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Inflation: Global economy faces ‘echoes of the 1970s,’ World Bank official says

World Bank Group's Franziska Ohnsorge joins Yahoo Finance Live to discuss inflation, recessionary risks, rising rates, and the outlook for the global economy.

Video Transcript

BRIAN CHEUNG: Let's shift over to the macro picture, which remains a massive story as the World Bank now this morning firing a warning about global growth. The international body saying the global economy will grow by 2.9% this year. That's a pretty substantial downgrade from the 4.1% it had forecast in January.

The concern now, whether or not there will be a combination of low growth and high inflation-- AKA stagflation. Let's bring in Franziska Ohnsorge, who is the Manager of the Prospects Group at the World Bank. It's great to have you on the program this morning. Thanks so much for taking the time.

I want to start off with just that headline number that you offered in that report-- again, a pretty marked downgrade, I imagine because of the Russia invasion of Ukraine, which didn't happen the last time you had these projections. What do you see as the biggest risk to the global economy? And could this really be a nasty recession that could really encapsulate the whole world?

FRANZISKA OHNSORGE: Yeah, thank you. Glad to be with you today. Thank you. Even six months ago, we had expected a slowdown. But this slowdown is much worse. I mean, as you said, you showed the forecast downgrade-- that was about one-third downgrade.

In addition, our global inflation is at a 14-year high. Of course, that carries echoes of stagflation of the 1970s-- and so does the quintupling, the five-fold increase in oil prices. And so does the near doubling of global food prices. And so does the past decade of very accommodative monetary policy.

So there are these echoes of the 1970s. And that is also the main risk to the global economy, that we face a prolonged period of high inflation and weak growth.

BRIAN CHEUNG: So I guess the question here is, what can governments and central banks do to address this? Maybe we'll start off with the central bank side of things, because we know that they have a blunt tool through possibly raising interest rates to make aggregate inflation come down. But the report also highlights a lot of these issues are supply chain-related-- shutdowns in China, a war happening in Eastern Europe. So how aggressive should they be in making sure that they can actually lower aggregate inflation?

FRANZISKA OHNSORGE: Yes. Stagflation is a really knotty policy problem, because the remedy to high inflation is a policy that will have as a side effect stagnation, or something worse. So both central banks and ministries of finance have to navigate this very narrow path between enough tightening to reduce inflation, but not so much tightening that you get a deep downturn, let alone a recession.

So it's a really difficult balancing act. The one good thing that has dramatically improved since the 1970s is the fact that central banks now prioritize inflation, something it didn't do at the time. Price stability was not their main priority. Now, it isn't.

They've spent 30 years, three decades, building credibility. And that is also the reason why financial markets nowadays expect a much smaller rate hike, cumulatively, than was necessary in the 1970s to bring inflation back within target ranges. That will be tested in the next year-- in the coming year, whether that kind of interest rate hike, just sort of on the order of 200, 300 basis points in 2022 and '23, is sufficient to reduce inflation.

AKIKO FUJITA: Franziska, it's Akiko here. I wonder if you can weigh in specifically on the impact you're seeing to emerging economies. Obviously, already shouldered with so much debt coming out of the pandemic-- that debt has only ballooned as we've seen the dollar grow stronger, as we've seen the rates go up. And then you've got the supply issues, especially around food. How does that compare to the 1970s?

FRANZISKA OHNSORGE: That's exactly the right question to ask. In the 1970s as well, just like now, a lot of the stagflation debate was about the United States. But the problem is much bigger than the United States. If you think back to the 1970s, it took a synchronized monetary policy rate hike, a doubling from 1975 to '81, a doubling of global interest rates to 14%-- that's what ended global inflation-- very high inflation.

With the global recession of 1982-- these rate hikes tipped the global economy into a global recession. But of course, what we remember as an end to inflation in advanced economies, emerging markets remember as the beginning of a string of debt crisis, because growth was weak-- there was a global recession. And interest rates went up very steeply.

And that's what tipped a lot of the countries that were highly indebted at the time into debt crisis. That's the concern that this happens again now. Government debt is now as high as it was not for 35 years. You have to go back to 1987 to see this kind of government debt in emerging markets and developing economies-- 66% of GDP.

And private debt is just at record high levels-- much higher than it ever was in the '70s. So that makes countries very vulnerable to rising borrowing costs.

BRIAN CHEUNG: So on that point, I mean, what can some of the advanced nations do to make sure that there isn't any sort of, I guess, collapse that happens in those fragile countries? Because we know that there could be spillover effects, as we saw, for example, in 1997.

So should they be engaging with them in terms of debt relief? Are there other things even on the vaccination front? We have to remember we're still in a pandemic. Ohnsorge

FRANZISKA OHNSORGE: Yeah. That's absolutely right. There are two types of policies. First is to use the three decades of policy credibility-- inflation fighting credibility that is used by acting early-- basically by acting early. Because the one lesson from the 1970s is that a delayed monetary policy response needs to be a bigger monetary policy response.

And that's where the good news are. Central banks are actively now tightening policy, and very clearly with the goal of reducing inflation-- something that took much longer in the 1970s to get to. So that is a good sign. And, of course, then on the other side, there's the problem of growth.

That is kind of our most likely scenario. Growth is going to slow, and the fundamental drivers of growth are slowing. There is very little way that this can be escaped over the next decade. In fact, we estimate that over the 2020s, this underlying fundamental growth will be 0.6 percentage points less than in the 2010s-- so the difference between these two decades. There is very little that can be done in the short-term about this. This is just underlying trends.

AKIKO FUJITA: Yeah, I mean--

FRANZISKA OHNSORGE: [INAUDIBLE] needs reforms. But where there is still a question mark is whether inflation comes back down within target ranges without too much of a disruption.

AKIKO FUJITA: A sobering outlook either way you look at it. Franziska Ohnsorge, it's good to talk to you today-- appreciate the time. Manager of the World Bank Group's Prospects Group.