1. Background:

There has been a general increase in price levels globally since the COVID-19 pandemic. Inflation dynamics today are a result of lingering supply shocks since the reversal of strict COVID-19 lockdowns and have been exacerbated by the Russian invasion of Ukraine — which created vast uncertainty particularly regarding energy. Supply shocks remain persistent thus creating inflationary pressures that have caused many central banks to implement contractionary monetary policy to combat dramatically rising prices.

However, a new threat is facing the world today: Stagflation. The World Bank revised growth projections for 2022 from 4.1% to 2.9% and 2023 to be 1.7% amid global stagflation risk, stating that the current global outlook resembles the dangerous and hectic economic climate in the 1970s (World Bank, 2022). The main similarity between the global outlook now and in the 1970s is that there are persistent supply shocks that occurred during a time of accommodative monetary policy. On the other hand, it is reassuring that many central banks globally now have clear mandates to target price stability and well tested monetary policy tools to achieve their goal.

Generally speaking, the objective of central banks is to promote economic growth while maintaining price stability. Therefore, it is important to understand the dynamics of inflation and the labor market and to work towards preventing such phenomena before they become a reality. However, Jordan has been suffering from modest economic growth and high unemployment. The objective of this policy brief is to highlight the current economic situation in Jordan, to examine whether stagflation is a current reality for the Jordanian economy and highlight some recommendations to improve the current economic outlook.

2. What is stagflation ?

The word “Stagflation” is a combination of 2 words: stagnation and inflation. Stagnation refers to a slow or growing economy with growing unemployment, and inflation refers to a sustained rise in the general price level. Stagflation is unique because it is a phenomenon that breaks the natural economic relationship between unemployment and inflation and creates an undesired economic climate that is difficult to combat.

Unemployment:

The unemployed population are individuals who are currently not in paid employment, or self-employment, but are willing and able to work, and have been “actively looking for a job”- which is defined by submitting a job application or having an interview in the last 2 weeks. The unemployed population does not include those who are legally too young to work (15 years and under), those who are in full-time education programs, those who are retired, and caregivers or housewives.

Unemployment involves high economic, psychological, and social costs (JSF, 2022) including:

1. A decline in a nation’s output/production/GDP and income (economic cost).

2. In addition, through the loss of tax revenues- from income taxes- and increases in government spending in the form of unemployment benefits (economic cost).

3. Lengthy periods of unemployment can lead to a loss of self-esteem, depression, and even suicidal behavior (psychological cost)

4. Unemployed individuals tend to feel angry, frustrated, and desperate. High unemployment rates tend to be associated with increases in crime, domestic violence, drug abuse, and divorce. High and persistent unemployment rates can even lead to social unrest (social cost).

Inflation:

Inflation is the sustained increase in the general price level of an economy, causing a fall in the purchasing power of a currency. Inflation can be a result of growing demand (demand-pull inflation) or a result of an increase in the costs of production (cost-push inflation). Inflation must be monitored and controlled since high inflation (and hyperinflation) is dangerous and will significantly reduce the living standards of individuals through eroding their purchasing power.

Inflation is bad for many reasons, such as but not limited to:

- Decrease in the purchasing power of a currency (the financial ability to buy products and services). For example, JD100 today buys less goods than JD100 twenty years ago.

- Increase in the cost of imports to local citizens.

- Decrease in real wages.

High inflation can be difficult to control and could lead to a strictly contractionary economic environment that can discourage investment.

Relationship between Unemployment and Inflation:

Unemployment and inflation tend to have an inverse relationship — they tend to move in opposite directions — as referenced by the Phillips Curve. This is because inflation is usually a product of growth and expansion, whereas unemployment is a product of contractions and recessions.

Here is how this relationship works according to economic theory: when there is growth in the economy there also tends to be low, or falling, unemployment. When more people are working, more consumers have the disposable income to purchase goods and services which will cause an increase in the demand for goods and services. This will create inflationary pressure on prices. In this situation, low unemployment is coupled with high inflation.

On the other hand, during periods of high unemployment, customers purchase fewer goods and services, which will reduce demand for such goods and services and will thus lead to inflation.

