Stagflation
The unrelenting slowdown in the US economy is causing global growth to slow. The International Monetary Fund, in a recent announcement, has adjusted its global growth forecast down from 4.1% to 3.7% for 2008 and has indicated that there is now a 25% chance of a worldwide recession. The US Federal Reserve Chairman Ben Bernanke, speaking for the first time after the Bear Stearns bail out, acknowledged that the US may experience negative growth going forward. At the same time the world is grappling with increasingly pervasive inflation driven primarily by high food and energy costs. The global economy has not experienced such persistent inflation and weak growth since the 1970s. Are we seeing history repeat itself?
Slowing economic growth coupled with incessant inflation could cause an economy to slip into a phase of stagflation (an economic term for rising inflation coupled with stagnating economic growth). A slowing economy is associated with excess capacity, and usually falling prices. Central banks have traditionally combated a struggling economy by using an expansionary monetary or fiscal policy. The problem the US faces today is that they are reducing interest rates in order to keep the economy above water in the short term when inflation is already a problem. Loose monetary policy at this stage could exacerbate inflation further, and the US might exhaust ammunition to lower rates further (because they’re already so low) if the economy continues to slow.
The upside is that the US is still a long way from where it was in the 1970s. At that time, the US experienced double digit inflation rates reaching a record high of 12.3%. Currently US inflation at 4% seems tame relative to the past. At present oil prices are hovering around the $100 mark. The 70s also endured sky-high oil prices on the back of the 1973 oil crisis during which oil prices rocketed four-fold in the space of 5 months. While it may seem that the present is not as bad as the past, we cannot discount the fact that the US may be in the early stages of stagflation.
South African inflation has also continued to surprise on the upside and is currently close to breaching the 10% mark. Unlike the US, the South African Reserve Bank (SARB) has responded to increasing inflation by raising interest rates. Consumer demand, money supply and private sector credit extension have all slowed in response to increasing interest rates. But inflation in South Africa is not being stimulated by loose monetary policy, and, unlike in the US, the Reserve Bank has plenty of ammunition in reserve (in the form of cutting interest rates) to enable it to adopt an expansionary monetary policy should the economy slow precipitously. The dilemma faced by the SARB is that the factors driving inflation at the moment cannot be controlled by using macroeconomic tools.
South Africa is a small open economy and is still subject to the vagaries of global economies. Nevertheless, the aggressive response of the SARB so far has placed South Africa in a relatively strong position to stimulate growth going forward should news out of the US continue to disappoint.
