Dubravko Mihaljek, Chief Advisor at the Monetary and Economic Department of the Bank for International Settlements in Basel, presented the odds of 2023 becoming the year of stagflation. The presentation took place on 31 January 2023 at the Institute of Public Finance.


Before the war in Ukraine started, world economy analysts and central banks believed that the pandemic-induced inflation would be a passing trend and that it would quickly return to its lower rates dating back to the 2008-09 financial crisis. The medium-term macroeconomic scenario for the Eurozone estimated inflation rates to return to their lower values and highly expansive monetary policies to continue.


However, the war in Ukraine brought about a wave of inflation that the world economy and central banks had not seen since the 1970s. Prices of energy, raw materials, food and many intermediate goods skyrocketed. Bottlenecks in world supply chains and workforce shortages became an issue in many sectors of the economy. Prospects for economic growth were also reduced: the war delayed the recovery process of world economy, economic activity in China was slowed down due to strict pandemic measures, while major central banks started raising their interest rates. The prospect of stagflation – economic stagnation accompanied by high inflation – in early 2023 becomes a central short-term scenario for the world’s economy.


Since the beginning of the pandemic and the war in Ukraine, growth estimates have proven to be too pessimistic on several occasions, while inflation estimates, on the other hand, turned out to be too optimistic. The world’s economy has proven itself to be resistant to shocks in the supply of goods and services system, while monetary and fiscal authorities were hailed as innovative for stimulating demand and favourable financing terms while maintaining financial stability. A very favourable state of affairs at the labour market is also an unexpected development despite stricter monetary policies and milder growth.


Based on the experience of smaller and open economies – such as the Czech Republic, Chile, Iceland, Israel, Norway, New Zealand, Peru – further economic growth, workforce shortage and relatively high inflation rates in more restrictive monetary policy conditions is not an unlikely scenario. Faced with strong inflation pressures at the labour and real estate markets as well as growing life expenses, their central banks started raising interest rates much earlier than the main central banks started doing the same, emphasising that they would retain their restrictive policy until the inflation pressure is reduced.


The main inflation measure has been appeased in the meantime, but core inflation still exceeds planned inflation by a great measure. It is still not clear to what extent inflation trends are a reflection of short-term factors – such as time gaps in monetary transmissions or under-estimation of households’ purchasing power – as opposed to deeper changes to the structure of the labour market and total demand, which might also foster inflation in the medium-term. The estimation process is additionally complicated by the interplay of inflation, fiscal and monetary policies. Inflation substantially increases tax revenues, especially VAT revenues, and enables state budgets to easily service higher public debt costs and maintain transfers to households, e.g. subsidies for higher energy costs.


“In such a complex environment – complicated even further by the suspense of the war in Ukraine – it may take some additional time for inflation to settle down. Economic policy analyses might switch their focus to deeper changes to labour markets and the overall economic structure. Such changes and the corresponding analyses might lead to some fundamental settings of monetary policy based on the model of guided inflation being reassessed”, Dubravko Mihaljek concluded.