The Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. US and global equities are already back in a bear market, and the scale of the crisis that awaits has not even been fully priced in yet.
NEW YORK â€“ ForÂ a yearÂ now, I haveÂ arguedÂ that the increase in inflation would be persistent, that its causes include not only bad policies but also negative supply shocks, and that central banksâ€™ attempt to fight it would cause aÂ hard economic landing. When theÂ recessionÂ comes, I warned, it will be severe and protracted, withÂ widespread financial distress and debt crises. Notwithstanding their hawkish talk, central bankers, caught in a debt trap,Â may still wimp outÂ and settle for above-target inflation. AnyÂ portfolioÂ of risky equities and less risky fixed-income bonds will lose money on the bonds, owing to higher inflation and inflation expectations.
How do these predictions stack up? First, Team Transitory clearly lost to Team Persistent in the inflation debate. On top of excessively loose monetary, fiscal, and credit policies, negative supply shocks caused price growth to surge. COVID-19 lockdowns led to supply bottlenecks, including for labor. Chinaâ€™s â€œzero-COVIDâ€ policy created even more problems for global supply chains. Russiaâ€™s invasion of Ukraine sent shockwaves through energy and other commodity markets. And the broader sanctions regime â€“ not least the weaponization of the US dollar and other currencies â€“ has further balkanized the global economy, with â€œfriend-shoringâ€ and trade and immigration restrictions accelerating the trend toward deglobalization.
Everyone now recognizes that these persistent negative supply shocks have contributed to inflation, and the European Central Bank, the Bank of England, and the US Federal Reserve have begun to acknowledge that a soft landing will be exceedingly difficult to pull off. Fed Chair Jerome Powell now speaks of a â€œsoftish landingâ€ with at least â€œsome pain.â€ Meanwhile, a hard-landing scenario is becoming the consensus among market analysts, economists, and investors.
It is much harder to achieve a soft landing under conditions of stagflationary negative supply shocks than it is when the economy is overheating because of excessive demand. Since World War II, there has never been a case where the Fed achieved a soft landing with inflation above 5% (it is currently above 8%) and unemployment below 5% (it is currently 3.7%). And if a hard landing is the baseline for the United States, it is even more likely in Europe, owing to the Russian energy shock, Chinaâ€™s slowdown, and the ECB falling even further behind the curve relative to the Fed.
Are we already in a recession? Not yet, but the US did reportÂ negative growthÂ in the first half of the year, and most forward-looking indicators of economic activity in advanced economies point to a sharp slowdown that will grow even worse with monetary-policy tightening. A hard landing by yearâ€™s end should be regarded as the baseline scenario.Â
While many other analysts now agree, they seem to think that the coming recession will be short and shallow, whereas I have cautioned against such relative optimism, stressing the risk of a severe and protracted stagflationary debt crisis. And now, the latest distress in financial markets â€“ including bond and credit markets â€“ has reinforced my view that central banksâ€™ efforts to bring inflation back down to target will cause both an economic and a financial crash.
Nouriel Roubini is Professor Emeritus at the Stern School of Business, NYU and author of the forthcoming book Megathreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them.