When Nouriel Roubini, one of the world's most well-known economists, stated in August 2021 that the risk of stagflation was imminent and a serious threat, the conservative neoliberal orthodox economists undoubtedly did not take him seriously. The recent statements from the leading figures of the World Bank and the International Monetary Fund (IMF) show that the World Bank's relatively more Keynesian stance continues when it comes to the stagflation risk. However, a neoliberal orthodox understanding has been revived on the IMF front, showing that the organization, which followed more of a Keynesian approach during the long Dominique Strauss-Kahn then Christine Lagarde presidencies, is plotting its route using an approach focused purely on price stability.
The same is undoubtedly true for the U.S. Federal Reserve (Fed). In fact, global and leading economies are experiencing the heaviest cost inflation in the last 40-45 years. There has been a historical jump in input costs in all the most critical commodities and intermediate products in terms of agriculture and food, energy, metals and mines – the production wheels of the world economy. In the oil crises of the 1970s, the tightening of monetary policies did not work in slowing or breaking the inflation trend, which continued to rise in terms of cost inflation, dragging leading countries, particularly the U.S. and European countries, into stagflation. It is a case we can refer to in terms of economic literature as we find ourselves in the same situation, 45 years later.
Fed Chair Jerome Powell's statement is clear: "It seems that many things that cause inflation to rise are beyond the control of the Fed. External factors make it difficult for the Fed to control inflation." This is because the effectiveness of monetary policies in the fight against cost inflation is weak. Between 1970 and 1990, it was accepted in the economic literature that the solution to combating cost inflation was to directly control financial policies. Forty-five years later, intervening solely with monetary policies – while ignoring governments' fiscal and direct economic policy measures because neoliberal orthodox economists do not like them – is an invitation for stagflation once again.
Stagflation occurs when efforts are made to control the cost inflation-oriented issue of high inflation by only tightening monetary policies, suppressing the demand in the economy, household consumption and private sector investment expenditures while simultaneously aggravating the problem of severe economic recession and unemployment. Powell says that in the Fed economists' analyses of the American economy in terms of its growth trend and labor market, front-loaded interest rate increases – the highest since 1994 – and a decision to continue interest rate increases in the July meeting can both be tolerated. Market economists, as usual, are encouraging the Fed to raise interest rates quickly at the risk of a severe recession.
It is obvious that the U.S., as the country that prints the international reserve currency, the dollar, will not restrain itself from financing the record federal budget deficits, which will be caused by the heavy recession, by printing unbacked dollars. However, we will see whether it is possible to replicate the situation of the 1970s when such actions today could seriously endanger sustainable development goals, the green development revolution and the fight against climate change, which were not on the agenda at that point.
The World Bank recently published the Global Economic Outlook report. Just like the Organisation for Economic Co-operation and Development (OECD) and the IMF, the report emphasized that the heavy recession that will be caused by the policy measures of some central banks (which accelerated monetary tightening and/or put acceleration on their agenda due to the global inflation, together with the global inflation and unemployment problem that will continue to rise) will increase the risk of stagnation.
The "stagflation risk" pointed out by the World Bank in its report may also hinder the steps to be taken to stop climate change. While some of the world's leading central banks risk a heavy recession with their tightened monetary policies, focusing on rapidly pulling down inflation, at the same time, they also risk massive unemployment and disrupting investments that will protect the planet.