Global cooperation, skillful leadership needed to address stagflation

By Song Kyung-jin

Rising inflation and low growth are portents of stagflation, which the world previously experienced in the 1970s. Protracted "quantitative easing" since the 2008 global financial crisis, disruptions in global supply chains initiated by the COVID-19 pandemic and further exacerbated by the war in Ukraine, and record-high energy prices have all attributed to rising inflation around the world.

Whether or not the global economy is heading toward stagflation is not certain, but the possibility of it is growing. Mohamed El-Erian, an Egyptian-American economist, already warned that stagflation is "unavoidable" due to declining growth and rising inflation.

Yet there is little room for international policy coordination and cooperation as done immediately after the eruption of the global financial crisis in 2008. The U.S.-China competition and the war in Ukraine stand in the way of mustering the will for global collaboration, which is much needed at the moment.

Global "quantitative tightening" is aggressively underway to contain inflation. The Bank of Korea raised its policy rate from 0.5 percent in August of last year to 1.75 percent in May this year on the back of the highest inflation forecast in 11 years at 4.7 percent.

The U.S. Federal Reserve raised its policy rate 75 basis points to a range of 1.50 percent to 1.75 percent, the highest increase since 1994. At roughly the same policy rate in Korea and the United States, Korean capital markets are already sensing investor nervousness.

Another 50 or 75 basis point increase is expected at the next Federal Open Market Committee (FOMC) meeting. The Fed's policy rate is forecast to reach 3.4 percent by the end of 2022 and 3.8 percent by 2023. However, already higher than expected inflation (8.6 percent in May according to the U.S. Bureau of Labor Statistics) is likely pointing to a higher policy rate by the end of 2022. It will strengthen the U.S. dollar against emerging market currencies, thus pushing up inflation across emerging economies.

The Bank of England announced its plan to raise interest rates at all of its meetings this year, bringing its policy rate to 1.25 percent in June. The European Central Bank is expected to raise interest rates in July for the first time in 11 years.

At the same time, global economic institutions such as the World Bank and the Organization for Economic Cooperation and Development (OECD) have downgraded their annual growth forecast. The World Bank, for instance, cut its growth forecast for 2022 to 2.9 percent from January's 4.1 percent. My unwise bet is an additional cut or two in its growth forecast in the second half, hence a further cut in the growth forecast for 2023. The World Bank's World Economic Prospects released this month mentions "stagflation" several times therein.

Reducing inflation requires a set of counter-inflationary policies. Removing protectionist trade measures will help fight inflation. According to Gary Hufbauer et al. at the Peterson Institute for International Economics, eliminating the Trump-era tariffs on steel and aluminum and Chinese imports could reduce inflation by around 1.3 percentage points.

Growth-friendly regulatory reforms and tax reforms that are conducive to inducing innovation and competitiveness can help fight inflation and low growth. The Yoon administration's decision to install a regulatory reform strategy meeting is a welcome step in the right direction. The president himself should preside over each and every meeting to see that it serves its purpose and produces meaningful outcomes.

Unnecessary or excessive regulations with regards to startups for instance should be lifted or eased to boost the startup ecosystem, an integral part of the innovation ecosystem. Startups created 724,000 jobs in 2020, accounting for 22 percent of all jobs created that year. It is also in line with enhancing productivity together with education and labor reforms. Tax reform should include tax policy measures such as the Earned Income Tax Credit to protect the vulnerable and reduce inequality.

Counter-inflationary policies at the national level are limited in that high energy and food prices and disruptions in the supply chain are driving up inflationary pressures around the world. A global problem needs a global solution in a still much globalized world. The world at the moment is in an economic leadership deficit. The world needs more wise and skillful political leaders than populists.

Leaders must remember the lessons of the 1933 London Economic Conference that was convened to fight the Great Depression, reduce tariffs, revive international trade and stabilize currency exchange rates. The meeting failed due largely to the leaders of two countries, the U.S. and Germany, who were engrossed in domestic affairs and indifferent when it came to serving the global common interest. The failure prolonged the Great Depression.

Although weakened, the G20 is still the premier forum for international economic cooperation and is the right venue to find optimally coordinated and collaborative measures to fight the crisis. It is the forum that brings together the advanced economies and the emerging and developing economies that are more severely affected by the unfolding economic risks. Indonesia, which holds this year's G20 presidency, should quickly convene a virtual meeting of leaders. A failed G20 will only reinforce the arrival of economic crisis and stagflation.

Dr. Song Kyung-jin (kj_song@hotmail.com) led the Institute for Global Economics (IGE), based in Seoul, and served as a special adviser to the chairman of the Presidential Committee for the Seoul G20 Summit in the Office of the President. Now, she chairs the international cooperation committee called the Innovative Economy Forum.