The threat of stagflation



Austerity policies can exacerbate stagnation. Demand-driven policies, in turn, may not have a significant effect on economic growth

Nouriel Roubini,[1] a well-known macroeconomic analyst who operates in the US, with reference to the rich countries, thinks that the threat of stagflation is proving to be more and more credible. The current economic policy, which combines monetary and credit expansion, as well as fiscal impulses, with a view to stimulating demand, with insufficient responses from supply, will produce, according to him, an increase in inflation. “Combined, such dynamics of supply and demand” – he says – “can generate stagflation, a general increase in prices and recession, in the style of what happened in the 1970s”. Even a severe debt crisis such as occurred in that decade could potentially occur. Here is how he characterizes the threat of stagflation:

While these persistent negative supply shocks threaten to dampen growth potential, continued loose monetary and fiscal policies could dampen inflationary expectations. A wage-price spiral may then ensue in an environment characterized by a recessionary trend worse than that of the 70s – when debt-to-GDP ratios were much lower than they are now.[2]

Jayati Ghosh,[3] a notorious analyst of the world economy, believes that stagflation is also a threat, but now for non-developed countries, whose markets are said to be emerging. Global interdependence has increased in recent decades to such an extent that these nations are at risk due to the consequences of macroeconomic policies implemented by rich countries. It is noted that many of these countries are suffering from price increases even when the levels of economic activity and employment remain low and even in decline. Here is how you characterize the risk that this situation could last:

Many emerging market countries are now facing a quadrupole attack: a persistent pandemic with an unclear end, internal and external constraints to expanding government spending, unintended impacts of fiscal and monetary policies in advanced countries, international trade patterns that create inflationary pressures in combination with restrictions to the expansion of exports.[4]

What lacks explanation in the two theses – which are probably correct – is the possible scarcity of supply in the medium and long term. Why might the supply of goods not expand sufficiently under the effects of rising aggregate demand?

It must be seen, first of all, that there may be episodic causes such as, for example, the coronavirus pandemic. As is known, the spread of this disease around the world prevented the continuity of certain economic activities, broke the supply chains of inputs, locked workers at home; in addition to putting a significant part of the workforce in poverty. But here we also need to investigate whether there is a structural cause that can prevent the expansion of supply even if aggregate demand is growing. Before providing an answer to this key question, it is necessary to show why contemporary economies suffer from a permanent inflationary bias.

Commodity price inflation as we know it today is a characteristic post-war phenomenon. And this can be verified in the following figure, which shows the secular evolution of the level of consumer prices, in the United States, between 1774 and 2011. There is a pattern that is valid for the economies of the world in general. It is quite evident that these prices began to grow continuously only after the abandonment of the gold standard in the 1930s and the end of the stagnation that only occurred with the outbreak of World War II.

Between 1946 and 1971, while the gold-dollar standard was in force, these prices began to rise almost continuously. It should also be noted that the growth rate of these prices suffers an upward inflection from the last one in 1971, when the pure dollar standard came into force, that is, when paper money ceased to be officially pegged to gold through a conversion rate fixed by the State. And this result has an explanation.

As the demand for money is endogenously determined in the mercantile circulation, the continuous growth of prices shows that the monetary system of countries in general sanctions almost without restriction this demand, which comes from the economic system itself. Now, these monetary systems are currently nucleated in central banks and commercial banks. It should be noted, then, that the increase in the demand for money comes from the increase in production and/or from the autonomous increases in the prices of commodities. And these autonomous increases basically come from decisions taken within the corporations that dominate the various markets.

Faced with a surge in demand, firms in an industry basically have two extreme alternatives: either increase production volume or raise prices. More often than not, they choose a combination of these two possibilities. Therefore, it is a matter of knowing why they, in certain circumstances, raise costs for consumers instead of providing them with more products.

Orthodox theory holds that this situation only occurs around full employment. Now this theory is usually fanciful. Behold, the almost full employment of the workforce – and even of production capacity – are incompatible with the inherent anarchy of the capitalist economy. If something occurs eventually, it cannot last. A central question then arises: “what is the limit to the growth of the potential supply of goods?” – a limit beyond which – or even slightly before it – the price level begins to rise with the expansion of aggregate demand.

