Global Economy Facing Threat Of Stagflation

Source : The Straits Times, Dec 18, 2007

Growth may slow to 4-year low and inflation could hit 10-year high

WASHINGTON - THE world economy is facing the risk of stagflation - the double whammy of suffering 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.

The worst United States housing slump in 16 years, coupled with a tightening of credit by banks, have brought the world's largest economy 'close to stall speed', according to former US 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,' says Morgan Stanley co-chief global economist Joachim Fels.

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 tenfold increase in oil prices drove both unemployment and inflation above 10 per cent.

Mr Feldstein, who heads the national bureau that serves as the arbiter of when US recessions begin and end, said the combination of a stalled economy and rising inflation could be seen as a form of stagflation.

'It depends on how you want to define it,' he said. 'If you say an inflation rate of 3.5 per cent and a recession is stagflation, then we could have stagflation.'

Mr David Hensley, director of global economic coordination at JPMorgan, sees global growth of 2.4 per cent this quarter and next, and inflation at 3.5 per cent.

That is 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.

Even so, no less an authority than Mr Greenspan himself expressed concerns.

Speaking on ABC's This Week programme aired last Sunday, he said a period of 'remarkable disinflation' is ending.

'We are beginning to get not stagflation, but the early symptoms of it,' he said.

The situation 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 bigger: 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 last month at the fastest pace in more than two years.

As of last Friday, investors put a 74 per cent probability on another quarter percentage-point cut in the Fed's benchmark overnight rate next month, down from 100 per cent the day before.

If the global economy faced only the risk of faster inflation, the policy prescription would be clear: higher interest rates.

Yet, with growth slowing in the US and Europe, central banks remain under pressure to cut rates

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