• Monetary and fiscal policy stuck in a “dilemma”
• Roubini expects lower stock indices worldwide
US economist Nouriel Roubini has often been accused of notorious pessimism, earning him the unflattering nickname “Dr. Doom.” But the forecasts of the economics professor at New York’s Stern School of Business have sometimes been surprisingly accurate, especially during the 2008 financial crisis. In his most recent article, which Roubini published together with Brunello Rosa in “Project Syndicate”, he warns of stagflation, which can neither be stopped by an expansive monetary policy nor by fiscal policy stimuli. What moves him to his pessimistic expectation?
Two violent supply shocks: COVID-19 pandemic and Ukraine war
Inflation rates have been rising inexorably since the beginning of 2021. Roubini identifies the extremely expansive monetary policy associated with the corona pandemic, fiscal policy stimuli, scarcity of raw materials and the disruption of global commodity chains as the reasons. Just as many central banks such as the Fed and the Bank of England were normalizing their monetary policy, new stagflation pressures were added with the war in Ukraine. The reason: the western sanctions imposed on Russia after the Russian invasion are again increasing energy and food prices and exacerbating the problem of scarcity of raw materials. Roubini, who tweeted that the war in Ukraine was the beginning of “Cold War 2.0,” suspects that these effects will cool down global economic growth considerably. A recession is becoming more and more likely.
“Dilemma” of the central banks and ministries of economy
In general, the task of monetary and fiscal politicians is to use fiscal measures to mitigate the negative consequences of an economic slowdown. However, Roubini currently sees little room for maneuver for such interventions. Fiscal policy, like monetary policy, has its hands tied: the central bankers’ “dilemma” consists in the fact that the two goals of curbing inflation and economic growth seem to contradict each other at the moment. The rapid normalization of monetary policy is essential to contain inflation – which in practice means raising interest rates, ending bond purchases and contracting central bank balance sheets. However, it is precisely these measures that are slowing down economic growth. Therefore, according to the economist, the central banks must proceed cautiously with the normalization, even if this entails the risk of inflation expectations escalating further and a wage-price spiral. In addition: High interest rates would make the high debt payments of the states more expensive, which could lead to a “financial crash in the bond and stock market”. Given this debt trap, central banks would have to exercise extreme caution in raising interest rates, especially since central banks finance the brunt of government debt.
The economic ministries of the individual states were also in a difficult situation. Stimuli and falling taxes would keep private demand, which should actually fall due to the global reduction in supply, artificially high. Apart from that, there is no scope for further financial injections, since the state budgets have been overstrained by the extremely expansive fiscal policy of the past two years.
Division of labor: Monetary policy limits inflation, fiscal policy ensures growth
After all, the European countries with their investment programs in the energy transition and the upgrading of their armies have decided on sensible support programs that have led to urgently needed demand for the economy. There have also recently been tax reductions in several states, particularly with regard to energy costs. This fiscal policy easing contrasts with the rate hikes by the increasingly hawkish central banks. In the face of this apparent contradiction, Roubini suspects: “Prior coordination appears to have given way to a division of labour, with central banks dealing with inflation control and lawmakers dealing with growth and supply issues.” According to the US economics professor, a certain “temporary equilibrium” was established in this way in the past few weeks, in which the stock markets were able to distance themselves significantly from their lows for the year. In addition, the interest rates on long-term government bonds rose only moderately in the first weeks of the war due to investor demand for “safe havens”.
Roubini: “Temporary Equilibrium” is likely to tip over
However, the enormous stagflationary pressures that persist could bring a tragic end to such macroeconomic equilibrium in the coming weeks. The first signs are the bond interest rates, which have risen sharply in the last few days, as well as the interest rate differences (“spreads”) between short-term and long-term US Treasury bonds. In addition, tighter sanctions against Russia and further tax breaks could further increase inflationary pressures, which would thwart central banks’ anti-inflation efforts. Also, central banks would need to balance their balances of payments to reduce the money supply – which in turn could mean higher interest rates on long-term bonds. That’s why Roubini only speaks of a “temporary” equilibrium.
What does it all lead to?
So much for Roubini’s analysis of the most important indicators of the global economic crisis. But what does all this mean for the individual investor? “Dr. Doom” outlines two “endgames”. On the one hand, politicians could give up one of the following four goals: combating inflation, high economic growth, low key interest rates and tough sanctions against Russia. Taken together, the objectives contradict each other, but if one of the four is left out, the unfortunate situation could be overcome comparatively lightly – with “perhaps lower stock indices”.
On the other hand, according to Roubini, politicians could continue to try to pursue all four goals simultaneously – but none of these four interests would be fully satisfied. Rather, this project would result in a highly questionable macroeconomic constellation, in which both stock indices and previous hard currencies would be crushed. The latter “endgame” would therefore have even more serious effects than the first scenario.
All in all, Roubini does not expect much good for the future: “One way or the other, households and consumers will feel the hardship, which will have political consequences,” is his rather hopeless conclusion.
Tim Kerkmann / Editor finanzen.net
Image sources: Vivien Killilea/Getty Images for Berggruen Inst., BEST-BACKGROUNDS / Shutterstock.com