The ongoing Russian-Ukraine war and lockdowns in China in the face of interest rate hikes could renew supply chain woes and push the U.S. economy into stagflation in 2023.
Chamara Gunetileke, the senior director at Acuity Knowledge Partners, an analytics and business intelligence firm, warns that the threat of stagflation is real.
“We believe the probability of the U.S. slipping into stagflation remains moderately high,” he told International Business Times in an email. “On account of the recent supply-chain issues in China, tight commodity supplies due to the Russia-Ukraine conflict, healthy demand, and the ongoing rate-hike cycle.”
“Stagflation” is a term economists use to describe a situation of slowing economic growth and rising inflation and unemployment. Increasing raw materials and energy costs cause it. They force producers to scale back production, lay off workers, and hike prices.
It’s an ugly situation for both Main Street and Wall Street.
For Main Street, stagflation squeezes family budgets on both ends. On the income end, layoffs push people to the unemployment lines, collecting unemployment compensation checks, which are a fraction of what they used to earn at work.
On the cost-of-living front, price hikes mean fewer items in the family baskets.
For Wall Street, stagflation squeezes both the top and the bottom lines. On the top line, it drives revenues lower as consumers cut back on spending. On the bottom line, stagflation drives earnings lower, with the problem being more pronounced for firms that lack the pricing power to pass on the higher costs to consumers.
Sometimes stagflation is mild, as the supply side shocks to the economy are short-lived. Other times they are severe as supply-side shocks last for quite some time, as was the case in the mid-1970s and early 1980s.
That may be the case this time, should the Russian-Ukraine war shocks persist for much longer and the Fed continues to hike rates.
Gunetileke is particularly concerned about the industrial capacity constraints and logistical bottlenecks in China. They could reduce the supply of Chinese goods to the U.S. market and push up prices as holiday demand picks up.
“China is a major supplier to the U.S., accounting for around 17% of total U.S. imports, and higher import prices would drive up inflation in the broader U.S. economy,” he explained. “The pandemic accelerated the diversification of manufacturing capacity away from China; however, this is a long-drawn-out process, and the U.S. remains heavily dependent on Chinese goods for now, which means any supply-chain disruption in China creates shortages in the U.S., as well.”
Then there’s the continuation of the Russia-Ukraine war, aggravating the situation as the West tightens financial restrictions on Russia. They could keep up the pressure on commodity prices.
Stagflation could complicate monetary policy in 2023, as the Fed must deal with two problems simultaneously: higher inflation and higher unemployment.
“[The year] 2023 is likely to be a challenging year for the Fed in balancing inflation and economic growth, especially with steeper rate hikes already implemented this year,” said Gunetileke.