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29 September 2021

Are we heading for a new era of “stagflation”?

The economic outlook for the future is uniformly grim.

By James Meadway

“Stagflation”, an appropriately ugly word coined in the 1970s to describe the grisly combination of high inflation and low growth that afflicted that decade, is making a return to economic discussion. Nouriel Roubini, the “Doctor Doom” credited with predicting the 2008 financial crash, has suggested that the “mild stagflation” of earlier this year could be followed by a more serious recurrence in the future. As I’ve written in the New Statesman over the past 18 months, endemic Covid alone would be enough to drive up costs and therefore prices across the world. The economic outlook is uniformly grim – perhaps more so than even Roubini thinks.

First, while inflation is higher than it has been, and is likely to remain so, this is not the result of the extraordinary expansion of the money supply over the past year, as most “inflation hawks” have argued. Their theory seems simple – more money chasing the same goods makes prices go up – but in reality the volumes of Quantitative Easing (QE) cash that central banks such as the Bank of England have issued since early last year have made their way into different forms of hoarding, rather than spending.

The British government has spent, for example, extraordinary amounts on the furlough scheme and, in effect, paid for it with QE. But with households having saved an estimated £200bn since the start of the pandemic, that money is not entering the wider economy and so is having limited impact on prices. The injection of QE into the financial system has only caused prices to rise in specific markets – helping to support rising house prices in the UK and US stock markets.

The causes of the current general rise in prices are more serious, and harder to solve. The supply chain disruptions caused by Covid are obvious contributing factors, with the shock of lockdowns and factory closures last year still making their way through the system. But the ongoing, and perhaps permanent, impact of Covid as the virus becomes endemic – with people continuing to fall ill, being forced to self-isolate, and the extra costs and hassles of performing many economic activities – will result in significant costs across the economy.

We can put Covid in another context, too, as the first of the truly global disturbances that environmental collapse will bring. We have built an economic system that depends on ready access to cheap raw materials and a stable natural environment. Without these, the system begins to break down. As extreme weather events become more frequent, as epidemics break out more often, as crops fail, supply chains will falter and costs will rise inexorably. The current semiconductor shortage, for example, is driven not only by Covid but by fires in Texas and drought in Taiwan disrupting production.

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Finally, we are concentrating extraordinarily large investments in technologies and systems that do not produce growth as we usually measure it – as additions to Gross Domestic Product (GDP). Computers and data can do many wonderful things, but, as the Nobel Prize-winner Robert Solow pointed out more than 30 years ago, they do not add to productivity and therefore do not particularly contribute to growth. The “Solow Paradox” continues to be true, and is most likely getting worse, with bigger and bigger investments in digital technology producing poorer and poorer productivity performance in the aggregate.

Most solutions currently offered won’t work. The Bank of England Monetary Policy Committee (MPC) is reportedly considering an interest rate rise as soon as early next year. This won’t just force up the cost of borrowing and so squeeze what economic activity there is; in conditions where inflation is being driven by real – as opposed to monetary – factors, increases in interest rates seem likely to worsen the problem of rising prices. Primarily, it makes investment more expensive, exacerbating future supply issues. Better for the MPC, if it must do something, to begin unwinding QE.

But fiscal policy isn’t going to work either. The economy isn’t jammed because of too little demand; it is jammed because real life is jammed. The physical world we inhabit does, it turns out, have some limits. It is preferable for governments to spend more when it means the new costs we face can be fairly distributed – asking the wealthy to pay more, via taxes, for the increased costs of social care, for example. But deficit spending alone is not enough to deal with these structural problems.

Instead, three things need to happen. First, the pandemic has produced a shortage of labour (with Brexit playing its role in the UK). Workers should exploit this as much as possible, demanding inflation-busting pay rises and tilting the balance of power at work in their favour. This isn’t the 1970s: unions and labour have been weak for decades.

Second, just-in-time and market-oriented supply systems – such as the farcically short-termist UK gas supply system – should be ditched in favour of building resilient supply chains with significant redundancy. Allied to this, the tax system should be used to incentivise resilience – for instance, promoting domestic manufacturing – and to disincentivise those hoarding goods such as housing.

Third, we need to completely reconsider the role and purpose of the economy: turning policymaking away from the increasingly redundant measure of GDP, and redesigning our economies around things people really value: time with friends and families; green spaces. A society-wide cut in working time would be an excellent starting point.

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