The 'Great Moderation' is over

LouisYap

Publish date: Wed, 03 Aug 2022, 10:08 AM

In the 1990s, the global economy ushered in The Great Moderation Era of high growth and low inflation. After the outbreak of the global financial crisis in 2008, the global economy entered a period of so-called secular stagnation by American economist Summers. Low inflation, low interest rates and high government debt. We once believed that the long-term stagnation of "three lows and one high" would continue for a long time.

However, in 2022, high inflation will arrive by surprise. In June 2022, the US consumer price index (CPI) grew by more than 9% year-on-year, and major European countries are also facing similar inflation levels. Since the current price level far exceeds the Fed's average inflation target of 2%, high inflation has forced the Fed to start a steep process of raising interest rates and shrinking its balance sheet. In March, May, June, and July 2022, the Fed raised interest rates by 25, 50, 75, and 75 basis points, respectively. The U.S. dollar index recently broke through 108. Recently, the euro, pound and yen had all fallen to fresh two-decade lows against the dollar.

The strong rise in US long-term interest rates and the US dollar index has and will continue to have the following three impacts: First, the global financial market has intensified volatility. Recently, the prices of risk assets represented by the U.S. stock market and commodities have fallen significantly; second, some emerging market countries with high domestic economic and financial vulnerabilities may experience debt and financial crises after experiencing large-scale capital outflows and depreciation of their currencies. . Recently, countries such as Pakistan, Sri Lanka, Lebanon, and Myanmar have experienced financial crises; third, the global economy may be dragged into recession. In fact, some recent U.S. macro data have already shown some signs of recession.

In the short term, after the outbreak of the COVID-19 pandemic, all major countries have adopted extremely loose fiscal and monetary policies to rescue the market, and the rescue resources of developed countries are mainly invested in the consumer side, such as direct distribution to low- and middle-income families. Subsidies, resulting in a pattern in which consumption recovers faster than production recovery, and this uneven recovery pattern pushes up inflation. The new crown epidemic has directly impacted global production networks and global supply chains. With critical supply chain nodes out of supply due to the crisis, and the sharp rise in global transportation costs, especially ocean shipping costs, there is a significant shortage of goods and imported inflation in the final consumer market. The Russian-Ukrainian conflict broke out in February 2022 and continues to this day. With Russia exporting almost all-important commodities and Ukraine being one of the world's leading exporters of agricultural products, the ongoing conflict between the two countries will naturally push up global commodity prices, represented by energy and food.

From a deeper perspective, the ebb of economic globalization means that the optimal allocation of various factors on a global scale will encounter more obstacles, and the cost of the global flow of factors and commodities will rise. The roles and relationships of countries within the global production network will be restructured. The degree of division of labor, whether between products or within products, may also vary. In other words, if the rapid progress of globalization has significantly lowered the production costs of various products, thus bringing about the era of high growth and low inflation, then the ebb of globalization will significantly increase the production costs of various products, thereby An era of stagflation with low growth and high inflation.

Louis Yap

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