Stagflation: it’s all in the mix
Peter Warburton - 7 June 2017
The deteriorating performance of the UK economy, in terms of its real growth-inflation mix, is symptomatic of supply-side deficiencies and pinch-points. While real GDP growth still registers a respectable 2 per cent on an annual comparison, there are increasing doubts over its sustainability. A diet of near-zero policy interest rates and oodles of QE appears to have given us indigestion.
Popular definitions of stagflation – many dating back to the 1970s and 1980s – refer to the combination of high or rising inflation and a high rate of unemployment. As the most widely used measures of the unemployment rate in UK, US and elsewhere have recently returned to or extended beneath their 2007 lows, then stagflation would seem a million miles away. However, this narrow interpretation should be resisted on two counts.
First, a definition of stagflation that makes no reference to output growth is deficient. Weak or stagnant output growth may or may not be associated with an elevated unemployment rate: if measured productivity growth is low or negative, then sluggish GDP growth may manifest in the absence of real wage growth rather than a high unemployment rate.
Second, the rise of structural unemployment in the 1980s triggered numerous redefinitions of unemployment in a concerted effort to limit the degree of political embarrassment. Older unemployed workers were shuffled into retirement; the young unemployed were bribed to remain in education and training and many of the long-term unemployed were redefined as sick or incapacitated. By shifting the unemployed into other categories, and labelling their support as a pension or a sickness benefit, the unemployment count was managed down. The outcome is that henceforward millions of men and women were classified as inactive rather than unemployed and remain so today. Broad measures of unemployment come closer to capturing the reality of long-term, and especially male, joblessness.
An alternative definition of stagflation abstracts from the labour market altogether. Stagflation can be said to prevail when real GDP growth contributes less than one-third of nominal GDP growth, where that nominal growth rate is positive. In the best of all worlds, disinflationary growth, the real component is two-thirds or more of positive nominal growth. A real growth rate of between one-third and two-thirds of nominal growth is typical of a reflationary phase and any combination of growth and inflation within a negative nominal growth rate qualifies as deflation.
Taking 3-year averages to smooth out the erratic movements in the attribution of nominal growth to its real and inflationary parts, figure 1 shows the calculation for the UK over the past 60 years. The decomposition of GDP into household consumption and the residual is particularly instructive. The consumer boom of the middle years of the 1980s lifted the UK economy into reflationary territory, while the extended consumer boom of 1997-2007 propelled the UK into the dizzy realm of disinflationary growth – the so-called Great Moderation. The remainder of the economy fared distinctly worse and this pattern is repeating now. Stagflationary territory is close at hand.
Data source: Thomson Reuters Datastream
Share on LinkedIn: