Global stagflation shocks and the revision of monetary policy: lessons from the crises of the 1970s and 2020s

Abstract

The article clarifies what lessons for monetary policy under conditions of stagflationary shocks can be drawn from the analysis of inflation drivers, the global environment and approaches to macroeconomic policy in the run-up to and during the oil shocks of the 1970s and the supply shocks of the 2020s, caused by the pandemic and by the global effects of the full-scale war of the Russian Federation against Ukraine. The following factors have been identified that worsen the situation compared to the crisis of the 1970s for the monetary policy: larger-scale geopolitical threats; a wider complex of supply shocks and accelerated restructuring of the energy supply system under the influence of growing geopolitical threats; much more complex global supply chains; the more differentiated nature of countries’ vulnerability to the current supply shocks, that creates new sources of external instability as a result of the growing gap between interest rates and changes in exchange rates; strengthening the global implications of US Fed policy under conditions of stronger global integration; significantly higher levels of private and public debt; intensification of political and economic confrontation between the largest economies of USA and China. It is shown that the more favorable conditions for monetary policy compared to the 1970s are the developed institutional mechanism of anti-inflationary monetary policy, smaller institutional opportunities for emerging a "wage-price" spiral; greater resilience of EMs to external shocks. In order to increase the resistance of national and global economies to stagflationary shocks we need following corrections in monetary policy: decisive anti-inflationary policy in the face of threat of pro-inflationary behavior of economic agents; coordinated optimization and ensuring trust in monetary and fiscal policy, shifting fiscal policy to overcoming aggregate supply constraints; loosening the assumption of absolute elasticity of aggregate supply in the world of globalization and technological progress; correction the methods of measuring economic slack and estimation of equilibrium interest rate; adaptation of strategy, communication and tools of monetary policy to conditions of radical uncertainty; expanding the concept of monetary policy independence in small open EMDEs by taking into account the disproportionately large losses of this group of countries from importing inflation and recession from leading developed economies.