Is stagflation debt crisis the future?

The global economy is gradually falling into the bottomless pit of economic slowdown along with the threats of high inflation, which may lead to stagflation. But what is stagflation really? For the unbeknownst, stagflation refers to the situation of rising prices, a fall in the value of the currency, and no real economic growth in the country to increase the level of economic activities, i.e. no increase in job opportunities. The consequences of such a phenomenon might seem unrealistic, but the chances of it actually crippling the world economy is as real as it can get.

Image 1: A pictorial description of stagflation

Global inflation forecasts for the ongoing financial year 2022-23 have raised alarms and economic growth forecasts have undergone significant corrections over the last year (Refer Image 2). The economists are extremely fearful of the resemblance it bears with the horrifying economic slowdown of the 1970s. It also raises concerns about the risk of debt crises in emerging markets- a throwback to the early 1980s, when massive increases in policy interest rates were required to control inflation.

Image 2: Global economic inflation and growth forecasts for years 2022 and 2023

Reasons for Stagflation

Humanistic curiosity drives us to dig deep and ask questions regarding the reason for such a situation. Is it a demand-driven or supply-driven situation? Excessive aggregate demand growth due to loose monetary and fiscal policies by the governments and central banks to push the overall demand influx in the economy post-covid-19 pandemic proved to be fatal. The supply bottleneck due to covid-19, China’s Zero Covid Policy, the shortage of labor supply, and the lockdown of 2020, contributed to the supply side crashing down the economy. Some believe that it is a mix of both supply and demand factors that has led to this economic slowdown. However, in reality, it is the supply side that led to this downfall. All these factors of aggregate demand were actually to cope up with the economic slowdown created by the supply side during covid-19 but post covid-19 crisis, the supply bottlenecks continued to create a gap and widen the gap between the aggregate demand and aggregate supply. This led to an increase in economic prices and subsequent decrease in employment rates and this is why this inflation can be categorized as stagflationary.

The factors stated above make this situation very much similar to the situations of the 1980s. In a similar pattern, global inflation is expected to rise this financial year and drop to near about 3% in October 2023, which will still be one percentage point higher than the average inflation rate of 2019. The reasons that would contribute to this drop in the inflation rate will be a decrease in the rate of global economic growth rate, monetary policy rigidity, fiscal support being phased out, commodity prices stabilizing, and supply bottlenecks alleviating. All these suggest that in the mid-term, the inflation rate would remain well-balanced even if it ends up being on a high note in the short term.

As positive as it may sound to just have a short-term high level of inflation, it may not be the case. Even in the 1970s, economists expected only a short-term rise in inflation that would be at maximum phase out in the medium term. However, the economy experienced continuous above-target inflation and subsequent inflationary shocks. The same could be expected even this time when the scale of the economy is 10 times more than what it was back in 1970.

This has alarmed all the central banks to tighten monetary policy and rope the situation down to the target level of inflation and not face the similar situation of the 1970s. The developed nations have decided to have a 200-400 basis point increase in the monetary policy rates to keep the inflation rates in check. As per historical standards, many economists have praised this decision and called it a moderate increase in the rates.

Image 3: US Fed’s interest rate tightening cycles during inflationary phases

If inflation expectations drop, the interest rate hikes needed to return inflation to the expected rate could be much higher than those presently predicted by the financial system. In comparison, it took six years for global interest rates to double to 14% in the 1970s (1975-1981). Between 1979 and 1981, the US policy rate increased by nine percentage points to 19%. The Great Inflation was ended by concurrent policy raising rates around the world. They did, however, cause a global economic downturn in 1982 and a sequence of debt crises.

How is Stagflation and Debt crisis even on a same sentence?

As we have talked about the intentions of the central banks and the government to lower the level of inflation, these institutions tend to increase interest rates. This tradeoff of intentions to lower inflation and increase the interest rate might boil over to a debt crisis in the economy.

As the economies will start following the policy of hard landing to tackle the situation of inflation, the debts will rise, along with the increase in the inflation rate, and weakened financial positions of each economic unit would make the emerging markets and developing economies vulnerable. Lower real interest rates would lower the returns for these units, pushing them into further debt. Now, if we compare the situation with the case of the 1970s, stagflation overlapped with the global wave of debt accumulation aggravating the condition but at present, we do not have the presence of any such global wave of debt, However, we might have the spillover effect of the Covid-19 slowdown. The depth of the economic hit due to covid-19 is huge and is likely to affect every economic slump for the next decade.

