Neo-liberalism and the rise of stagflation

Stagflation refers to the existence of economic stagnation in the context of increasing price levels. As such, it signifies a period of stagnant or decreasing economic growth and inflation. There is good reason to believe that the developed economies of the West, certainly that of the United States, may be heading for a period of mild stagflation reminiscent of the rampant stagflation of the 1970s. Australia would be an interesting exception, to which we return.

Although the level of stagflation is mild, with good reason to suggest that it will remain mild due to structural factors, it nonetheless still poses the same policy dilemmas as witnessed by dissension on the Federal Reserve Bank Board.

The connection between neo-liberalism and stagflation is intimate, for it was the onset of a turbo charged stagflation that undermined the dominance of Keynesian economics, and ushered in the return of neo-classical approaches. Although neo-classical theory no longer holds sway in academic economics it still continues to guide economic policymakers and the economic commentariat, which suggests that if we seek to apportion blame for "economic rationalism" we ought not blame the hapless economists.

It is ironic, therefore, that many discern the return of a mild form of stagflation in the industrial West after more than two decades of economic reform that began in earnest as a response to stagflation. The Chief Economist of the ANZ Bank, Saul Eslake, has suggested that, as previously, the cause of stagflation can be partly attributed to the growing role of the state in the economy under the rubric of "national security". The use of citation marks in the context of national security is Eslake's, and that is most revealing for the Chief Economist of the ANZ Bank is no Trotskyite.

However, we might actually argue for the very opposite. That is, that the return of stagflation can be partly attributed to the mania for de-regulation, which in turn has come about because of the pursuit of a neo-liberal economic agenda post the stagflationary spiral of the 1970s.

Many observers have supposed that the housing crisis in the US, that is reverberating around the world in the form of a liquidity crisis, has arisen because of lax regulatory oversight over the financial sector. By the same token, it is also supposed that the increasing price for oil, which is feeding into core CPI in the industrial West, has partly arisen due to speculators trading in oil futures made permissible by de-regulatory reforms.

A case can be made for re-thinking the reflexive drive for de-regulation in the interests of macro-economic stability. We may very well now be faced with the situation of a global economy that is far too complex for comfort, requiring greater levels of regulatory oversight, a globalised Keynesianism, to prevent poorly understood processes from undermining macro-economic performance. This would require reforming the system of international relations, which increasingly is out of step with the realities of a global economy.

The global credit crunch has arisen as a result of the sub-prime mortgage crisis in the United States. It is almost daily now that we see the effects of this crisis working its way through the financial system and the broader economy. The availability of credit has fallen to very low levels and this has obvious implications for aggregate demand and economic growth.

For consumers, who make up most of aggregate demand (70 per cent in the US) lower house prices (the S&P/Case-Shiller Index is in free fall) and large debt burdens has led to a significant decline in consumer confidence that will go on to impact retail sales. This applies across the industrial Western economies.

For business, a credit crunch leads to a lowering of funds available for investment which lowers business confidence and capital investment. Because of the liquidity crisis the sub-prime melt down reverberates throughout the economy, dampening aggregate demand. That is to say, it leads to economic stagnation.

The sub-prime crisis was made possible by key de-regulatory reforms. In 2000 the US Congress passed the Commodity Futures Modernization Act. These reforms led to the rise of unregulated credit default swaps.

Banks would lend sub-prime mortgages and investment banks would buy these as Collateralised Debt Obligations in order to pass along risk. It is the passing along of the risk of borrowing to sub-prime lenders that lies at the heart of the sub-prime crisis, which was made possibly by unregulated credit default swaps. When house prices fell and many sub-prime borrowers de-faulted the rug was pulled out from under the system which worked upon an underlying assumption that house prices would not fall, enabling sub-prime borrowers to refinance their loans. In this way the sub-prime crisis is a bit reminiscent of the Third World Debt crisis of the 1980s.