDEs). In the 1970s and early 1980s, as now, high levels of debt, elevated inflation, and weak financial positions left EMDEs vulnerable to tightening financial conditions. The stagflation of the 1970s coincided with the first global wave of debt accumulation over the past half century. Low global real interest rates and the rapid development of syndicated loan markets have contributed to the growth of EMDE debt, especially in Latin America and many low-income countries. The 2010s were characterized by the fourth (and ongoing) wave of global debt accumulation, including the largest, fastest, and wide-ranging growth in emerging market government debt in 50 years. A number of LICs are already either in a debt crisis or close to one. The sheer magnitude and speed of debt accumulation increases the associated risks.

Figure 1. Events in the 1970s and 2020s: similarities

BUT. Growth slowdown after global recessions

A. Growth slowdown after global recessions

B. CPI inflation

B. CPI Inflation Graph

FROM. Real interest rates

C. Real interest rate chart

D. Changing food and energy prices

D. Graph of food and energy prices

Sources: Federal Reserve economic data; Haver Analytics; The World Bank.

Notes: CPI = consumer price index; EMDE = emerging market and developing countries. A. The figure shows the change in global growth (in percentage points) between 2021-24 and 1976-1979; covers three years after the recovery from the global recession; B. Annual averages of headline and core CPI inflation in the US and the world (average of 66 countries). 2022 based on averages from January to May 2022; C. The figure shows nominal and real (CPI-adjusted) short-term interest rates (T-bills or money market rates with maturities of three months or less). Global interest rates are weighted by GDP in US dollars. The sample includes 113 countries, although the sample size varies by year; D. Percent change in monthly energy and food price indices over a 24-month period. Due to limited data prior to 1979, energy price changes were estimated using oil price changes.

Critical differences from the 1970s

While the similarities described above are worrisome, there are important cyclical and structural differences between the 1970s and the current situation. This means that the global economy may yet avoid a repeat of this episode of stagflation.

  • Smaller upheavals. At least so far, the magnitude of commodity price spikes has been smaller than it was in the 1970s. For now, global inflation in 2022 is still on a less broad base than it was in the 1970s, and core inflation remains moderate in many countries, even if it has risen recently.
  • More robust monetary policy framework. Fundamentals of Monetary Policy over time, they began to focus more and more on price stability. In the 1970s, central banks often had competing goals – striving both for high output and employment, and for price stability. By contrast, central banks in advanced economies and many emerging market economies now have clear price stability mandates, usually expressed in terms of a clear inflation target (Figure 2). As a result of improved policy frameworks and better anchoring of inflationary expectations, inflation, in particular core inflation, has become much less sensitive to inflationary surprises.
  • More flexible economy. The 1970s were a time of significant structural economic inflexibility, many of which have since changed. Today’s greater economic flexibility, with less centralized wage setting and less financial restraint, allows for a faster response to supply and demand in sectors where prices rise most rapidly, and reduces the likelihood of a price-wage spiral becoming fixed. In addition, since the 1970s, the energy intensity of GDP has declined significantly, making the economy more resilient to energy price shocks (World Bank 2022a).
  • Less fiscal placement. The 1960s and 1970s were marked by expansionary fiscal policies. On the contrary, fiscal tightening is expected in the coming years as governments withdraw from the unprecedented fiscal support provided during the pandemic.

Figure 2. Events in the 1970s and 2020s: Differences

BUT. Number of countries with inflation targeting

A. Number of countries with an inflation targeting schedule

B. Labor market flexibility

B. Schedule of labor market flexibility

FROM. US inflation expectations

CUS inflation expectations chart

D. Global energy intensity

D. Graph of global energy intensity

Notes: TOE = tons of oil equivalent. A. Based on explanations from the IMF Annual Report on Exchange Arrangements and Currency Restrictions and country-specific sources; B. Collective bargaining rates indicate the percentage of employees with bargaining power. Union density measures show the number of union members as a percentage of the total number of employees. Aggregation is based on the median of a balanced set of 25 countries; CUS consumer inflation expectations are based on an April 2022 University of Michigan survey; D. Energy includes coal, natural gas and oil. TOE stands for tons (metric tons) of oil equivalent. Aggregates calculated using GDP weights at 2010-2019 average prices and market exchange rates.

Sluggish response to serious risks

Concerns about persistently above-target inflation have already prompted central banks in most advanced economies and many emerging markets to tighten monetary policy amid a sharp slowdown in growth. Despite this tightening, as of May 2022, real policy rates (adjusted for actual inflation) remain extremely negative on average for advanced economies (-5.2 percent) and on average for EMDE (-3.2 percent) .

If inflation expectations become unpegged, as they were in the 1970s, due to persistently elevated inflation and recurring inflationary shocks, the increase in interest rates needed to bring inflation back to target in advanced economies will be larger than it is at present expected by the financial markets. This evokes the specter of soaring interest rates that curbed inflation but also triggered a global recession in 1982. This global recession also coincided with a series of financial crises and ushered in a protracted period of weak growth in many emerging markets.

If current stagflationary pressures pick up, the EMDEs are likely to face economic risks again due to lower loosely anchored inflation expectations, heightened financial vulnerabilities and worsening growth prospects. This is forcing their governments to urgently bolster their fiscal and external reserves to stave off potential contagion, strengthen their monetary policy framework to reduce policy uncertainty, and pursue structural policies to revive growth.