19 September 2022


This is not stagflation

The current environment of soaring commodity prices, high inflation and major geopolitical uncertainties has very logically reminded analysts of the 70s and therefore of the threat of "stagflation".

Christophe Morel

The current environment of soaring commodity prices, high inflation and major geopolitical uncertainties has very logically reminded analysts of the 70s and therefore of the threat of “stagflation”.  However, today’s environment does not precisely match the pattern of stagflation, which is defined by simultaneously high inflation, low growth and, especially, high unemployment. The tensions on the labour market in the developed countries contradict the scenario of stagflation. Instead of stagflation, the present “reconstruction” environment is even approaching a scenario closer to “reflation”.


The recent crises (trade disputes between the United States and China, Covid and the war in Ukraine) have awakened minds to two imperative implications for Europe – the need for investment to accelerate the environmental transition and the need to accelerate strategic independence (in the sectors of defence, the digital economy, health, energy and even food). For Europe, we estimate that these additional investment requirements will total about 3% of GDP over 10 years: 2% for the environmental transition, 0.5% for the digital economy, 0.4% for defence and 0.3% for energy security. Given that employment is “complementary” to investment, this means that in order to come out on top from these economic transitions, companies will need to develop their human capital. This period of boosting public and private investment can even raise the prospect that full employment might now be a possibility. This would invalidate the threat of stagflation.

Scarcity of labour on two fronts

Even beyond support for growth and employment, it is true that the current period, with its change of economic model, is inflationary. This is because the surge in investment in the developed economies is so strong that it has naturally come up against a shortage of resources, in physical capital, human capital and financial capital: the change of economic models requires raw material resources that do not exist in sufficient quantity. Businesses are also faced with a shortage of labour on two fronts. First, demographic constraints are reducing the “quantity” of available human capital. Second, the need for transition requires new skills, which do not yet exist. The economic policy responses to this two-fold labour scarcity will involve a combination of training and immigration.

Increasing the investment rate without any adjustment of consumption and therefore of savings will stress the financial market, and this pressure on financial resources will be reflected in an additional increase in real interest rates. A rise of 3% in the investment rate without any adjustment of savings would lead in the long term to a further increase in “balancing” interests rates, in the order of 250 basis points on the reference German Bund.

Paradigm shift in monetary policies

Finally, inflation will last and will persist beyond the drop in oil and gas prices that will come at some point. This change in the fundamental economic situation will lead to a paradigm shift in the thinking and actions of central banks. Although central banks cannot combat the inflation caused by rises in the prices of raw materials, they do have the mission to intervene if there is a risk of a price/wage spiral. For that reason, their eyes are obviously focused on the anticipations of inflation. However, aside from these anticipations, there is  a threshold level of inflation at which economic behaviour starts to change: households and businesses become more attentive to price changes and start adjusting more systematically, in particular via wage claims. We have evaluated this threshold at 8%, which means that, given the latest published inflation figures (+8.5% over one year in the United States and +8.9% in the Euro Zone), we have reached the tipping point.

This paradigm shift in monetary policy is reflected in three ways. First, the central banks can no longer maintain their “forward guidance”, i.e. provide information on their future monetary policy intentions with high visibility. They return to “data-dependent” mode, which increases uncertainty and therefore the volatility of yield curves. Second, capitalizing on the monetary experience of the 80s, central banks will not lower their key rates in the event of recession, in order to avoid re-boosting inflation anticipations, even if this will have a high short-time cost on growth. Finally, central bank “put” is no longer automatic in the event of a correction on the financial markets. The recent declarations of the heads of the central banks show that the improved financial conditions this summer were not seen as positive. In other words, central banks can even wish for an adjustment of the price of risky assets.

Consequently, the central banks will amplify their monetary tightening measures, both by hikes in their key rates, which are still underestimated by the markets, and by accelerating the shrinking of their balance sheets.

Recession on the horizon

This new situation profoundly modifies the methodology for drawing up an economic scenario. Until now, the customary procedure was to start with the macro-economic prospects and then to examine inflation and determine what it implied for monetary policy. Now, this sequence has to be revised: first, the horizon must be extended, by presenting the long-term growth prospects to determine what they mean for the inflation regime and the reaction of the central banks. From there, we can deduce the macro-economic prospects. From this point of view,, the developed economies are confronted by two adversities. First, the increase in commodity prices over the past few months will trigger a global industrial recession at the turn of the year. Second, the developed economies will have to digest the rise in increase rates and the withdrawal of liquidities, which will forcibly constitute a “test” for the real economy. Since the American economy has advanced the furthest along the path of monetary normalization, it will be the first to be affected.

Finally, for the next 18 months, the developed economies will be confronted by recession, which will give the impression of stagflation. However, the combination of investment programmes and recruitment needs enables us to predict that economies will emerge on the up from this period, with a desired and desirable normalization of interest rates.


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Edited by Groupama Asset Management – middle : 25 rue de la ville l’Evêque, 75008 Paris – Website: www.groupama-am.com

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