An Ugly Word for an Ugly Situation

1970s-style stagflation is now playing on central bankers' minds

- By John Hawkins

'Stagflation' is an ugly word for an ugly situation-the unpleasant combination of economic stagnation and inflation.

The last time the world experienced it was the early 1970s when oil-exporting countries in the Middle East cut supplies to the United States and other supporters of Israel. The 'supply shock' of a four-fold increase in the cost of oil drove up many prices and dampened economic activity globally.

Stagflation was thought to have been left behind-but now there is a real risk of it coming back, according to the latest annual economic report of the Bank for International Settlements (BIS), which warns that "we may be reaching a tipping point, beyond which an inflationary psychology spreads and becomes entrenched."

By "inflationary psychology" the BIS means that expectations of higher prices lead consumers to spend now rather than later, on the assumption that waiting will cost more. This increases demand, pushing up prices; thus expectations of inflation become a self-fulfilling prophecy. The danger of stagflation comes from this inflationary cycle becoming so entrenched that attempts to curb it through higher interest rates push economies into recession.

What's driving inflation?

As well as its own expert staff, the BIS brings together expertise from its 63 member central banks, which includes the those from major economies such as the US Federal Reserve, the European Central Bank, and the Bank of England. The 3 African member banks are the central banks of Algeria, Morocco, and the South African Reserve Bank.