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US faces risk of slipping into stagflation

Global growth this quarter and next may be slowest in four years: analysts

(WASHINGTON) The world economy is facing the risk of both recession and faster inflation.

Global growth this quarter and next may be the slowest in four years, while inflation might be the fastest in a decade, say economists at JPMorgan Chase & Co.

The worst US housing slump in 16 years, coupled with a tightening of credit by banks, has brought the world’s largest economy ‘close to stall speed’, according to former Federal Reserve Chairman Alan Greenspan. At the same time, rapid growth in China and other emerging markets is driving energy and food prices higher worldwide.

‘What lies ahead is a period of stagflation – slow or no growth combined with rising inflation – in the advanced economies,’ said Joachim Fels, co-chief global economist at Morgan Stanley in London.

Harvard University economist Martin Feldstein is among those who say it would be just a mild case of what the world endured in the 1970s and early 1980s, when a 10-fold increase in oil prices drove both unemployment and inflation above 10 per cent.

Still, it poses a dilemma for the Fed and other central banks as they struggle to decide which problem they should tackle first.

How they respond will go a long way in determining which danger proves to be the biggest: a slumping global economy or rising prices worldwide.

For now, traders in futures markets are betting the Fed will remain focused on supporting growth, even after the latest government inflation reading last week showed consumer prices rose in November at the fastest pace in more than two years.

As of Dec 14, investors put a 74 per cent probability on another quarter percentage-point cut in the Fed’s benchmark overnight rate in January, down from 100 per cent the day before.

‘Central banks don’t have as much flexibility as they’d like, with inflation rising and demand slowing,’ says David Hensley, director of global economic coordination at JP Morgan Chase in New York. His team sees global growth of 2.4 per cent this quarter and next and inflation at 3.5 per cent.

That’s a far cry from the bad old days more than a generation ago, when world growth slowed to just 0.7 per cent in 1982 while inflation ran at an annual rate of 13.7 per cent, according to data compiled by the International Monetary Fund.

‘The numbers now are very different than what they were then,’ Mr Feldstein said in a Dec 14 interview. ‘We are not back to the very high inflation rates we had in the late 1970s and early 1980s, fortunately.’

Speaking on ABC’s This Week programme aired yesterday, Mr Greenspan said a period of ‘remarkable disinflation’ is ending. ‘We are beginning to get not stagflation, but the early symptoms of it,’ he said.

‘This is a much tougher monetary-policy environment than anything I experienced,’ Mr Greenspan told the Wall Street Journal on Dec 14. Through the first 11 months of this year, consumer prices rose at an annual rate of 4.2 per cent. That’s up from 2.5 per cent for all of 2006 and, if maintained in December, would be the highest rate in 17 years.

‘The numbers are scary,’ says Stephen Cecchetti, former director of research at the New York Fed, who’s now professor of international economics at Brandeis University’s International Business School in Waltham, Massachusetts.

It isn’t just a US concern. Inflation in Europe last month rose at its fastest annual pace since May 2001, increasing by 3.1 per cent as food costs soared.

 

Source: Bloomberg (Business Times 18 Dec 07)

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