Stagflation: a toxic cocktail

The pandemic and its impact were not limited to the purely health-related, which turns out to be the most tragic aspect of this episode, but also aimed directly at the heart of the nations’ economy through various transmission mechanisms that have been combined with factors additional measures that exacerbate its consequences and make it difficult to overcome.

Quarantines and mobility restrictions on the population reduced their income (consumption and savings capacity), as well as reduced the production of goods and services due to the temporary closure of processes considered not “of primary necessity.” Given the above, and as a palliative measure on the impact on people’s pockets and to partially appease social pressure, governments made use of bonuses and benefits aggressively, that is, to an important group of the population and not necessarily with the expected targeting as the damage spread throughout society. It should be considered that for this the governments used their own resources, debt, or in the case of Chile a combination of public resources and the AFP savers themselves, reducing their own savings for their pensions, thus creating a future problem, which could be the subject of another analysis. The injection of large amounts of money, in a short time, without adequate targeting, with a half-machine productive apparatus, generated an inflationary impact on most of the world’s economies through the exchange rate, greater demand and reduced supply.

Domino effect worldwide

If we add the drought affecting China and Taiwan, for example, with its effect on the production of computer micro chips (water intensive to purify the silicon), we have a domino effect on all mass consumer goods, from phones to automobiles, which have reduced their production with its consequent effect on prices worldwide. As if that were not enough, the complete closure of large cities/factories in China and the collapse of its ports meant an astronomical rise in the value of freight, delays in deliveries and shortages of products in various categories globally. Finally, we have the Russian – Ukrainian war, where key products such as the global supply of wheat (Ukraine is one of the main world producers) and Russian gas for an important part of Europe are affected, apart from the stability and pain of its own. What does a war mean? In this way, we have that, in addition to the effects of demand inflation derived from the measures to help people, other external elements beyond the control of the authorities were added, resulting in a supply shock that has enhanced the effects of a inflation at a global level with a significant loss of purchasing power of the population, aggravating the social effects in the countries.

A complex scene

In the scenario of inflation due to increased demand associated with fiscal aid, it is reasonable to confront it through a restrictive monetary policy through successive increases in the interest rate. However, and as we have already seen, the external supply shock not only deepens the fall in the level of consumption and savings, but has gone further with its own dynamics that have motivated successive rate increases, each time higher. , and that they have not been able to stop prices, but have ended up aggravating the situation and we arrive at the worst scenario of all, a drop in the level of product and inflation at the same time, what we call stagflation.

Precisely the danger of stagflation is the loss in the effectiveness of the monetary policy tool by the authority to maintain inflation within a target range, thus raising rates so aggressively to compensate for both the fundamentals demand and external, end up exacerbating the drop in product and the social effects; but they do not necessarily reduce inflation, perhaps producing more damage than the good that is sought to be achieved, with the aggravation of social and political aspects, already complex at a global and local level.