A global supply chain crisis can foster serious stagflation.Nuriel Rubini

How will the world economy and markets evolve next year? “There are four scenarios:Mild stagflationFor the past few months.

The recovery in the first half of 2021 was due to the impact of delta variants, supply bottlenecks in both commodity and labor markets, and shortages of some commodities, intermediate inputs, final goods, and labor. Bond yields have fallen in recent months, and recent stock market revisions have been modest so far, reflecting expectations that perhaps mild stagflation will be temporary.

The four scenarios depend on whether growth accelerates or slows, and whether inflation remains persistently high or slows. Wall Street analysts and most policy makers anticipate a stronger-growing “Goldilocks” scenario while mitigating inflation in line with the central bank’s 2% target. In this view, recent stagnant episodes are primarily caused by the effects of delta variants. When it disappears, so does the supply bottleneck, unless new toxic variants emerge. After that, growth will accelerate and inflation will fall.

For the market, this will represent the resumption of the “refre trade” outlook from the beginning of the year, when stronger growth was expected to support stronger earnings and higher stock prices. In this rosy scenario, inflation subsides, inflation expectations are fixed at around 2%, bond yields rise gradually with real interest rates, and central banks ease quantitative easing without shaking the stock and bond markets. I am in a position. In equities, there is a rotation from the US to foreign markets (Europe, Japan, emerging markets) and from growth, technology and defense equities to cyclic and value equities.

The second scenario involves “overheating”. Here, growth accelerates as supply bottlenecks disappear, but inflation remains stubbornly high as it turns out that the cause is not temporary. With unused savings and stagnant demand already high, continued ultra-loose monetary and fiscal policy will further boost aggregate demand. The resulting growth is associated with inflation above sustainable targets, denying the central bank’s belief that inflation is temporary.

The market reaction to such overheating will depend on how the central bank reacts. If policymakers lag behind the curve, the stock market may continue to rise for some time as real bond yields remain low. However, subsequent rises in inflation expectations will eventually push up nominal bond yields and even real bond yields as the inflation risk premium rises and stocks are forced to adjust. Alternatively, as central banks become hawkish and begin to fight inflation, real interest rates rise, bond yields rise, and again they are forced to make larger adjustments to equities.

The third scenario is ongoing stagflation, with high inflation and much slower growth in the medium term. Inflation will continue to be funded by loose monetary, credit and fiscal policies. Central banks that have fallen into debt traps due to high public and private debt ratios will have a hard time normalizing interest rates without causing a financial market crash.

In addition, hosts of medium-term, persistent negative supply shocks can curb growth over time, boost production costs and increase inflationary pressures.As i have I got it Previously, such shocks were the elimination of globalization and rising protection trade, global supply chain balkanization, aging demographics in developing and emerging economies, immigration restrictions, and Central American ” It could result from “decoupling,” the impact of climate change on commodity prices, and pandemics. , Cyber ​​warfare, and opposition to income and wealth inequality.

In this scenario, nominal bond yields will be much higher when inflation expectations are lifted. Real yields are also higher (even if the central bank is lagging behind the curve) as sharp and volatile price increases push up the risk premium on long-term bonds. Under these conditions, the stock market will be ready for a sharp correction (reflecting at least a 20% drop from the last high) in the territory of the potentially bearish market.

In the final scenario, growth slows. The weakening of aggregate demand turns out to be not only a temporary horror, but also a sign of new normality, especially if monetary and fiscal stimulus measures are withdrawn too soon. In this case, lower aggregate demand and slower growth will lead to lower inflation, equities will be modified to reflect weak growth prospects, and bond yields will fall further (because real yields and inflation expectations are lower). ).

Which of these four scenarios is most likely? Most market analysts and policy makers have pushed the Goldilocks scenario forward, but my concern is that the overheating scenario is more prominent. Given today’s loose financial, fiscal and credit policies, the decline of delta variants and associated supply bottlenecks overheat growth, leaving central banks trapped between rocks and difficult places. Faced with debt traps and persistently above-target inflation, even if fiscal policy remains too loose, it will almost certainly weaken and lag behind the curve.

However, in the medium term, various persistent negative supply shocks can hurt the global economy, which can have far worse consequences than mild stagflation and overheating. Full stagflation is accompanied by much lower growth and higher inflation. The temptation to lower the real value of large nominal fixed-rate debt ratios puts central banks in response to inflation, rather than fighting it, at the risk of economic and market collapse.

But today’s debt ratios (both private and public) are significantly higher than they were in the stagnant 1970s. As the inflation risk premium pushes up real interest rates, public and private agents with too much debt and much lower incomes face bankruptcy, Stagnation debt crisis What I warned.

The Pangrosian scenario currently priced in financial markets can end up being a dream come true. Economic observers need to remember Cassandra, whose warnings were ignored until it was too late, rather than sticking to Goldilocks.

Nuriel Rubini was a professor of economics at New York University’s Stern School of Business.He has worked for the IMF in the United States Federal Reserve And the World Bank.

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A global supply chain crisis can foster serious stagflation.Nuriel Rubini

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