Rising inflation and a slowing of global economic activity have led to speculation about whether we are facing a period of stagflation. But it will hardly turn out that bad as the economic structures have changed radically over the past 50 years, writes Nordea's Chief Economist Helge J. Pedersen in his latest blog.
Over the past months, inflation has risen significantly globally and is now at an all-time high in many places since the financial crisis. The uptick in inflation is mainly due to the strong upswing in the global economy, which has led to massive capacity problems at manufacturers who are currently finding it hard to meet demand. This has resulted in surging commodity prices and transport costs as well as long delivery times. Moreover, this trend has been exacerbated by record-high gas and electricity prices.
Now growth is slowing down, which has given rise to fears that we are facing a period of stagflation – that is, economic stagnation and high inflation. A situation that reminds us of the late 1970s and early 1980s.
However, I don’t believe it will turn out that bad and especially not here in Denmark. Because the situation today is actually quite different from back then.
Towards the end of 1973 the world economy was hit hard when the Arab countries decided to use oil as a weapon against the (Western) countries supporting Israel during the Yom Kippur war. Supplies were reduced and prices increased, and the consequences were serious as the black gold was then by far the most important energy source.
In Denmark, oil accounted for 90% of the total energy consumption, so companies’ and households’ energy bills rose drastically and so did unemployment and the current account deficit. To economise on the sparse currency reserves, the government introduced car-free Sundays, which, by the way, I as a 14-year-old cycling paper boy appreciated very much. At the same time we got used to putting on Icelandic sweaters also indoors to keep heating at a minimum on cold winter days.
All the while, inflation almost by itself climbed upwards as a result of the then cost-of-living adjustment and inconsistent stop-and-go policies. In the beginning of the 1980s, inflation reached two-digit levels while yields on government and credit bonds rose above 20%. This trend basically undermined economic stability.
Underlying demand in the global economy is high at the moment, and the green transition will lead to enormous public and private investments over the coming many years.
Helge J. Pedersen, Nordea Group Chief Economist
We are in a different place today. The oil crises – as you know there was another oil crisis in 1979-80 – became the catalyst for a comprehensive reassessment of both energy, fiscal and monetary policies. Thus heavy duties were imposed on petrol while homes and properties underwent massive energy improvements. The latter also played a part in creating new jobs during difficult times. At the same time, policymakers focused on ensuring security of supply, partly by freeing us from oil as the primary energy source, partly by starting a close collaboration with the other Nordic countries through integration of the energy infrastructure. A regional collaboration which today is an international exemplar and creates great advantages as a result of the countries’ wide range of sustainable energy sources. So in light of the latter, the current period of high energy prices will probably be relatively short and not have serious consequences for the Danish economy.
Economic policy has also been reassessed. Internationally, the purpose of monetary policy was changed to ensure low and stable inflation rates, and emphasis was put on responsible fiscal policies in most countries in the western world, including Denmark.
At the same time, structural reforms and globalisation have considerably increased international competition and productivity. Together with, for example, the arrival of digital trading platforms and regulatory requirements about increased price transparency, it has made it somewhat more difficult to raise wages, prices and margins compared with the 1980s.
The underlying drivers of inflation are thus very different today than back then. This also applies even if the pandemic prompts some companies to relocate production from low-wage countries in Asia in order to reduce the risk of future value chain disruptions or if labour mobility remains hampered by travel restrictions. The latter could result in a more general shortage of labour locally and lead to higher wage growth, which companies will try to pass on to the consumers in the form of higher prices.
But I generally do not think we are in for a longer period of stagnation. Underlying demand in the global economy is high at the moment and the green transition will lead to enormous public and private investments over the coming many years.
Thus, growth will continue at a high pace, and inflation will slow down again from the current levels once the pandemic is over and the logistics issues have been solved. If it takes 3, 6 or 12 months, only time will tell. And if the energy bill gets out of control in the meanwhile, we can always take another round with the woollen sweater and car-free Sundays. The latter would definitely also improve the CO2 balance.
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