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EXPLAINED: What Is Stagflation And Why Omicron Has Sparked Debate Over Economies Getting Stuck In A Rut

The decision by countries around the world to impose travel curbs and the looming fear of fresh outbreaks fuelled by the Omicron variant of the novel coronavirus has led to concerns that economies — especially the US, which is dealing with decades-high inflation rates — will be caught in a bout of stagflation, a situation where prices go up while the economy struggles to grow. But just like it’s still early days to conclude definitively that Omicron will take the world back to the worst days of the Covid crisis, the impact this variant has on economies cannot be predicted for certain. Here’s what you need to know.

Why Is There A Talk Of Stagflation Now?

Stagflation, that vexing doldrums economies dread falling into, is a portmanteau of ‘stagnation’ and ‘inflation’: a situation where the economy does not grow, but costs do. That is sort of counter-intuitive to how things are supposed to be. You see, it is when the economy is doing well and unemployment is low and businesses are growing that prices can normally be expected to go up, because people have spending power.

But a situation where there is no growth, yet prices are high points to a supply-side problem. A growth problem means that businesses are not producing enough as they are worried that there will not be enough buyers for their products. That prompts them to reduce hiring and conserve capital even as whatever little they produce sees high demand, which in turn fuels high prices.

Now, while Covid lockdowns and restrictions that have lasted for more than a year had brought major supply-side shocks and led to a cut down in production, the recovery — thanks in a big way to stimulus packages announced by governments across the world, especially in the developed world, and particularly by the US — has been quick to take hold. Faced with a flood of pent-up demand and the so-called ‘revenge spending’, businesses have struggled to fulfil orders and are out to step up on hiring.

Amid all this, the arrival of a novel coronavirus variant that experts are worried could be the most stubborn yet to have been encountered has led to fresh closures and travel bans. Experts fear that Omicron will take the world back to square one even as economies were taking fledgling steps to recovery. Fresh restrictions could again hit demand, forcing companies to again cut down on production and hiring, even as consumers flush with cash thanks to government aid face high prices. That would be the stagflation scenario that economic policy-makers have to navigate past, experts say.

How Did Markets React To Omicron?

Writing in Bloomberg, Mohamed El-Erian, the chief economic adviser at financial services firm Allianz SE, noted that the markets reacted sharply to Omicron and the restrictions imposed in its wake, with investors selling off risk assets while oil prices, too, saw a drop.

The Dow Jones Industrial Average briefly fell by more than 1,000 points while the S&P 500 index dropped 106.84 points, the benchmark Wall Street index marking its worst day since February. Al Jazeera noted that the slide was driven by banking, travel and energy company stocks “as investors tried to reposition to protect themselves financially from the new variant”.

Significantly, it added that the fresh restrictions prompted investors to make a beeline for stocks that had benefited from the stay-at-home scenario, like Zoom Communications or Peloton, the maker of home exercise equipment. Shares in both companies were said to have risen by about 6 per cent.

El-Erian said that “the markets’ sharp moves were consistent with a reduction in overall economic dynamism and a partial rotation back to at-home activities because of Covid-related disruptions”.

He told Fox News that the rapid spread of Omicron could worsen supply chain issues, further feeding into the record-high inflation the US economy is facing. “Those two things together: lower growth, high inflation are stagflation, and that’s what the market is worried about right now,” he said.

What’s Fuelled Inflation In US?

Earlier this month, the US saw its consumer price index zoom to 6.2 per cent over the year-ago period, its biggest jump since 1990. But while the chair of the country’s monetary policy regulator, the Federal Reserve, and White House officials said that the rise in prices would be “transitory”, experts have pointed out that inflation would continue to dog the economy in the immediate future.

The factors behind the inflation though have not been too tough to find. Even as the US lost 22 million jobs in the thick of the pandemic and saw economic output register a massive fall, a robust recovery took hold “fuelled by massive government spending and a bevy of emergency moves by the Fed”. Then, as vaccines took hold and cases declined, the lifting off restrictions brought a healthy flow of people back into shops and malls.

The sudden increase in demand saw companies struggle to cater to customers. The scramble for supplies led to a rise in freight charges and costs of procuring goods, something that they passed on to buyers. “A sizeable chunk of the inflation we’re seeing is the inevitable result of coming out of the pandemic,” Jason Furman, a Harvard Kennedy School economist and former adviser to ex-President Barack Obama, was quoted as telling news agency Associated Press (AP).

Government spending, including President Joe Biden’s USD 1.9 trillion coronavirus relief package, which put USD 1,400 payments into most households’ pockets in March this year, overstimulated the economy, he added. This inflation, experts have noted, is likely to last till supply-side issues are not met. El-Erian notes that “the drivers of high and persistent inflation continue to broaden, making further increases likely in the months ahead”.

So, Will The US See A Bout Of Stagflation?

El-Erian says that it “is too early to deem stagflation a baseline scenario” although the rise of Omicron is a worry given the impact it can have on industrial production. While other economists have acknowledged the concerns over the US experiencing a stagflation reminiscent of the 1970s, when rising oil prices coincided with high unemployment, it has been pointed out that the situation now is different.

For starters, the employment scene actually looks promising as businesses fall over each other to hire the workers willing to return to offices amid the continuing ‘Great Resignation’, which has seen millions voluntarily sign off from the jobs space. Further, as El-Erian himself notes, company and household balance sheets are in a strong position due to all the stimulus spending. AP cited a business research group as saying that more consumers were anticipating inflation than in over 10 years past, they didn’t “seem all that worried”.

“For the time being, at least, they feel that the benefits are outweighing the negatives,” was the comment on consumer outlook while another expert said “most economists are expecting growth to accelerate in the fourth quarter… so it doesn’t suggest that we’re facing both a tanking of growth and higher inflation”.

In fact, El-Erian said that the “top policy risk” would be a “continued misreading of inflation dynamics” by the Fed. Furman told AP that the US economic policy regulators “need to stop telling us that inflation is transitory, start becoming more worried about inflation, then act in a manner consistent with being worried”. Sign are that the Federal Reserve Board is already making moves in that direction with Powell having announced that it will start reducing the monthly bond purchases it began last year as an emergency measure to try to boost the economy.

Also, in September, Fed officials had “forecast that they would raise the Fed’s benchmark interest rate from its record low near zero by the end of 2022 — much earlier than they had predicted”.

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