As we talk about the past and try to predict the future, let us look at the trend of debt and interest rates with respect to emerging markets and developing economies. As we can see (Figure 4) there has been a rise in the total debt of the units from both sources, especially private sources since the 1970s. The increase in debt was even higher in the financial year 2020-2021 due to the adverse effects of Covid-19 and supply-chain blockage. These data are indicators of the US economy but similar trends hold true in other economies as well. The condition gets worse in third-world countries, where the low real interest rates and development of syndicate loan facilities pushed these units towards debt. The condition is worst in Latin America and sub-Saharan Africa.

In segment D of Figure 4, we can see the disparity between the nominal global interest rate and the real interest. In some instances, we can see that the real interest is even negative, making the debt-heavy countries and economies put through the worst.

Present Day Scenario

In the present day, such a situation where the developed countries would move toward hard handling of the high inflationary situation, the cost of borrowing will increase. This would again lead to worse conditions for Latin America and African countries which are heavily dependent on debt. Heavy interest payments on the external debt by the LAC will take a hard toll on their GDP and this will be accompanied with an economic slowdown. This would push them into a vicious circle of debt and eventually erupt into a global debt crisis. Approximately 60% of the world’s poorest countries are already in or are at high risk of debt distress.

Image 4: A pictorial comparative study on historic patterns of debt and interest rates

What can these economies do in such a challenging situation?

The hard handling of inflation by the super economies is fixed, as a result, other economies have to be prepared for it. This begins with careful adjustment, credible strategy formulation, and coherent policy communication.

Talking about preparedness, India being one of the fastest-growing economies in the world will also be subjected to this economic slump. While the RBI and Finance Minister refuse the fact that India would be under any economic slowdown or would face any stagflation being a cost-pull or demand-pull, the recent statistics give mixed signals. With the increase in the economic activities of the country, as other economies pull out of manufacturing units from China and see India as a prospective land for it, a positive ray of hope is seen. However, we operate in a global economy, where the effect of one factor spills over to all other economies. So, even if we say that the Indian Economy is robust enough to sustain the slump, its trade with other economies would affect its operation. Moreover, as suggested by the Economists, India would also follow the policy of hard-handling the situation rather than going for a soft one because supply-side stagflation is impossible with soft policies.

All this brings us to one question: what if the stagflation is long-term and hard handling won’t suffice for the solution? This would put the economies further in the debt crisis with no visible ray of hope but as we say “History repeats itself”. If this stagflation is a new picture of the same old scenario of 1970-80, then as history suggests- we will definitely bounce back.

-Prachi Shree
Junior Editor, TJEF


The Washington Consensus: Steps to build an economy?

Imagine being in charge of a country which has undergone a rapid change for the worse in terms of an economic standpoint. It is definitely difficult to get the country back on track. Because of the help of the IMF and the World Bank you can now start afresh. However, it is still confusing about what has to be done to build your economy from scratch. Thankfully there are a set of rules to help you in this endeavor in setting up a self-sufficient economy known as the Washington Consensus. So let us find out what it is and how it functions.

What is the Washington Consensus?

John Williamson, an economist, first used the term “Washington Consensus” in 1989. He was discussing a set of measures that had gained acceptance among Latin American politicians in reaction to the early to mid-1980s macroeconomic unrest and debt crisis. In order to aid in the recovery from the debt crisis, these measures were also supported by specialists in Washington’s international institutions, particularly the International Monetary Fund and the World Bank as well as the US Treasury.

A note of caution, these rules are only meant to be descriptive and not prescriptive, which means that these rules do not guarantee the economy to be a success. Definitely there will have to be some considerations taken in place depending on the scenario of the country and what can actually be done depending on the ability of the government.

Maintaining fiscal restraint, reallocating public spending priorities (from subsidies to health and education spending), reforming tax law, letting the market determine interest rates, upholding a competitive exchange rate, liberalising trade, allowing inward foreign investment, privatising state enterprises, removing barriers to entry and exit, and protecting property rights are among the main Washington Consensus policies. Williamson pointed out that these policies went against what was believed to be true in developing nations, many of which adopted state-dominated systems in the 1950s.

