Is Europe headed for stagflation?

Last year, the term “stagflation” was jumped on by media outlets worldwide. Inflation expectations in most countries were on the rise, while at the same time, bottlenecks in supply chains and commodities were raising concerns about stagnation or very slow growth in national economies. The Russian invasion of Ukraine, which has been underway for a good two weeks, has made a Europe-wide stagflation even more likely.

Painful memories of the 1970s oil crisis

Inflationary tendencies are often associated with phases of economic boom – but in the case of stagflation, inflation and economic activity move in opposite directions. Of the numerous stagflationary phases economies have at times experienced – in the US alone, there have been 22 since 1960, according to the Digital Leaders Fund – the 1973 oil crisis is particularly memorable because of its long duration. Back then, the trigger of the ensuing global stagflation was also a war: the Yom Kippur War, followed by an oil embargo.

Fighting stagflation with economic and monetary policy measures is difficult

Even during the Coronavirus crisis, the ECB has thus far refrained from reacting to rising inflation in the Eurozone by raising key interest rates; the multi-billion bond-buying programme is to be scaled back. How these measures will affect the European economic activity remains to be seen. The war in Ukraine and the expected restrictions on raw material supplies could slow the economy to an extent that would make an end to the loose monetary policy extremely difficult to implement. The already announced key interest rate hike could therefore turn into a distant prospect. Thomas Fricke, economist and co-founder of the “Forum New Economy”, pointed out in a recent article that the US was able to move past the consequences of stagflation during the oil price crisis much faster than, for example, Germany. At the time, the US government invested heavily into stimulating the economy in addition to raising key interest rates to combat high inflation, thus successfully preventing mass unemployment and countering the dangers of the wage/price spiral.