The spectre of "stagflation" threatens the world once again. This time, the risk is the direct consequence of political provocations and war.

Stagflation is a composite word implying inflation with stagnation. Stagnation refers to weak, "near zero" growth, inevitably worsening unemployment.

The term "stagflation" was supposedly first used in 1965 by Iain Macleod, then UK Conservative Party economic spokesperson. It caught on in the 1970s, when high inflation and unemployment ended an economic era dubbed the "Golden Age of capitalism" describing the post-World War 2 boom.

Normally, in a recession, the inflation rate—i.e., the overall rate at which prices increase—falls. As unemployment rises, wages come under pressure, consumers and businesses spend less, reducing demand for goods and services, slowing price rises. Similarly, when the economy booms, the labour market tightens, pushing up wages, in turn passed on to consumers via increasing prices. Thus, inflation rises and unemployment falls during a boom.

However, stagflation poses a dilemma for central banks. Normally, when economies stall, central banks try to stimulate growth by cutting interest rates, encouraging more borrowing, and thus spending. But that could also fuel further price rises and higher inflation. On the other hand, if they raise interest rates to check inflation, growth may slow even more, further worsening unemployment.

The growth of world trade after WW2 increased demand for the US dollar, the de facto world currency under the 1944 Bretton Woods (BW) international monetary agreement. During the 1960s, US economic growth was increasingly sustained by government military and social expenditure. Spending increased for both "defence", especially the Vietnam War, and President Lyndon B Johnson's social programmes.

As LBJ was reluctant to acknowledge the rising costs of the Vietnam War, it was difficult to raise taxes to pay for his "swords and ploughshares" spending. Instead, spending was financed by government debt, from selling US Treasury bonds. Thus, the world financed US government spending, including the war.

US monetary policy was obligingly expansionary. Unsurprisingly, inflation shot up from 1.1 percent during 1960-64 to 4.3 percent in 1965-70. Higher inflation also eroded US competitiveness, further worsening its balance of payments deficit,

and undermining US ability to honour its BW commitment to maintain full convertibility to gold at USD 35 per ounce. This obligation did not go unnoticed by foreign governments and currency speculators.

As inflation rose in the late 1960s, US dollars were increasingly converted to gold. In August 1971, US President Richard M Nixon ended the exchange of dollars for gold by foreign central banks, effectively violating its BW commitment. A last-ditch attempt to salvage the international monetary system—through the short-lived Smithsonian Agreement—failed soon after. By 1973, the post-WW2 BW international monetary arrangements were effectively done with.

Oil exporting, European and other countries which held reserves in US dollars suddenly found their assets worth much less. With Venezuela, the Middle East-led Organization of Petroleum Exporting Countries (OPEC) reacted by dropping their earlier willingness to keep oil prices low.

In October 1973, "nationalist" Saudi monarch Faisal embargoed oil exports to nations supporting Israel. The oil price almost quadrupled—from USD 3 to nearly USD 12 per barrel when the embargo ended in March 1974. This rise was paralleled by great increases in other commodity prices during 1973-74.

Commodity supply shocks and higher commodity prices increased production costs, consumer prices and unemployment. As rising consumer prices triggered demands for higher wages, these in turn increased consumer prices. Thus, wage-price spirals accelerated price increases and inflation.

The 1979 Iranian revolution triggered a second oil price shock. The resulting "great inflation" saw US prices rise over 14 percent in 1980. In the UK—then deemed the "sick man of Europe"—inflation averaged 12 percent a year during 1973-75, peaking at 24 percent in 1975.

In the 1960s, unemployment in the seven major industrial countries—Canada, France, West Germany, Italy, Japan, the UK and the US—rarely exceeded 3.25 percent. But by mid-1982, it rose to 8 percent, exacerbated by interest rate hikes, ostensibly to fight inflation.

In October 2021, the International Monetary Fund, the European Central Bank, the US Fed and other such institutions believed the factors driving inflation were transitory. None of these authorities saw an urgent need for interest rate hikes.

But in the last month, the war in Ukraine and sanctions against Russia have driven up the prices of commodities such as wheat and oil. This will exacerbate rising inflation in much of the developed world.

This time, 'stagflation' is the direct consequence of political choices, especially for war, not unavoidable economic trends. Developing countries are fast learning where they really stand in this unequal world of endless war, e.g., from the European treatment of Ukrainian refugees.

Peace is therefore imperative. The alternative is the barbarism of conflict among big powers in which most of us have no vested interests.

Copyright: Inter Press Service

Anis Chowdhury is adjunct professor at Western Sydney University and the University of New South Wales, Australia. 
Jomo Kwame Sundaram is a former economics professor and a former assistant secretary-general for economic development at the United Nations.