The 10 rules of the Washington Consensus

  • Reduce national budget deficits

Large budget deficits lead to high variable tax rates. To counteract this, it was suggested to observe fiscal discipline either by raising tax revenues or by reducing domestic spending to reduce the amount of spending done by the government.

  • Redirect spending from politically popular areas toward neglected fields with high economic returns

Some aspects of public spending, such as subsidies to state-owned businesses or for the purchase of food or fuel, caused economic distortions and favored wealthier urban people over the impoverished in rural areas. Reducing subsidies for politically connected economic sectors may cost some people money, but it frees up funds for expenditure on infrastructure, education, and fundamental social services.

  • Reform the tax system

Reforms should enlarge the tax base and eliminate the exclusions that exempt some people and organizations with political ties from paying taxes. Taxation that is more inclusive and straightforward can boost productivity, increase tax revenue, and lessen tax evasion.

  • Liberalize the financial sector with the goal of market-determined interest rates

Government interest rate regulations typically penalize savers, deter investment, and stifle financial progress; restricting credit typically encourages corruption and benefits political insiders. Market-based interest rates encourage saving and ensuring that banks or the financial sector, not politicians in the government, decide how much credit is given out.

  • Adopt a competitive single exchange rate

A competitive, market-driven exchange rate can encourage export-led economic growth and alleviate balance of payments issues; avoid inflated exchange rates that deter exports and cause currency rationing.

  • Reduce trade restrictions

Trade barriers that support particular interests should be eased generally. Tariffs are better to quotas and other arbitrary trade restrictions that stifle trade since they allow for progressive reduction, local enterprises to adapt, and produce money for the government as opposed to quota rents for special interests.

  • Abolish barriers to foreign direct investment

Foreign investment that is prohibited or restricted at home gives monopolies to native companies and lessens competition. A country can increase its capital, create jobs, and develop its workforce through foreign investment, but also increasing competition for native businesses. Domestic businesses that attract FDI can encourage intellectual property breakthroughs that advance development.

  • Privatize state-owned enterprises

State-owned businesses frequently operate inefficiently and rely on subsidies from the government, which increase countries’ fiscal deficits. While some unemployment may result from privatization, these changes are more likely to boost firm productivity and profitability.

  • Abolish policies that restrict competition

Removing regulations and obstacles that prevent new firms from entering the marketplace can stimulate competition, efficiency, and economic growth.

  • Provide secure, affordable property rights

Investment and individual liberty are encouraged by a legal system that awards and preserves property rights, including the rights of those who hold land without legal documentation and work undocumented jobs in the informal sector. Owners can obtain financing thanks to private assets, which grows the economy and the revenue base of the government.

Effects of the Washington Consensus

By the middle of the 1990s, the benefits had mainly fallen short of expectations, especially in Latin America, where reforms had been pursued with particular zeal. The Washington Consensus was expanded to prescribe a longer list of adjustments in response, which is evident in the increasing number of terms and conditions associated with IMF and World Bank loans.

However, sluggish development, recurrent fiscal crises, and widening inequality cast doubt on the success of the entire project, severely harming the Washington Consensus’ political reputation. A new wave of leftist governments appeared in Latin America in the 2000s, many of which ran on platforms promising to reverse these regulations.

Major Criticisms

  1. Free trade is not necessarily advantageous for emerging economies, according to some economists. To ensure long-term prosperity, several strategic and young industries must first be preserved. These businesses can also need protection from imports in the form of subsidies or taxes.
  2. Government assistance has allowed Chinese businesses to make significant investments in Asia, Latin America, and Africa’s developing nations. These businesses frequently make infrastructural investments, opening doors for long-term trade and growth.
  3. Privatization can boost output and raise the standard of the good or service. Privatization, however, frequently causes businesses to disregard specific low-income segments or the social demands of a rising economy.


There can never be a fixed set of rules that even by theory can help to build a self-sufficient economy, the short-term impacts of these rules did not help the targeted economies, however it helped them build a strong base on which these economies can stay stable and thus helped the long-term growth of these economies. Any sets of rules can only be descriptive and not prescriptive for an economy, as each economy in itself is unique and all require different solutions for them to get through their problems. Sure, these rules could be taken as an outline, but definitely not the guidebook to build an economy.

Abishek Jeremy Lobo

Editor, TJEF