Economic Research Department
No. 89 - February 25, 2008
2008: is stagflation back?
 2008: is stagflation back? The symptoms are
there in the combination of high commodity price
rises, high inflation and slower growth. Except that
appearances can be deceptive.
 It is a fact that the sharp rise in energy, food
and manufacturing commodity prices is an
inflationary shock. The inflation figures automatically bear its traces. Other potential sources of
inflation are also putting in a showing: a
depreciating exchange rate, and a rise in money
supply. Central banks are being vigilant mainly in
order to nail down inflationary expectations. A
latent anxiety about inflationary risk is perceptible
in what they say.
 Yet core inflation is still modest and signs of
second-round effects are marginal. Above all, the
ongoing and future growth slowdown should
dissipate any inflationary pressures, especially as
the current financial crisis is deflationary.
 Assuming the price of oil remains steady, we
are forecasting average annual inflation of 3.2% in
2008 in the United States (compared with 2.9% in
2007), slowing to 2.4% in 2009. In the eurozone,
inflation should come in at 2.4% in 2008
(compared with 2.1% in 2007) and edge back to
1.8% in 2009.
What is stagflation?
The spectre of stagflation is once more rearing its
head as the price of oil tops the 100 dollar per barrel
threshold and as unemployment is on the rise in the
United States. Referred to by Alan Greenspan on
16 December last, the fear of seeing a return of the
scourge of the 1970s spread rapidly. The word was
coined in 1965 by the future Chancellor of the UK
Exchequer, Iain Macleod, to refer to the
combination of rising inflation and recession, and
the concept perfectly describes the economic
climate of the 1970s.
At the time, the global economy suffered a doublewhammy. The first one – the oil shock – was a
supply-side shock as a result of OPEC's decision to
cut its output. In 1973, the price of oil went up
fourfold (see chart). Production costs in OECD
countries went through the roof, followed by
consumer prices. This triggered prices/wages spirals
and accelerated the spurt in inflation. In 1979,
Hélène BAUDCHON
Phone: +33 1 43 23 27 61
helene.baudchon@credit-agricole-sa.fr
OPEC's new restrictions again caused the oil price to
rise by a factor of 2.5 and triggered a further bout of
inflation.
USD/Barrel
Oil prices
100
2003-08: 3rd oil
shock
79: 2nd oil
shock
80
60
73: first oil
shock
40
20
0
60
65
70
75
80
85
90
95
00
05
in current USD
in 2005 USD (US GDP deflator, Q4 2005=1)
Source : OCDE, CASA
The second shock that confronted developed
countries was the decline of the Fordist model and
the sharp slowdown in productivity that had
underpinned growth in the three boom decades
following WWII.
A third element played an important role as well:
Central banks, which were less vigilant about
inflationary risk, and which miscalculated growth
potential, tried to stimulate growth through
expansionary monetary policies, which only fed into
further rises in inflation without having the desired
impact on growth.
Do the same shocks generate the same
effects?
Similar oil-price rises, higher producer prices, rising
inflation, slowing productivity gains and growth also
apply to the present. Should we be concerned that
the mechanisms that led to stagflation in the 1970s
could resurface? The answer is no, insofar as the
same shocks do not always produce the same
effects, and because the mechanisms at work in the
1970s are today inoperative.
The surge in commodity prices
Higher oil prices date back to 2002. At that time,
Brent cost 20 dollars a barrel, its average over the
1990s. Its price has therefore risen fivefold since
then. In constant dollars, it is back at the same level
as at the time of the second oil shock of 1979.
(Cont’d page 2)
Grégory CLAEYS
Phone: +33 1 57 72 03 29
gregory.claeys@credit-agricole-sa.fr
Internet: http://www.credit-agricole.com - Economic Research
Hélène BAUDCHON
Phone: +33 1 43 23 27 61
helene.baudchon@credit-agricole-sa.fr
Grégory CLAEYS
Phone: +33 1 57 72 03 29
gregory.claeys@credit-agricole-sa.fr
The label of third oil shock is therefore largely
deserved. The rise in nominal terms has been
providentially limited for those currencies that have
appreciated against the dollar but it is still
substantial: between January 2002 and February
2008, the multiplier is 3 when oil is priced in euros
and almost 4 when invoiced in Sterling.
has far less impact on inflation today than yesterday.1
Given the transmission lags, the risk of imported
inflation, while not zero, seems limited in the absence
of a buoyant economic environment, contrary to
2002-2004, a period of economic upswing.
yoy, %
Driven by similar strong demand, oil price rises
have coincided with a surge in commodity prices
across the board. Prices for farm commodities have
recently been the main focus of attention, spawning
the term "agflation". At 900 dollars an ounce, gold is
no exception to the trend. And it is especially in
demand as it is seen as a safe haven against inflation.
