Mea Culpa and I Told You So


Did this typical economist title grab your attention? Allow me to explain. We economists like to highlight every occasion when we are right. I guess this is one of those moments. At the end of February, just after the start of the war in Ukraine I stated that inflation in the west could see double digits. My reasoning was quite down to earth – it usually is: the war in Ukraine is a negative to the already strained global supply chain and this will affect price developments. This seems to be playing out currently. According to the initial estimates, inflation in the Netherlands jumped to almost 12% in March, a level not seen since 1975!


Inflation in the eurozone (7.5%) and the US (8.5%) is far from reaching these figures and I am not 100% sure that it could go to double digit. Because of the ongoing supply chain disruptions, the problems China is still experiencing with Covid-19 and the fallout in several hard and soft commodities because of the war in Ukraine, I am also not 100% sure that they will not go to double digit. An optimist will emphasize that the glass is half full, while the pessimist will emphasize that the glass is half empty. When I argue that inflation will surely see a further uptick from current levels what am I arguing: the glass is half full or half empty?


So far for being a narcist! A way more important characteristic of an economist, at least according to me, should be honesty telling his audience that he was wrong. Even though I started arguing at the end of February that the war in Ukraine could lead to a significant further uptick in inflation, I did not think that this could lead to a rate hike by the ECB. My reasoning was, once again, quite down to earth: the war in Ukraine will lead to a significant loss of momentum here in Europe and the ECB would not want to be seen as the institution that pushed the economy into a stagflation. Given all that is priced in by the market and the consensus expectation, I am getting the feeling that I looked at this issue way to mechanically. In short, I am most willing to say Mea culpa here.


I am one of the economists who started talking about stagflation right after the war in Ukraine started, but without defining what I exactly mean by stagflation. After all, there is not a uniform definition of stagflation as is the case with recession.


The so-called misery index is often used to measure the degree of distress in an economy by looking at unemployment and inflation developments. In this way the index helps to determine how an average citizen is doing. The index assumes that both an increasing unemployment and inflation creates distress in a society.  In this way a significant increase in the index can be seen as a proxy for stagflation. The current levels of the misery index in both the eurozone and the US are roughly comparable with levels seen during previous crisis periods (admittedly depending a bit on which index you use). But there are significant differences between the current pandemic crisis and previous crises.


During the global financial crisis inflation was not really an issue in the eurozone and the US, while unemployment had increased visibly. Europe of course also had to deal with the sovereign debt crisis. In both economic blocs inflation even dipped below zero percent in 2009. Roughly the opposite is the case today: in both regions unemployment is low or declining, while inflation has increased very sharply. I know it is a value judgement, but, while inflation is surely hurting, I am willing to think that unemployment creates far greater distress with households. The eurozone unemployment falling to a record low of 6.8% in February means that people who find a job see a boost in their nominal income, which is a positive in the current environment as it somewhat dampens the negative effect of inflation. In this respect the current increase in the misery index has a totally different connotation than the high levels seen during the previous crisis.


So, if the current development in the misery index is so different compared to previous episodes, making a direct comparison and interpretation difficult, could this also hold for other developments in the economy? I tend to think yes, especially regarding sectors such as the labor market that got derailed during the pandemic. I do realize that on both side of the Atlantic the dynamics were quite different.


This derailing had of course a very special reason: we globally paused the economies to fight off the virus. In business cycle analyses the labor market is considered a lagging indicator in the sense that it “…changes sometime after the economic, financial, or business variable with which it is correlated changes”, according to site I would argue though that during the pandemic it actually preceded the other developments because of this abrupt pausing. I believe that this change in the sequencing of economic developments still greatly influences the underlying economic dynamics one way or the other. For example, in the Netherlands according to recent research by the Chamber of Commerce about 200,000 entrepreneurs are on the verge of failing through bankruptcy or voluntary business termination, because of the ending of the corona support after the unpausing of the economies.


In the end, defining what I mean by stagflation in advance, which I interpret as very low economic growth in combination with very high inflation, could have saved me lots of confusion about what to expect from the ECB. It seems that the ECB is willing to accept (significantly) lower economic growth rates to tame inflation. Not sure how the ECB would have reacted if the economic outlook was bleaker to start with. Here I am asking myself is the glass half full or half empty with regards the expected slowdowns in the eurozone and the US. Not sure I am willing to answer this question…

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