IS THE WORLD ECONOMY RUNNING TO STAGFLATION OR RECESSİON?

Rıza Mehmet KORKMAZ
UGM General Manager

The world economy has recently faced stagflation, especially due to the Covid-19 pandemic and the subsequent effects of the Russia-Ukraine War. According to the World Bank's "Global Economic Expectations 2022 June Report"; Russia's war with Ukraine and the bottlenecks in global supply caused by this war, increasing food and energy prices with increasing demand, climate change and drought risk, combined with the damage caused by the Covid-19 epidemic, have led to a period of long-term weak growth and increasing inflation. It further fueled the possible slowdown in the global economy. This situation has also increased the risk of stagflation, which will have troublesome consequences especially for countries in the middle and low income group.

Markets predict that global inflation will peak by mid-2022 and then, although it may decrease slightly with the tightening of monetary policies, it will still remain high. On the other hand, global growth is also trending in the opposite direction; It has followed a sharp downward trend since the beginning of the year, and growth figures are expected to be below the average of the 2010s for the remainder of this next decade. Moreover, there is no glimmer of hope that the Russia-Ukraine War will end in the near future, and the concern that Russian natural gas will be cut off in retaliation in the winter of 2023 has deeply shaken European countries.

Although there is no risk of recession for Turkey in the short term under these conditions, it should be remembered that high inflation and the risk of contraction that may occur if the momentum in exports declines indicate the possibility of stagflation. It would not be a prophecy to say that the coming winter will be difficult for the world and our country's economy. Considering that the world may go into recession not slowly but very sharply and rapidly, it would be beneficial to take economic measures to increase the confidence of the market and not to compromise on financial discipline.

One of the most hotly debated topics in economic circles and even in daily conversations lately is undoubtedly the possibility of "stagflation or even recession in the world economy." So, is there really such a possibility? If so, how serious is it? How will our country be affected by this? While discussing the subject, it seems useful to first put the definitions in place.

WHAT IS STAGFLATION?

In its simplest form, stagflation is "an economic depression in which inflation and unemployment occur together and inflation occurs within a recession." Stagflation refers to "the economic situation that occurs when production in an economy decreases or at least does not increase, there is unusable production capacities, and in an environment where there is insufficient economic growth, widespread and continuous price increases, that is, inflation, occur at the same time." The person who first used this term in 1965 was not an economist, but Iain Macleod, a Conservative Party Member of Parliament in England.

1973-74 OIL CRISIS…

The word stagflation began to appear in our daily lives after the 1973-74 Oil Crisis. With the great increase in crude oil prices in the world, prices have increased in general and unemployment has occurred. Between 1973 and 1982, developed and developing countries felt the impact of stagflation. Although stagflation was observed in some countries from time to time in the following years, a widespread and long-term stagflation was not observed worldwide. [one]

MAIN REASONS OF STAGFLATION…

Theories that try to explain stagflation essentially emphasize that "high inflation, high unemployment and low growth must be seen together" to talk about stagflation and attribute its main reasons to the following factors:

-Goods and labor markets come into balance under different conditions,

- Mistakes made in anti-unemployment policies,

-High price policies of companies operating under incomplete competition conditions,

-Intensification of the struggle over income sharing in the economy,

-Disruption of labor peace, wages not being flexible downwards,

-Technological changes.

A CONTRADICTORY SITUATION ACCORDING TO THE KEYNESIAN APPROACH…

Stagflation also expresses a contradictory situation in Keynesian economics. Because the Keynesian approach is based on "models in which only one of unemployment or inflation will be experienced in an economy at a certain moment" and does not foresee "the situation of experiencing both economic problems at the same time". The high inflation and high employment experienced in the world economy after the Great World Economic Depression of 1929 and the Second World War also supported the Keynesian theory in the beginning. However, widespread unemployment accompanied by rapid price increases resulting from the 1973 Energy Crisis also shook economic theories. "Implementation of contractionary monetary and fiscal policies with traditional tools" to prevent inflation has further exacerbated unemployment. On the other hand, following expansionary policies to reduce unemployment further increased the inflation rate and a dilemma emerged; High inflation, shrinking growth and unemployment were observed together. In order to resolve this dilemma, it was necessary to "develop new approaches in economic theory and use other methods to solve new problems.

