What is stagflation?

We ought to fear the "Spectre of stagflation", says the <em>FT</em>.

The Financial Times' lead story today highlights the "spectre of stagflation", the economic phenomenon where inflation spikes even as growth stays flat.

David Keohane and Claire Jones write:

Inflation expectations, as measured by the difference between nominal and inflation-linked bond yields, ticked up to near 3.3 per cent on Tuesday, levels not seen since September 2008.

Investor fears that the UK could be simultaneously hit by stagnant growth and high inflation, as experienced in the 1970s, were exacerbated by poor economic data pointing to the probability of another economic contraction in the first quarter of this year.

Stagflation—a portmanteau of "stagnation" and "inflation", if that's not clear—is one of the major fears in orthodox economics, because the two phenomena are usually viewed as a trade-off. Central bankers put up with higher inflation expectations to boost low growth, and vice versa; if growth is low and inflation high, those policy levers lose their effectiveness. Ultimately, the fear is that stagflation will be locked in in the long term.

The last serious stretch of stagflation was in the 1970s, and is largely credited with leading to the current inflation-averse international monetary regime. In Britain and the US, inflation expectations had ticked steadily upwards, thanks, in part, to the over-effectiveness of centralised bargaining over pay. The common story told is that, as unions began to demand above-inflation pay rises, they were granted frequently enough that the demands themselves increased the rate of inflation. The annual rate of change in RPI peaked in August 1975 at an astonishing 26.9 per cent.

This time round, inflation expectations are being raised by the actions of the Bank of England—albeit to nowhere near the same extent. Nonetheless, the Bank, having expressed a belief that inflation oughtn't come down until after the economy picks up, is responsible for the fact that expectations have hit the pre-crisis peak.

The fears of stagflation are currently just that—fear hasn't turned into reality yet—but, as with so many economic phenomena, it has a nasty tendency to become a self-fulfilling prophecy. Hopefully, the underlying pattern of growth will turn from stagnation eventually, before inflation expectations get calcified at 3+ per cent; but if it doesn't, and the Bank of England is forced to keep inflation high in the face of the continued corrugated economy, we could see the current situation become the new normal.

Inflation. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Why Angela Merkel's comments about the UK and US shouldn't be given too much weight

The Chancellor's comments are aimed at a domestic and European audience, and she won't be abandoning Anglo-German relationships just yet.

Angela Merkel’s latest remarks do not seem well-judged but should not be given undue significance. Speaking as part of a rally in Munich for her sister party, the CSU, the German Chancellor claimed “we Europeans must really take our own fate into our hands”.

The comments should be read in the context of September's German elections and Merkel’s determination to restrain the fortune of her main political rival, Martin Schulz – obviously a strong Europhile and a committed Trump critic. Sigmar Gabriel - previously seen as a candidate to lead the left-wing SPD - has for some time been pressing for Germany and Europe to have “enough self-confidence” to stand up to Trump. He called for a “self-confident position, not just on behalf of us Germans but all Europeans”. Merkel is in part responding to this pressure.

Her words were well received by her audience. The beer hall crowd erupted into sustained applause. But taking an implicit pop at Donald Trump is hardly likely to be a divisive tactic at such a gathering. Criticising the UK post-Brexit and the US under Trump is the sort of virtue signalling guaranteed to ensure a good clap.

It’s not clear that the comments represent that much of a new departure, as she herself has since claimed. She said something similar earlier this year. In January, after the publication of Donald Trump’s interview with The Times and Bild, she said that “we Europeans have our fate in our own hands”.

At one level what Merkel said is something of a truism: in two year’s time Britain will no longer be directly deciding the fate of the EU. In future no British Prime Minister will attend the European Council, and British MEPs will leave the Parliament at the next round of European elections in 2019. Yet Merkel’s words “we Europeans”, conflate Europe and the EU, something she has previously rejected. Back in July last year, at a joint press conference with Theresa May, she said: “the UK after all remains part of Europe, if not of the Union”.

At the same press conference, Merkel also confirmed that the EU and the UK would need to continue to work together. At that time she even used the first person plural to include Britain, saying “we have certain missions also to fulfil with the rest of the world” – there the ‘we’ meant Britain and the EU, now the 'we' excludes Britain.

Her comments surely also mark a frustration born of difficulties at the G7 summit over climate change, but Britain and Germany agreed at the meeting in Sicily on the Paris Accord. More broadly, the next few months will be crucial for determining the future relationship between Britain and the EU. There will be many difficult negotiations ahead.

Merkel is widely expected to remain the German Chancellor after this autumn’s election. As the single most powerful individual in the EU27, she is the most crucial person in determining future relations between the UK and the EU. Indeed, to some extent, it was her intransigence during Cameron’s ‘renegotiation’ which precipitated Brexit itself. She also needs to watch with care growing irritation across the EU at the (perceived) extent of German influence and control over the institutions and direction of the European project. Recent reports in the Frankfurter Allgemeine Zeitung which suggested a Merkel plan for Jens Weidmann of the Bundesbank to succeed Mario Draghi at the ECB have not gone down well across southern Europe. For those critics, the hands controlling the fate of Europe are Merkel’s.

Brexit remains a crucial challenge for the EU. How the issue is handled will shape the future of the Union. Many across Europe’s capitals are worried that Brussels risks driving Britain further away than Brexit will require; they are worried lest the Channel becomes metaphorically wider and Britain turns its back on the continent. On the UK side, Theresa May has accepted the EU, and particularly Merkel’s, insistence, that there can be no cherry picking, and therefore she has committed to leaving the single market as well as the EU. May has offered a “deep and special” partnership and a comprehensive free trading arrangement. Merkel should welcome Britain’s clarity. She must work with new French President Emmanuel Macron and others to lead the EU towards a new relationship with Britain – a close partnership which protects free trade, security and the other forms of cooperation which benefit all Europeans.

Henry Newman is the director of Open Europe. He tweets @henrynewman.

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