The inflation figures automatically bear traces of
these developments, and all countries are affected
by the shock. To give only a few statistics, in the
United States, inflation stood at 4.3% year-on-year in
January 2008, fuelled by its "energy" component,
which rose by 20.4% (and carries a 9% weighting in
the index) and by its "food" component, which was
up by 4.9% (for a 14% weighting). In the eurozone,
total inflation came in at 3.2%, and in France at
3.1%. In China, it is racing ahead at 7.1%.
On the other hand, until recently, no trace of the oil
shock was discernible in the growth figures. From
2004 to 2007, strong growth and rocketing oil
prices went hand-in-hand (see chart), as oil price
rises were in fact being driven by the very strength
of demand and not by any supply-side shock as in
previous oil shocks.
yoy, %
Oil shocks and global growth
USD/Barrel
80
7,0
70
6,0
60
5,0
50
40
4,0
30
3,0
20
2,0
10
1,0
0
72
75 78
81
84 87
90
93 96
Source: IMF, CASA
99
02 05
08
real GDP
average 1970-2000
in 2005 constant USD
The other inflationary shocks
Commodity price rises are not the only external
source of inflation. Countries whose currency is
depreciating are exposed to the risk of imported
inflation. The United States is one of them. Since
February 2002, the dollar has shed 22% of its value in
effective terms and the pace of depreciation speeded
up in the second half of 2007. However, signs of
imported inflation are so far hardly visible. Import and
consumer prices are rising for the same reason,
namely higher commodity prices. Excluding energy,
trends in consumer prices and imports are anything
but parallel and coincident (see chart). A falling dollar
No. 89 – February 25, 2008
US: import and consumer prices
3,0
yoy, %
4
2,8
3
2,6
2
2,4
1
2,2
0
2,0
-1
1,8
-2
1,6
-3
1,4
-4
core inflation
imports excl. oil (rhs)
1,2
1,0
2000
2001 2002
Source: BLS, CA.
2003
2004
2005
2006
2007
-5
-6
2008
The recent rise in the price of imports from China
has also helped to fuel concerns. It is a fact that
since early 2007, these prices have been rising,
reversing their virtually unbroken falls since
December 2003 (the first available comparison
point). Between then and January 2007, the
aggregate fall amounted to almost 3%, whereas in
January 2008, import prices were up 3.3% yoy. The
trend is not insignificant, especially as 16% of US
imports of manufactures are from China. While
these trends are certainly unfavourable in inflation
terms, they nevertheless form an integral part of the
process of reducing the US current account deficit.
To a lesser degree, we can discern similar concerns
at the “inflation targeting BoE”. With a drop of
9.4% in sterling's real effective exchange rate since
January 2007, the UK's central bank also worries
about imported inflation passing through into
consumer prices. If, for the time being, consumer
prices do not seem to have been affected by the
higher prices paid for imports, the recent explosion
in input prices (up 19.1% yoy in January) is partly
explained by the fall in the currency.
And finally, if the Fed has dropped all references to
money supply since the end of the "monetary
experiment" which it pursued from 1979 to 1982,
other central banks are concerned about the recent
sharp rise in money supply and its potential impact
on medium-term inflation. In accordance with the
second pilar of its monetary policy, the ECB in
particular repeats that an increase in M3 significantly
above its reference level of 4.5% (11.5% yoy in
December) could have a long-term impact on
inflation. Like the ECB, the most hawkish members of
the BoE's Monetary Policy Committee are also
worried about the persistently high growth rate of M4.
See, for example Marazzi et al, April 2005, "Exchange rate pass
through to US import prices: some new evidence", International
Finance Discussion Paper, No.833, Board of Governors.
1
2
Hélène BAUDCHON
Phone: +33 1 43 23 27 61
helene.baudchon@credit-agricole-sa.fr
Grégory CLAEYS
Phone: +33 1 57 72 03 29
gregory.claeys@credit-agricole-sa.fr
However, we need to put this risk into its proper
perspective, given the fact that the link between
money supply and inflation has been loosened so
much since the 1980s. As Fed Chairman Ben
Bernanke explains,2 the deregulation process and
the rapid pace of financial innovation have triggered
a break in the relationship linking money supply and
other macroeconomic variables. If the ECB is not
turning away from monetary analysis like the Fed, it
is increasingly forsaking purely monetary aggregates
to focus more on credit aggregates. In recent
months, their rate of increase has slowed, which is
reassuring in terms of inflation for the months ahead.
Should we be afraid of stagflation? No…
If we want to compare the stagflation of the 1970s
with the present day, we must first start by putting the
pace of inflation today into proper perspective with
that of back then. For example, compare the US figure
of 4.3% in January 2008 to the 14.6% of April 1980.
After reaching double-digit figures in the late 1970s,
inflation in OECD countries gradually declined,
stabilising at around 2% in the 1990s (see chart).
