NEW YORK —How will the global economy and markets evolve over the next year? There are four scenarios that could follow the “mild stagflation” of the last few months.
For markets, this would represent a resumption of the “reflation trade” outlook from earlier this year, when it was hoped that stronger growth would support stronger earnings and even higher stock prices. The second scenario involves “overheating.” Here, growth would accelerate as the supply bottlenecks are cleared, but inflation would remain stubbornly higher, because its causes would turn out not to be temporary. With unspent savings and pent-up demand already high, the continuation of ultra-loose monetary and fiscal policies would boost aggregate demand even further.
Moreover, a host of medium-term persistent negative supply shocks could curtail growth over time and drive up production costs, adding to the inflationary pressure.
Faced with a debt trap and persistently above-target inflation, they will almost certainly wimp out and lag behind the curve, even as fiscal policies remain too loose. The Panglossian scenario that is currently priced into financial markets may eventually turn out to be a pipe dream. Rather than fixating on Goldilocks, economic observers should remember Cassandra, whose warnings were ignored until it was too late.
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