ACCORDING TO FRIEDMAN AND PHELOS…

According to the monetarist approach advocated by economists such as Milton Friedman and Edmund S. Phelos; If employees predict that inflation will rise in the coming period, the wages they currently receive do not motivate them to work, and they only wait for high-paying jobs to work. Because employees know that price increases reduce the real value of their monetary wages. As a result, price increases in the long run also cause unemployment to increase.

Another explanation for stagflation is based on Keynesian models and shows that the cause of stagflation is "the inelasticity of wages and prices downwards despite the demand and supply shocks affecting the economy." Due to changes in the composition of total demand, demand for goods in some sectors may increase, while demand for goods in others may decrease. In sectors with increasing demand, production also increases; However, lack of machinery, technical equipment or personnel may limit production increase. Therefore, the increase in demand in these sectors results in price and wage increases in the short term, as there is not enough production increase. In sectors where there is a decrease in demand, layoffs and production reductions occur instead of decreasing prices. Because even if employers' profits decrease, workers will not agree to work for lower wages. In this case, employers try to reduce their costs by parting ways with some of the workers. After all, when aggregate demand is constant but the demand composition changes; Prices in the economy are rising and the unemployment rate is increasing.

THE IMPACT OF THE COVID-19 PANDEMIC AND THE RUSSIAN-UKRAINE WAR…

IMF “WORLD ECONOMIC OUTLOOK JULY 2022 REPORT”…

In the IMF's "World Economic Outlook July 2022 Report" (Table 1); global growth will decrease from 6.1% in 2021 to 3.1% in 2022; This decrease will continue in 2023 and will be 2.9%; It is estimated that this decline will be more severe, especially in the USA and the Eurozone. The World Bank's growth forecast for 2022 is 2.9%.

EXPECTATION IN THE MARKETS…

WHAT CAN BE DONE TO FIGHT STAGFLATION?

One of the various policies proposed to combat stagflation, which has begun to affect the world, is expense policies. In this context, cost-reducing measures are recommended; Price and wage indicators are determined to reduce rising prices and wages, prices and wages can be frozen, and companies and unions come to an agreement on reasonable wage increases.

Another policy to combat stagflation is tax-based income policy. Workers and firms that accept lower wages and prices are subject to lower taxes; Those who do not accept are punished with high taxes.

Another solution is the indexing method. In this method, wage increases are indexed to the current inflation rate; if the actual inflation rate falls below the expected inflation rate in wage agreements; Since wage costs will have increased faster than the prices of goods and services, less labor will be employed. When wages are indexed according to current inflation rates; Since monetary wages automatically reflect the decrease in the inflation rate, there is no risk of unemployment.

Tax cuts and other production incentive measures are another method to increase employment, investment and total supply and prevent stagflation.

Although there are different solution proposals, everyone agrees that it is necessary to use both macroeconomic and microeconomic tools together to solve today's economic problems.

A SERIOUS RISK FOR DEVELOPING ECONOMIES…

In light of these developments, it should be reminded that; Sharp increases in production were needed to escape the stagflation of the 1970s. Increasing interest rates by central banks of developed countries in order to restrain inflation, which also triggers a global stagnation, carries the risk of triggering a financial crisis in developing economies (EMDEs). If existing stagflationary pressures intensify, developing economies will again face serious economic problems due to their increasing financial fragility and weakening growth. This situation makes it even more urgent for these countries to strengthen their financial structures and monetary policies, and makes it necessary to implement a series of reforms to stimulate growth. [2]

WHAT IS RECESSION?

Recession; It refers to "economic growth slowing down for a certain period of time, becoming negative, or turning into a contraction for a short period of time." Recession, which generally means stagnation, is also explained as "the presence of idle capacity in the economy or the economy growing at rates lower than long-term growth rates".

