Stifling economic growth is the real danger, not stagflation
By Nigel Green, CEO & Founder of deVere Group
During a week of a raft of central bank meetings, stifling economic growth, not stagflation, is the true danger here, and this should be what the banks focus on.
Earlier this week, Dr Doom, AKA economist Nouriel Roubini, told Bloomberg that the European Central Bank (ECB) and Bank of England (BoE) need to continue hiking rates to stave off stagflation.
Last week the ECB hiked rates for the 10th consecutive time, to take the deposit rate to an all-time high of 4.00% from the low of -0.50% in just over a year.
The decision was announced a matter of days after it was reported the central bank would upwardly revise its inflation forecast for 2024.
Although the ECB upgraded its inflation outlook for next year to 3.2% from June’s 3.0% forecast, the Governing Council indicated an end to its most aggressive hiking cycle in history.
Elsewhere, the Bank of England is due to increase rates by another 25 basis points on Thursday, to take the cost of borrowing to 5.5%, the highest since 2008. Yet Rou bini said the BoE “should be hiking rates all the way to 5.75%. The signals are telling us they’re not sure whether they want to hike more,” yet without further rate increases, “there could be a de-anchoring of inflation and true stagflation,” he added.
To my mind, crushing global economic growth, which is already slowing down, via monetary policy will be far more damaging to an economy than stagflation in the short-term.
Naturally, neither extreme is ideal, but hampering longer-term economic growth is the principal threat, not short-term stagflation.
Furthermore, we should look at the warning signs of a likely impending recession in the US, in the form of the inverted Treasury yield curve.
The inverted yield curve in the US signals a recession is on the cards as it’s a sign of a tight credit market and weak economic growth.
This inverted yield curve has gone before the majority of US recessions since 1950, and, of course, the knock-on effect of a recession in the world’s largest economy would have a serious, far-reaching impact across the globe.
As it stands, traders forecast the Federal Reserve will keep rates on hold at Wednesday’s meeting, according to the CME FedWatch tool. However, Roubini said the Fed may still need to hike rates further, with the first cuts not happening until “maybe towards the middle of the year (2024). They can’t say they are done. Headline inflation is going higher, oil prices going higher, there is potential there will be another hike.”
Meanwhile, suppressing growth via the cost of capital becoming prohibitive for individuals and businesses leads to a drop in capital formation, a reduction in entrepreneurial activity and an economic development slowdown.
We would see a deceleration in innovation and development and a decline in overall investment. These effects impact the potential for future growth and weaken the competitiveness of an economy on the world stage.
In addition, stifling growth will inevitably result in job losses and a stagnant labour market. Insufficient job opportunities may lead to a rise in unemployment rates, lower consumer spending, and a drop in overall economic well-being.
What’s more, the impact of suppressing growth could also become evident through increased income inequality and decreased government revenue.
All sections of society typically benefit from enhanced prosperity stemming from economic growth, yet when this growth is quashed, income inequality tends to be exacerbated which could spark social unrest and decreased social cohesion.
Moreover, an economy in growth generates more tax revenue for governments, so they can fund essential services such as healthcare, education, and infrastructure development.
Although stagflation could result in a budget crunch, hindering growth can be even more damaging, possibly requiring austerity measures that impact households and public services.
Even if further rate hikes impede economic growth, the longer-term implications will be much worse than a short period of stagflation.