IMF revises growth projection

The United States grew 12.5% year-on-year in the second quarter while the UK logged a significant 22.5% growth and the eurozone chalked up a 14.3% expansion.

AS Covid-19 movement restrictions start to ease worldwide, economies around the globe are clawing their way towards recovery. This is evident from the strong growth recorded during the second quarter of 2021.

The United States grew 12.5% year-on-year in the second quarter while the UK logged a significant 22.5% growth and the eurozone chalked up a 14.3% expansion.

China’s economy expanded by 7.9% in the second quarter, down from 18.3% in the first quarter. Initial views are that generally, the strong performance will extend to the third quarter. China had rebounded faster compared with others due to its zero-Covid policy. Meanwhile, Malaysia’s economy grew by 16.1% from a 0.5% contraction in the previous quarter.

Although the fast rebound can be attributed to the extreme low-base comparisons, the pace of vaccination rollouts, which had led to the easing of pandemic restrictions, also played a key role in driving the economy. Coupled with the pent-up demand drawn by the lockdowns, the global economy is well on its way to recovery.

However, the outbreak of the Delta variant has certainly dented the recovery prospects as some countries reimposed restrictions to rein in the virus. Also, there were concerns that the emergence of new variants could blunt the vaccination effects and therefore could derail growth. This is true not only in advanced economies but more so for low-income economies due to the divergence in vaccination access and distribution.

At the same time, supply chain bottlenecks pose another hurdle for the global economy. Pandemic outbreaks, coupled with weather disruptions, have resulted in shortages of critical input materials, dragging manufacturing activities in several countries. Combined with the demand and rebound in commodity prices, consumer price inflation has been surging on the back of the great mismatch of supply and demand.

Due to these factors, the International Monetary Fund (IMF). during its recent annual meeting. has revised its global growth for 2021 to 5.9%, slightly below its July forecast of 6% while keeping the 2022 forecast unchanged at 4.9%, indicating that short-term growth prospect is still tilted to the downside.

Possibility of stagflation?

In light of the surging inflation rate, slowing growth and IMF’s revision, there are mounting speculations and concerns that the US economy is showing signs of an imminent stagflation.

Stagflation occurs when an economy has persistently high inflation combined with stagnant growth. It is caused by cost-push inflation when some force or condition increases the cost of production. A sudden adverse shock on the supply side, such as an increase in oil prices, can increase the possibility of a stagflation.

Looking at the US economy, it is currently at a difficult position. Against the backdrop of surging inflationary pressures, there are mixed readings about the strength of both domestic demand and the conditions of the labour market. When the economy reopened, consumer demand fuelled the market but the supply side fell short and failed to cater the demand and economists widely agreed that a supply chain crunch is one of the factors.

The supply and demand mismatch has been driving up consumer and commodity prices. This has prompted some analysts to believe that inflation is much more persistent and sustainable than what they initially thought.

Recent data showed that inflation in the United States is still running red-hot. Headline inflation edged higher to 5.4% year on year in September from 5.3% in August, beating the market forecast of 5.3%. Excluding volatile prices of foods and energy, core inflation remained unchanged at 4% year on year.

Meanwhile, the unemployment rate is below 5% but labour shortages in some industries signalled a tightening labour market while the overall job growth was subdued. While we are seeing elevated consumer demand, business and consumer confidence has dampened, which could be a sign of moderating domestic demand.

Two spending bills before Congress – the US$1 trillion (RM4 trillion) bipartisan plan that has passed the Senate and the US$3.5 trillion (RM15 trillion) Biden’s Build Back Better Plan – are well-intentioned to lift long-term productivity. Yet, in the short-term, it would boost demand and put further upward pressure on inflation. This, along with rising inflation expectations, could spell stagflation.

If stagflation does materialise during the pandemic aftermath, the US economy may end up in a deep trough of a business cycle without any support to recover while having spillover effects on the global level. Investors will turn to safe-haven assets such as gold to safeguard their investments and move away from the more risky instruments such as Treasury bills and stocks which in turn will affect the financial market greatly.

Stagflation unlikely to happen

However, the possibility for a stagflation based on the current environment appears to be fairly low. There are a number of temporary factors behind the acceleration and recent gains in the Consumer Price Index or CPI are mostly concentrated in the more volatile components and are likely to be unsustainable. Much of the pressure, which stemmed from the cost side, can be attributed to the easing of restrictions and reopening of the economy.

Besides, the inflation rate that we are seeing is not near the highs of the 1970s and 1980s. As a comparison, the average inflation rate in 1980 was an eye-watering 13.5%.

Stagflation during the 1970s and 1980s was due to surging inflation as the result of the huge spending on the Vietnam War and the Great Society programme, which was a set of domestic measures to eliminate poverty and racial injustice. At the same time, the job market stiffened, wage growth accelerated, causing businesses to increase prices. It was further exacerbated by Arab oil impediments and spiking oil prices, and the Federal Reserve’s mishandling of the accelerating inflation.

Even though inflation could turn out to be more persistent and sustainable, we are sceptical that economic growth will be stagnant in the long-term and that much of the recent disappointing data pointed to being pandemic-related. Having resurfaced quickly from the 2020 downturn, the numbers could be pointing towards a healthy economic growth for the upcoming quarters.

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