Main indicators of recession: Unemployment, contraction in demand and weakening of the investment tendency caused by the pause in production or the decrease in production. If the recession deepens and continues for a long time and delays economic recovery, it means depression in the economy

In order for technical indicators to indicate a recession, some critical thresholds must be exceeded. All macroeconomic indicators; Real income, employment, industrial production, retail and wholesale trade data are included in these measurements.

RECESSION TYPES…

According to these thresholds, while some economists accept "the contraction of the economy for two consecutive quarters, that is, three months or more" as a recession; According to some economists, the negative course of a country's Gross Domestic Product should be monitored in order to understand whether there is a recession or not. According to quarterly growth rate graphs, V, U, W (double dip) or L-shaped recession types can be seen. The most common recession type in Turkey between 1980-2015 is type V; In other words, the economy revives shortly after hitting bottom and begins to grow again. Although the Turkish economy experiences more frequent economic fluctuations, it recovers quickly with its economic rebound ability and begins to grow.

REASONS OF RECESSION…

The reasons why country economies enter recession are listed as follows:

-Economic growth falling below the population growth rate

-The national income per capita becomes declining or stagnant.

-Unemployment increase

-Stoppage or decline in economic activities

-Decline in production activities.

In order for the recession to end, the confidence of consumers and entrepreneurs must return to pre-crisis levels. During recessions, governments give priority to monetary and fiscal policies that will stimulate the economy and increase total demand.

The global recession was experienced in the crises of 1975 (-0.9%), 1982 (-1.4%), 1991 (-0.3%), 2009 (-2.8%) and 2020 (-4.4%). It is seen that it developed with the financial crisis in developing countries (Table 2).

(Table 2)

Now, again and again, with the high rates of increases in oil prices and the energy supply problem arising from the Russia-Ukraine War, a new energy crisis is on the doorstep; Voices have begun to rise that there will be stagflation or even recession in the world.

IS A GLOBAL RECESSION COMING?

The Russia-Ukraine War deeply shook the global economy in just 6 months. Table. As can be seen in Figure 3, purchasing indices are on a downward trend globally. On the other hand, the leading Global Services and Manufacturing PMI data for August 2022 announced by S&P Global indicate a serious slowdown, above expectations, and that the downward trend will continue, especially in Europe. Following the August 2022 PMI data announced, it is even stated by economic circles that the economic situation in Germany and Italy, the largest economies of the Euro Zone, is worse than the 2008 crisis, according to the criterion calculated by subtracting stocks from orders for the next period.

PMI DATA IN EUROPE AND THE USA…

The contraction of the manufacturing sector in European economies, including the UK, seems to have accelerated with the rise in energy prices. While the German Composite PMI fell from 48.1 in July to 47.6 in August, the lowest level of the last 26 months, as the gas crisis became acute; In the UK, manufacturing PMI data decreased from 52.1 in July to 46.0 in August; In the USA, the situation is not very different and the services PMI decreased from 47.4 to 44.1 and the manufacturing PMI decreased from 52.2 to 51.3; It is also seen that the Composite PMI in the Euro Zone decreased from 49.9 to 49.2. [3]

(Table 3)

When the global purchasing manager index (PMI) for production and new export orders are compared, it is seen that export orders are also on a downward trend in parallel with the decrease in PMI (Table 4). This situation also gives danger signals for our country's exports, considering that the euro/dollar parity has fallen below 1.

(Table 4)

When we examine Table 5; World economies experienced a significant contraction between December 2021 and June 2022 due to the Russia-Ukraine War; It can be seen that Turkey differs positively in this table and is among the countries with growing GDP. There is a shrinkage in Japan, China, South Korea, India, the USA, the United Kingdom, Canada, EU countries (except Denmark) and many other countries.

(Table 5)

HAS THE USA ENTERED A RECESSION? HOW WILL THE WORLD BE AFFECTED BY THIS?