OECD inflation and its volatility
(5 year rolling volatilty)
60%
yoy %
18
16
14
50%
12
10
40%
30%
8
6
20%
4
2
10%
0
0%
75
80
85
90
95
Volatility
00
05
Inflation (rhs)
Source: OCDE, Datastream, CA
The "Great Moderation" effect
Two main reasons explain this evolution: new
monetary policies and a deeper globalization.
for commodities, the deflationary effects of their low
labour costs persist. By fanning the flames of
competition, they have encouraged a general trend
of falling prices in the tradable goods sector. With
the manufacturing platform having now largely
shifted to Asia, the power to set prices has also
shifted, delivering purchasing power gains for
households but reduced margins for European and
US businesses.3
Failing any challenge to the commitment of central
banks in their fight against inflation and the
globalisation of trade, their beneficial effects on
inflation should continue to operate in the years
ahead.
No discernible pass-through to core inflation
To date, the rise in commodity prices corresponds
simply to a deformation of relative prices. Unlike the
stagflationary episode of the 1970's, prices have
not risen across the board. The signs of passthrough to underlying inflation are still marginal.
The charts below speak for themselves: core
inflation has not gone off the rails like headline
inflation. And by the end of the year, while the risk
that it will be dragged upwards is not zero, it is
minimal. This is partly because the structural factors
responsible for the Great Moderation continue to
operate. It is also partly because slowing growth
exerts disinflationary, if not deflationary pressures.
Deflationary effects of slower growth
A property shock added itself to the oil shock as of
2006, combined with a financial crisis from 2007. It
is the combination of shocks that could put an end
to strong global growth and to US growth in
particular. From this point of view, and in our central
projection, the oil shock is a greater risk factor for
growth than for inflation. It is not as inflationary as the
oil shocks of the 1970s. It does, however, jeopardise
growth, by putting downward pressure on household
purchasing power at a (very) bad time.
Thanks to the deployment of nominal anchoring
policies from the 1980s onwards (control over
money supply by the Fed under Paul Volcker and at
the Bundesbank, inflation targeting in New Zealand,
Canada and then in the UK), the central banks
actively took part in the global disinflation
phenomenon, also known as the "Great
Moderation".
yoy, %
14
12
From the late 1990s, the trend was strengthened by
the globalisation of trade and the integration of
counties offering cheap labour into the
international trading environment. While emerging
countries are now being accused of fostering the
resurgence of inflation through their strong demand
2
Bernanke B. (2006) “Monetary Aggregates and Monetary Policy
at the Federal Reserve: A Historical Perspective”, at the Fourth
ECB Central Banking Conference, Frankfurt.
No. 89 – February 25, 2008
US: inflation (CPI)
16
headline
core
yoy, %
16
14
12
10
10
8
8
6
6
4
4
2
2
0
0
1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
grey areas: US recessions
Source: BLS, CA.
3
Kohn D. (2005) “Globalization, Inflation, and Monetary Policy”,
remarks at the James Wilson Lectures, The College of Wooster,
Wooster, Ohio.
3
Hélène BAUDCHON
Phone: +33 1 43 23 27 61
helene.baudchon@credit-agricole-sa.fr
yoy, %
Grégory CLAEYS
Phone: +33 1 57 72 03 29
gregory.claeys@credit-agricole-sa.fr
Eurozone : inflation (HICP)
3,5
3,0
ECB inflaiton target: close
but below 2 %
3,5
% points
2,0
3,0
1,5
2,5
2,5
2,0
2,0
1,5
1,5
1,0
headline
core
0,5
1,0
0,5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: Eurostat, CA.
What's more, this shock is going hand in hand with
a deflationary financial crisis. Deflation is already
visible in falling asset prices (securities and
property). There could also be a risk of debt-led
deflation. "When debt levels are high, a deflationary
period may be triggered, even if nominal incomes
continue to grow," as A. Brender and F. Pisani wrote
in 2003.4 This is because, if the debt service burden
becomes unbearable, households and businesses
alike cut back on their spending, which has an
adverse effect on GDP growth and hence on growth
in incomes, making the debt burden even greater. In
addition, the debt is secured by collateral. If the
collateral falls in value, as is the case right now, the
debt burden also grows heavier as a result. Borrower
solvency is eroded, and access to credit is cut off.
Living standards have to be reduced, which in turn
again impacts growth and asset prices. It is to
counter that kind of vicious circle that the Fed acted
so aggressively to cut rates.
In both the US and the eurozone, the outcome of
these shocks is sub-optimal growth in 2008 of
around 1.6-1.7% over the full year. In the US, the
economy is likely to hover on the brink of recession
in the first half, before being rescued by the fiscal
stimulus and the first effects if the Fed's rate cuts.
