Central banks warn of the danger of stagflation but see a crisis like the one in the seventies as “unlikely”

With governments and economic institutions of all kinds striving to reduce inflation by any means possible, stagflation is no longer anathema.

After the alert issued by the World Bank only two weeks ago, this Sunday it is the Bank for International Settlements (BIS) that alerts to one of the most painful processes that an economy can face: a combination of rising prices and stagnation.

“There is a risk of stagflation: the persistent interruptions due to the pandemic, the war in Ukraine, the sharp increase in the price of raw materials and financial vulnerabilities cloud the outlook,” he emphasizes in his iconic annual report, which exudes a radical change in tone compared to the contained optimism of last summer.

The good news is that the coordinator of the central banks sees a crisis comparable to that of the seventies of the last century, when the rise in oil prices unleashed an inflationary spiral that lasted over time and ended up knocking down the economy: “It is unlikely, thanks to macroprudential frameworks, improvements in monetary policy and lower energy dependence.”

The bad news is that the challenges are so "overwhelming" that they force "to act promptly and decisively before inflation takes hold," in the words of the head of the Basel-based agency, Agustín Carstens.

“If it takes root,” warns the Mexican economist, “the costs of redirecting and controlling it would be higher.

The longer-term benefits of safeguarding stability for households and businesses outweigh any short-term costs.”

Just over a year ago, when prices timidly began to rise, the general slogan was clear: after years of lethargy, inflation, although surprising, would be transitory.

Today, that passing episode has become a different animal: even if, as everything seems to indicate, the nightmare scenario like that of the seventies ends up being avoided, the degree of uncertainty is enormous.

"The world economy is in danger of entering a new era of high inflation," exposes the entity based in Basel (Switzerland).

At this point, the priority is to prevent the vicious circle from feeding back: that increases in the cost of living do not give rise to disproportionate increases in margins and salaries —and that these are deferred over time— and vice versa: “The traffic light is in the red: wages are already on an upward trajectory in some countries, and claims for compensation for past losses, indexation [to the strong] and a return to centralized trading have begun to emerge.

Similarly, companies are finding it easy to raise prices,” says Carstens.

“The prospects are uncertain.

But it is likely that inflation will exceed the targets of most jurisdictions for some time.

To avoid the risk of regime change, central banks need to clearly communicate their ultimate goal:

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From the pandemic to the price crisis

After the global financial crisis, the biggest challenge for central banks —and, very particularly, for the ECB— has been to revive inflation and return it to the target range.

That has radically changed with the pandemic.

The biggest global recession in almost a century —in 2020, as a result of covid-19— gave way in 2021 to the highest growth in five decades.

And this, in turn, left the witness to a 2022 marked by the Russian invasion of Ukraine -which the BIS describes as the "most significant" geopolitical event since the fall of the

, 33 years ago- and prices that do not give truce: in three out of four countries analyzed by the BIS, the CPI rises at a rate greater than 5% per year.

To a large extent, this sudden rise responds to the brutal increase in the cost of raw materials due to the war.

But not only: both the health crisis and the Russian invasion of Ukraine have encouraged "new production models, a reorganization of global value chains" and even a certain trend towards "deglobalization".

All of them are inflationary forces in the medium and long term.

Fiscal deficits, especially significant in rich countries, also point in this direction.

"Inflation is back, not as a long-sought friend, but as a threatening enemy," point out the BIS technicians, who acknowledge that reality has pulverized all their forecasts, even the most pessimistic, with a "clearly contractionary" result. for the global economy.

"It's just a demonstration of how quickly the world can change: after many years trying to raise prices to the target, now they face the familiar and painful challenge of reducing it," outlines the head of economic and monetary analysis of the agency, Claudio Borio.

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Soft landing or hard landing, that is the question.

The first scenario would be, by far, the most desirable: inflationary pressures would "spontaneously" loosen, as the bottlenecks formed in various sectors in the exit from the pandemic are undone and the prices of raw materials —soared because of the war in the Ukraine—fall.

The need to raise interest rates and roll back debt purchases —in the countries or blocs where they are still under way— would be less.

And, therefore, the blow to the engine room of the real economy would be minor.

However, in this new ecosystem —unknown for several generations— there are also reasons to think of a “less benign” scenario, in which prices give no respite and force an even more forceful reaction from central banks.

"This could trigger a recession, an increase in financial stress and a stagflationary hard landing," the BIS technicians add.

Avoiding it, they settle, will not be easy: "It was complicated in the past and the current starting conditions make it a challenge".

There yes, the ghosts of the seventies would be lurking.