Return of Stagflation Between Concerns and Hopes

Politics - November 26, 2023

Stagflation is a Term that has Begun to Appear More and More Frequently in European Union Economic Discussions in Recent Months.

This economic phenomenon, characterized by a combination of economic stagnation and inflation, represents a significant challenge for policymakers and economists. Stagflation is a situation in which an economy is simultaneously in a state of financial stagnation and high inflation. This means that economic output, measured by gross domestic product (GDP), is weak or even decreasing, while the prices of goods and services continue to rise. Stagflation is considered a particularly problematic situation because it challenges traditional economic theories. Under normal circumstances, inflation tends to decline when the economy slows, but in stagflation, the opposite occurs, and this combination of factors makes it difficult for policymakers to take effective economic measures to solve the problem.

The causes of stagflation can be complex and variable, but there are a few main reasons that can contribute to this economic situation. Some of the most common causes include the so-called “supply shock” which occurs when there is a sharp decrease in the supply of goods and services in the economy. This decrease in supply can be caused by unexpected events such as wars, energy crises, or natural disasters that interrupt production and cause supply shortages.

Rising prices of raw materials, such as oil, can fuel inflation, and when the cost of raw materials rises, businesses often raise the prices of their products to cover higher production costs. This can lead to a general increase in prices in the economy, contributing to inflation. Monetary policies, such as control of the money supply and interest rates, can influence inflation and economic growth and, if monetary policies are poorly managed, can contribute to stagflation as when, for example, monetary authorities maintain interest rates that are too low for too long, fuelling inflation even in a slow-growing economy.

Fiscal policies, such as government spending and taxes, can also influence economic growth and inflation, and raising taxes or reducing government spending at a time when the economy is already weak can worsen economic stagnation. In recent months, the European Union has begun to grapple with the problem of stagflation and for several reasons, this phenomenon is becoming a growing concern across the continent.

One of the main factors contributing to stagflation in the European Union has been the persistent global supply shock. The COVID-19 pandemic has disrupted global supply chains, causing delays in the production and procurement of goods, leading to supply shortages in several sectors, resulting in an inevitable increase in prices. The price of raw materials such as oil, which continues to rise as a result of changes in demand and geopolitical instability, has had a significant impact on inflation in the European Union. This sudden increase in prices fuelled inflation, putting pressure on consumers and businesses.

European monetary and fiscal policies have played a role in perpetuating stagflation. In fact, the European Central Bank (ECB) has maintained extremely low interest rates and implemented asset purchase policies to stimulate the economy during the pandemic. However, these policies contributed to inflation, as they increased the amount of money in circulation but, at the same time, some European nations implemented restrictive fiscal policies to control public debt, reducing public spending. These policies have enhanced economic stagnation, creating a vicious cycle with inflation.

The European Union also faces structural problems that have contributed to stagflation and include a rigid labour market, low productivity and excessive bureaucracy, which can hinder economic growth and adaptation to financial challenges. The European Community must seek to coordinate its economic policies at a regional level to address stagflation including greater coordination of fiscal and monetary policies among member countries. To address the new challenges linked to the stagnant economic situation, European policies could include the simplification of regulations, technological innovation and improvement of the labour market, with targeted fiscal policies to stimulate economic growth without further fuelling inflation. The ECB should adopt a more cautious monetary policy, and this could lead to a gradual increase in interest rates, as has already happened in recent months, and a review of asset purchase policies.

Alessandro Fiorentino