When we examine the situation in terms of the US economy, where recession concerns are most voiced;

In the USA, many data other than unemployment (such as retail sales, industrial production, consumer confidence) showed a sharp decline; The inflation rate, which broke a 40-year record with 9.1% in June 2022, decreased to 8.5% as of July 2022; In the USA, where interest rates were reduced to support the economy hit by the pandemic in 2020, it was decided to increase interest rates at every US Federal Reserve (FED) meeting in 2022 in order to combat rising inflation, and the FED still increased interest rates to 2.5% and in the next two periods. There is an expectation of an increase of 75 basis points; Mortgage interest rates, which were 3.5-4% at the beginning of the year, are now at 5.5-6%[4]; Although the dollar index was already expected to strengthen, the rise occurred in a much shorter time than expected; It is seen that the EURUSD parity falling below 1 weakens the competitiveness of US products.

Growth forecasts for the US economy have been reduced from 2.5% to 1.3% for 2022 and 0.2% for 2023[5], while some more optimistic forecasts have reduced it to 1.4% for 2022 and 0.2% for 2022. was reduced to 1.3%; As can be seen in Table 6, the US economy, which contracted by 1.6% in the first quarter of 2022, contracted by 0.9% in the second quarter leading data; So we can say that the US economy has technically entered a recession.

(Table 6 - Source BEA)

However, some of the political and economic circles said; Although there was a contraction in the economy in the last two quarters, it argues that there is no recession in the USA due to the positive course in employment, personal income and consumer expenditures (Table 7).

(Table 7 – Source BEA)

WHAT DO ECONOMIC DATA AND INDICATORS SAY?

When economic data and indicators and economists' evaluations are examined; Inflation momentum maintains its continuity in the world, especially in the USA and the Euro Zone; However, a limited commodity price decline may be observed in July and August; A decrease is not expected in food and energy prices, which have increased with the ongoing Russia-Ukraine War; The mortgage crisis in China will have negative repercussions on the world economy; E-commerce, which previously provided serious price advantages, became widespread with the pandemic and 1 in every 5 dollars spent was subject to e-commerce, but it became increasingly expensive and pushed prices up[6]; Although it has been withdrawn somewhat recently, high logistics costs arising from increasing container and storage prices have also increased prices worldwide; In this respect, with these developments, the transition to stagflation may be shorter than expected in many countries, and the transition to recession is delayed from the end of next year to the beginning of next year; The recession in the USA will not be too big due to low unemployment and high savings rates; Since the FED expects a recession less, it will increase interest rates more fearlessly; Therefore, it is possible to evaluate that the rest of the world should be more careful.

WHAT IS THE SITUATION FOR Türkiye?

Keeping in mind that "crises will not come intermittently and slowly, but will definitely come hard and suddenly", the risks and opportunities in the current conjuncture for Turkey must be well identified and evaluated.

Economists,

“-The main agenda items in the Turkish economy are high inflation, high exchange rates, low interest rates, implemented monetary policies, macroprudential policies, wage increases, and slowdown in growth;

-EURTRY and USDTRY parities will negatively affect Turkey as an import-oriented country, and a decrease in EURUSD parity below 1 will have a negative impact on our exports;

-The contraction in the countries that are Turkey's main export markets (especially the Eurozone, the USA and the UK) will reduce the growth momentum in our exports, and in this respect, the alternative markets strategy should be implemented better;

-Due to the sanctions imposed after the Russia-Ukraine War, Russia may choose to procure many products from Turkey, and although this situation creates a good opportunity, embargo violations that may occur through origin deviation may create problems for our country in the future;

-Slowdown-Inflation-Stagflation-Recession-Disinflation chart remains valid for the world;

-The decrease in the volume of credit created in Turkey has reached critical levels; This decrease is on both the supply and demand sides;

-The recent failure of banks to provide loans has caused serious financial problems and made things difficult for foreign traders;

-The real sector stated that there was a decrease in Eximbank loan disbursements,

-New tax cuts and incentives can be expected soon;

