Economists are dusting off the dreaded portmanteau word “stagflation” to describe the looming crisis that threatens to envelop the eurozone this year.
Most will well remember the economic woes brought on by the Great Recession of 2007 to 2009, but this new challenge is of a different ilk, said Iain Begg, a professor at the London School of Economics’ European Institute.
“The former was a financial crisis with no surge in inflation, but this is a different sort of crisis largely emanating from the energy market. The better parallel is with the mid-1970s,” Begg said.
The conflict in Ukraine has increased gas costs, sending consumer prices soaring, and efforts to combat this inflation have slowed economic growth.
Economists define “stagflation “as a period of slow economic growth, high unemployment and inflation.
“This scenario qualifies as stagflation,” investment firm UBS said in a recent client note, prompting flashbacks to half a century ago, when the term was popularized amid an oil price crisis that plunged the United States and much of Europe into recession.
UBS has downgraded eurozone growth from 2.7 percent to 2.6 percent this year, and the European Commission recently said inflation in the eurozone will hit 7.6 percent this year, a major uptick from the May estimate of 6.1 percent.
The conflict in Ukraine, coupled with reliance on Russian gas, is a key driver behind Europe’s economic woes. The main gas pipeline from Russia has reduced capacity to as low as 20 percent at various times over the summer, sparking fears of a total cutoff.
“The (European Union) is in a perma-crisis, which implies a very challenging period ahead,” said Fabian Zuleeg, chief economist at the European Policy Center think tank. “But how and whether the EU manages to deal with all current challenges … will depend on difficult political choices in the coming months.”
The situation has been exacerbated by turmoil in two of the region’s largest economies, Germany and Italy. Last month, the relatively stable coalition government in Italy was upended by infighting over a key relief bill to combat inflation, culminating in the resignation of Prime Minister Mario Draghi.
Italy has since approved a 17.4 billion euro ($17.85 billion) package to shield households and consumers from inflation, which recently decelerated from a historic high of 8 percent, but turmoil in the country remains a headache for the European Central Bank, according to Begg.
“There will be a concern that financial markets will target Italy in a way that, first, obliges the European Central Bank to respond more emphatically, and second, leads to renewed pressure on other relatively indebted eurozone members,” Begg said.
Political upheaval in Italy has the potential to weaken the European Union, should anti-EU parties manage to succeed in upcoming elections, and early polling shows these factions gaining ground, said Angel Alonso Arroba, vice-dean in the school of public affairs at IE University in Madrid.
Last week, Deutsche Bank said that Germany is staring down recession, and Friedrich Merz, who is leader of the German opposition party, the Christian Democratic Union, recently said the nation is facing “the worst economic crisis since the founding of the Federal Republic of Germany (in 1949)”.
Arroba said that, since Germany is the economic engine of Europe, “recession there is bad news for the rest of the (EU)”.
“I am not sure whether Germany is heading for the worst crisis since its founding, but, certainly, we are in a difficult context for the world economy as a whole”, marked by inflation and the disruptive effects of the conflict in Ukraine, he added.
Germany can trace its current high reliance on Russian gas back to 2011 and a key decision to phase down nuclear energy production following the Fukushima disaster. Germany is now scrambling to diversify its energy mix, with new legislation that promises to expedite the country’s green energy transition by doubling renewable power capacity over the next eight years.
In a sense, Europe is importing the inflation it is experiencing at the moment. The good news, according to Begg, is that nations can alleviate this stress by switching to alternative sources of energy. The bad news is that this will take time, and for now, the European community has little choice but to “grin and bear it” when it comes to stagflation.
Arroba said: “Any response needs to be coordinated at the European level. Unity and cohesion in the response to the crisis will be critical. If European countries engage in competition among themselves, they will make things worse.”