Europe will not escape the US slowdown, as the
transmission channels are commercial and financial.
The strong euro is also a hindrance to growth.
With growth rates at that level, any remaining
pressures on the labour market will dissipate, and
inflationary risk with them. The chart below
illustrates this clearly for the United States. In view
of this, we feel we are highly unlikely to see the start
of a prices-wages spiral. Wages are no longer
inflation-linked, and the link between wages and
inflation has loosened, Wage inflation is limited and
partly absorbed by productivity gains. In the US, the
rate of increase in nominal hourly wage rates is
already starting to slow. In Germany, the ongoing
wage negotiations are wrongly worrying people.
4
Brender A., Pisani F. (2003) "Risque de déflation par la dette en
Europe et aux Etats-Unis : quelques observations", Revue de
l’OFCE, July 2003, No.86.
No. 89 – February 25, 2008
US: Unemployment gap and inflation
unemployment gap
core inflation acceleration (rhs)
2,0
1,5
1,0
1,0
0,5
0,5
0,0
0,0
-0,5
-0,5
-1,0
-1,0
-1,5
-1,5
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
grey areas: US recessions;
Source: CBO, BEA, BLS, CA.
green area: forecast
For the eurozone as a whole, the distribution of
value-added is still skewed towards profits, which
restricts employee bargaining power despite the net
fall in the unemployment rate. In the United States,
the deformation of the distribution of value-added in
favour of wages has begun and could potentially be
inflationary. To sustain their profits, businesses can
pass on higher prices into retail prices, but the
competitive environment and fragile demand are not
conducive to such behaviour.
To trigger a prices-wages spiral there has to be a surge
in inflationary expectations. These are effectively
driven higher by oil-price increases, but not
abnormally so. At any rate, the Fed and the ECB are
keeping an eye on things. And so far, inflationary
expectations are felt to be well-anchored.
Our forecasts
Oil price stability at its present level is a strong
assumption in our growth and inflation scenario. We
are counting on slowing economic activity to curb
demand for consumer goods and for commodities.
On the basis of these assumptions, inflation could
slow rapidly from this summer in the United States,
in the eurozone and in the UK (see charts). In the
meantime, inflation is likely to remain above central
bank targets partly due to unfavourable base effects
linked to the fall in energy prices in early 2007 and
partly to ongoing increases in food and energy
prices. In the United States and the eurozone
inflation should nevertheless have peaked, while UK
inflation, currently still at 2.2% yoy, could move
toward
the
3%
threshold
this
summer.
Subsequently, for the reasons set out above, inflation
should everywhere ease back towards 2% in 2009.
Each central bank acts in accordance with its
"individual" balance of risks. In the United States,
the UK, Canada and (shortly) the eurozone, the
"growth" risk will predominate over the "inflation"
risk, hence the easing of monetary policies (more
or less aggressive according to the scale of the
risks). But what has been given can (and should) be
taken back as soon as possible so as not to stoke
inflation unnecessarily once more and to prevent
the formation of new bubbles.
4
Hélène BAUDCHON
Phone: +33 1 43 23 27 61
helene.baudchon@credit-agricole-sa.fr
Grégory CLAEYS
Phone: +33 1 57 72 03 29
gregory.claeys@credit-agricole-sa.fr
y y,
%
US: inflation (CPI)
yoy, %
5,0
yoy, %
5,0
3,5
4,5
4,5
3,0
4,0
4,0
3,5
3,5
3,0
3,0
2,5
2,5
2,0
2,0
1,5
1,5
1,0
1,0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
headline
core (rhs)
Source: BLS, CA.
UK: inflation (CPI)
2,5
2,0
1,5
Forecasts
1,0
0,5
03
04
05
06
07
08
09
Source: ONS, CA.
EMU: inflation (CPI)
yoy %
3,5
3,0
2,5
2,0
1,5
1,0
0,5
99
00
01
02
03
HCPI
04
05
06
07
08
09
Core Inflation
Source : Datastream, CA
Crédit Agricole S.A. — Economic Research Department
75710 PARIS Cedex 15 — Fax: +33 1 43 23 58 60
Chief Editor: Jean-Paul Betbèze
Sub-editor: Sophie Bigot
Contact: publication.eco@credit-agricole-sa.fr
Website: http://www.credit-agricole.com - Economic Research
This publication reflects the opinion of Crédit Agricole on the date of publication, unless otherwise specified (in the case of outside contributors).
Such opinion is subject to change without notice. This publication is provided for informational purposes only. The information and analyses
contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crédit Agricole and its affiliates shall not be
responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crédit Agricole does not
warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based, although such sources of
information are considered reliable. Crédit Agricole therefore shall not be responsible in any manner for direct, indirect, special or consequential
damages, however caused, arising from the disclosure or use of the information contained in this publication.
No. 89 – February 25, 2008
5