-Turkey will enter the electoral arena in the near future, and this situation may bring about a break from fiscal discipline and populist policies;

-With the new asset peace regulation made with the temporary article 15 added to Law No. 5520 with the 50th article of the Omnibus Law No. 7417 dated July 1, 2022, the possible assets that will enter our country are important in terms of the financial resources to be created in the coming period,

-Consumer Confidence and Real Sector Confidence are still low; According to the economic orientation survey, PMI, sectoral confidence indices and other high frequency data, there is a slowdown in the Turkish economy as of August; Domestic and international orders are in a downward trend;

-Total orders registered in Turkey decreased; However, stocks have not decreased, the reduction in stocks is about to turn into a serious problem, and even if a decrease in stocks is observed, this decrease is not as severe as in orders;

-Our competitiveness within and outside the EU has decreased, and the reason for this cannot be clearly stated;

-There is no change in the inflation situation; The rise continues and the only positive news about inflation in the short term is the decline in commodity prices; The annual increase will continue, the reasons for this are wage increases, energy prices, exchange rate fluctuations and negative real interest rates;

-In the past, exchange rate and inflation did not move so closely and harmoniously with each other;

-There is a serious correlation between the increase in our foreign trade deficit and our energy deficit, and it is actually a positive situation that the correlation of other items with the foreign trade deficit is not as high as before;

-Turkey's foreign exchange supply has decreased recently while its current account deficit has increased, and the main factors here are monetary policy and the rising risk premium;

-The reserve loss is clear and the resource is balanced with net errors and omissions; There is a net error of 17.5 billion dollars in the first six months, and this amount may increase to 26 or 36 in the next 5 months,

-If the status quo continues, nothing should be expected from the current financing item, and if the current account deficit and the opening in the financial account continue, the stress will increase,

-We are entering a period in which companies will demand the most foreign currency for foreign debt repayments; There is a total of 182 billion USD of short-term external debt in Turkey, 85-87 billion USD of which belongs to the financial sector, and the foreign currency assets of banks are over 100 billion USD; 65-70 billion USD of debt belongs to the private sector, this debt does not pose a problem as long as business life continues to be vibrant, but the remaining 25-30 billion USD of debt should be monitored very carefully; It is very critical to know whether this situation will affect the risk of rollover; it should be remembered that rollover rates dropped to P in the 1994 and 2001 crises;

-Attention should be paid to the possibility of lowering Turkey's credit rating and preventing creditors from granting loans to Turkey due to their adherence to their statutes, which could also lead to a political crisis;

-He is of the opinion that "foreign exchange deposit accounts were tried to be kept, but these efforts were based on liraization and therefore could not show their full effectiveness."

NEXT WINTER WILL BE DIFFICULT FOR THE WORLD AND THE TURKISH ECONOMY…

As a result, although there is no risk of recession for Turkey in the short term under these conditions, it should be remembered that high inflation and the risk of contraction that may occur if the momentum in exports declines indicate the possibility of stagflation. It would not be a prophecy to say that the coming winter will be difficult for the world and our country's economy. Considering that the world may go into recession not slowly but very sharply and rapidly, it would be beneficial to take economic measures to increase the confidence of the market and not to compromise on financial discipline.

References

[1] Encyclopedic Dictionary of Economics and Business Life, Dünya Publications, page 390

2https://thedocs.worldbank.org/en/doc/18ad707266f7740bced755498ae0307a-0350012022/related/Global-Economic-Prospects-June-2022-Topical-Issue-1.pdf

3 https://www.pmi.spglobal.com/

4https://www.bankrate.com/mortgages/todays-rates/mortgage-rates-for-monday-august-22-2022/

5 https://www.conference-board.org/research/us-forecast, https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf

6 https://blog.adobe.com/en/publish/2021/09/15/adobe-digital-economy-index-ecommerce-hits-new-milestone-online-prices-continue-rise#gs.dut5ys

IS THE WORLD ECONOMY RUSHING INTO STAGFLATION OR RECESSION?

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