Stagflation and the Direction of the Economy

History always repeats itself, but it is not always the same. The recent economic landscape has been marked by a decline in economic growth accompanied by high inflation, known as stagflation. We flashback to the 1970s, when global inflation reached its peak of 14.4 percent. It was called the hyperinflation era. The main cause of the high inflation in that era was the increase in world oil prices.

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The periodic report of the International Monetary Fund (IMF), World Economic Outlook, published in April 2022, shows a decline in the projection of the world economic growth in 2022 to 3.6 percent from 4.4 percent in January. Meanwhile, inflation is estimated to amount to 5.7 percent in developed countries and 8.7 percent in developing countries, or higher than previous estimates. The outbreak of the Russian-Ukrainian war has broad implications, such as increasing prices for oil, food and distribution costs.

Even in our economy, the long-term implications need to be anticipated.

Although stagflation is certain to occur, the determining factors and dynamics are different from those in the 1970s, so the mitigation cannot be the same. Just like the previous stagflation, the current situation has contributed to changes in the future of the economy. Even in our economy, the long-term implications need to be anticipated.

Short term impact

The Indonesian Statistics (BPS) reported economic growth of 5.01 percent on an annual basis in the first quarter of 2022, a decline of 0.9 percent compared with the growth in the previous quarter, which amounted to 5.02 percent.

If compared to growth in the first quarter of 2021, which was still contracting by 0.70 percent, it can be said that there has been an economic recovery. In comparison, economic growth in the first quarter of 2019 was 5.07 percent. The problem is that the situation this year is completely different from that before the pandemic. For this reason, there is no luxury to be satisfied with the economic performance of the first quarter of 2022. April's inflation of 0.95 percent has pushed annual inflation to 3.47 percent with food and beverage inflation already amounting to 5.2 percent. The inflationary pressure cannot be underestimated.

April's inflation rate of 8.3 percent in the United States, although down from 8.5 percent in March, is still the highest on record in decades. Inflation in April in the United Kingdom, which reached 9 percent, is the highest in 40 years. Meanwhile, in the same month, inflation in Russia accelerated to 17.83 percent and in Ukraine it reached 16.4 percent.

The war has shaken the energy and food commodity markets. Russia and Ukraine are the world's main producers of energy and food commodities. As a result of the war, transportation activities around the Black Sea have almost been stopped, likewise with the implications of sanctions imposed on Russia or its retaliatory actions. War is a catastrophe, not only in its humanitarian aspect, but also for the dynamics of the global economy.

The Economist magazine (edition 21/5/2022) published a main report entitled, “The Coming food catastrophe”.

War not only kills with weapons, but also with the famine it causes. Together with Ukraine, Russia accounts for 28 percent of the wheat supply in the world, 29 percent of barley, 15 percent of corn and 75 percent of sunflower oil. The war has brought their supplies to a halt. India, which was previously expected to become the world’s food buffer, was unable to do so due to crop failure.

Meanwhile, China is also affected by the lockdowns of its territory due to the number of new COVID-19 cases consistently increasing.

The situation is still exacerbated by the internal conditions of the main engines of global growth, namely the US, the European Union and China. The EU will feel the most impact with economic sanctions and Russian countermeasures. Meanwhile, China is also affected by the lockdowns of its territory due to the number of new COVID-19 cases consistently increasing.

In this uncertain situation, mitigation is needed to anticipate short- and long-term difficulties. The increase in energy and food commodity prices will put pressure on our state budget posture (APBN), where the allocation of subsidies will swell. Fortunately, revenues have also increased due to increasing commodity prices, particularly coal and palm oil as our main export commodities.

If the fiscal pressure is relatively under control, monetary policy faces a challenging situation. If global inflation continues to increase, there is no choice for most of the world's central banks but to immediately increase interest rates. There are not many policy options available for Bank Indonesia other than to increase the benchmark interest rate. If interest rates increase, economic growth will weaken.

Despite this, it is still estimated that the economy will grow moderately in 2022 and 2023. Even if inflation increases and growth slows, it is unlikely that we will experience severe symptoms of stagflation.

The challenge is how to take advantage of the moderation of economic growth to increase productivity. The fiscal role in supporting social welfare is actually needed on a more permanent basis so that it can better support the health and education sectors. The expectation is that the productivity level of the population will actually increase. This situation resembles the post-World War II conditions, when the presence of the state in the economy was so prominent. With improved governance, such a situation is an opportunity for developing countries like Indonesia to overcome the lag in human resources as compared with other (developed) countries.

Apart from repeating itself, history also teaches that every crisis brings about fundamental changes. History also teaches us that we tend not to learn from history. Economic moderation due to global stagflation must be used as a transformational tool to overcome our backwardness.

KOMPAS/HERU SRI KUMORO

Prasetyantoko

A PRASETYANTOKO is rector of Atma Jaya Catholic University

(This article was translated by Hendarsyah Tarmizi)