Anwar Shaikh recalls in his magnum opus, Capitalism,[5] that the answer to this question had already been given in the XNUMXth century: “The classic answer”, he says, “which was developed by Marx and rediscovered by von Neumann, is that the maximum growth rate (…) is equal to the of profit”. In fact, the upper limit of the rate of accumulation – and, consequently, of the investment made in increasing production capacity – is not given by the real rate of profit, but by a rate lower than it, since part of the profit is intended for consumption roughly of capitalists and the State or even to the increase of idle capital. A new rate is then defined, now corrected by the rate of use of the growth potential. The maximum accumulation rate must therefore be equal to or less than this new rate. It is in this way that this rate somehow determines the maximum possible rate of growth of supply, that is, of GDP.

But, then, what determines the effective rate of accumulation in the contemporary capitalist economy? In this economy, note again, is currency wholly fiat, either in the form of base money or in the form of credit money created by commercial banks? Now, the growth of the product resulting from the accumulation of capital depends on future profitability. When the maximum possible accumulation rate is reached or even approached, demand impulses are transformed into price increases. And this is possible because contemporary competition is not competitive, but restricted by the dominance of large corporations and oligopolies. Firms' idle capacity may grow, but the prices of the goods they produce never fluctuate downwards – on the contrary, they tend to rise continuously.

Having said all this, it is possible to return now to the theme of stagflation that currently threatens both advanced economies and less or less developed economies. The next question to ask is how to find the expected rate of profit from new investments. This is the only way to affirm or deny the theses presented at the beginning of this note. Now, an assessment of the possible future profitability could only be made by the international agencies that deal with economic development, through a broad scope survey. However, it is customary to obtain guidance in this regard by consulting the performance of past profit rates in different countries around the world. Yeah, that's how you can think about the future by looking at the trends of the recent past.

Here, in the next figure, we present estimates (constructed by Michael Robert based on data from Penn World Table 10.0) of the evolution of average internal rates of return for the countries of the G-7, G-20 and emerging markets . And what they show is not a “smiling and hopeful” picture for the world ruled by capital accumulation. They suggest increasing difficulties in the coming years.

It should be noted, now, that these rates, which refer exclusively to the sectors producing goods, are gross, since, in their calculation, payments of financial debts and taxes were not excluded from the mass of profits. If it were possible to obtain the net profit rates, the equivalent graphs would be even more emphatic in presenting evidence that we want to emphasize here. Well, they show the same pattern of tendential decline in the rate of profit, a fact that now affects not one country or another, but the global economy as a whole.

It can be seen, then, that since 1997, approximately, the world economy entered a long depression. In fact, since then, it has been in a structural crisis that has not been resolved and that cannot be resolved since it is characterized by the existence of an overaccumulation of capital that, in the current stage of capitalism, cannot be reversed. Behold, the economic policies of capitalist governments no longer allow excess capital to be eliminated by the very logic of the crisis; therefore, this logic requires that there be a strong destruction and devaluation of the capital accumulated in the past so that the profit rate can recover. The crisis needed for this to happen would be devastating not only for national economic systems, but would have an equally intense impact on the imperialist order that prevails in the world today.

It is through this analysis that one arrives at the conclusion that the structural conditions for stagflation to occur in the core countries, now with their two nuclei – the Atlantic and the Asian – seem to be present. Certainly, they seem to be present in other peripheral countries as well.

The figure below gives an idea of ​​what is happening in the world. Inflation tended to accelerate across the board, although not to levels close to hyperinflation. But that is not the threat that hangs over the world's economies. The acceleration of inflation is generally related to the lack of supply. There are, as already mentioned, episodic factors brought about, for example, by the climatic emergency. However, there are also structural factors arising from the decay of the capitalist mode of production. Austerity policies can exacerbate stagnation. Demand-driven policies, in turn, may not have a significant effect on economic growth, resulting predominantly in further price increases.

Bear in mind, however, that the future can always present surprises.

* Eleutério FS Prado is a full and senior professor at the Department of Economics at USP. Author, among other books, of Complexity and praxis (Pleiad).


[1] He worked at the IMF and the US Federal Reserve. teacher of Stern School of Business from the University of New York. He is currently CEO of Roubini Macro Associates.

[2] Roubini, Nouriel. The real stagflation is real. Project syndicate, August 30, 2021.

[3]Jayati Ghosh is an Indian development economist. She is the President of the Center for Economic Studies and Planning at Jawaharlal Nehru University, New Dély. Professor at the University of Massachusetts, Amherst.

[4] Ghosh, Jayati. Specter of stagflation hangs over emerging markets. Foreign Policy, August 5, 1921.

[5] Shaikh, Anwar Shaikh. Capitalism– competition, conflict, crisis... New York: Oxford University Press, 2016.

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