This creates conflicting economic objectives for policy makers since the top goals for many governments globally are low unemployment and low inflation, which is difficult considering the dynamics discussed above. However, there are instances when inflation and unemployment are both high at the same time, a situation called stagflation.

Stagflation:

Stagflation is an undesirable economic situation in which there is high-inflation AND high-unemployment at the same time. This means that prices are rising without economic growth. Stagflation is usually a result of a supply shock; a sudden change in the supply of goods and/or services. Stagflation is difficult to control and could have long-lasting effects on the economy.

Globally, inflation is soaring due to supply-chain problems, supply shortages, a hike in fuel and gas prices, and a general increase in the costs of production. If the inflation coincides with high and rising unemployment, this will become stagflation.

Since the inflation crisis is a result of supply shocks, demand-side policy (monetary and fiscal policy) is unlikely to “solve” the problem, its impact will be limited. In addition, aggressive monetary policy to control inflation (like interest rate hikes) will have negative impacts on production and employment. As a result, aggressive contractionary policy could further enhance the threat of stagflation by possibly increasing unemployment and not effectively controlling inflation.

3. Analysis of the Jordanian situation:

The following graphs use the latest published data from the Department of Statistics to investigate whether stagflation is a current risk for the Jordanian Economy.

Figure 1 represents the unemployment rate from the first quarter of 2021 till the third quarter of 2022. Unemployment has always been high in Jordan, even during growth periods and booms. Unemployment has been falling moderately over the last year, nevertheless, it remains high, and purposeful action should be taken to lower unemployment and further tighten the labor market.

Figure 2 represents the inflation rate from the first quarter of 2021 till the fourth quarter of 2022. Inflation dynamics in Jordan can be described as “imported inflation” and inflation has been on the rise since early 2021 due to supply chain disruptions caused by the COVID crisis and exacerbated by the Russian invasion of Ukraine in February . Most of the inflation experienced in Jordan is in core inflation items like food and energy prices. There has been an upward trend in the prices of imported food items like the prices of Meat and Poultry as well as in the prices of Oils and Fats, which is likely putting upward pressure of food inflation in Jordan.

In addition, fuel prices have started to increase drastically in March, a week after the Russian invasion of Ukraine. The war created vast uncertainty regarding energy accessibility and supply and this uncertainty had an extreme impact on fuel prices since Russia supplies approximately 14% of the world’s oil and gas (IEA, 2021). However, this is a supply shock that could eventually alleviate either with the end of the war, and/or with investing in new capital for oil and gas extraction elsewhere in the world.

It can be observed in figure 1 and figure 2 that, while inflation has been rising since the first quarter of 2021, unemployment has been steadily decreasing. Although we cannot conclude from this data that inflation is caused by growth, it does indicate that stagflation does not seem to be a current reality for the Jordanian economy, it is, however, a dangerous threat and risk to the economic outlook of the Jordanian economy. With that in mind, policy must be calibrated to prevent stagflation.

4. Preventing Stagflation

The cost-of-living crisis was listed as the most severe risk facing the world in the short run, according to the Global Risks Report by the World Economic Forum. The short term will be dominated by persistent inflation that has been exacerbated by supply-chain shocks and severe increases in commodity prices. Policy makers are more likely to be hawkish on inflation given the economic climate and outlook, so they have been implementing contractionary monetary policy.

To prevent stagflation, the focus must be on lowering unemployment, boosting growth and productivity, and stabilizing prices in the most efficient and sustainable way. Firstly, with regards to unemployment, policies must be designed to promote investments in productive sectors that encourage growth and increase production. Real GDP growth over the last 17 years has been stubborn and relatively constant at 3%, which was not lowering unemployment effectively. More than 3% of the real GDP growth rate is needed to accelerate the decrease in unemployment.

Secondly, boosting growth and productivity needs capital investments. As shown in figure 3, the last 11 years gross fixed capital formation as a percentage of GDP has been falling. The private sector has invested much of the gross fixed capital, with the public sector only contributing between 2%-5% over the last decade, which is mainly due to the lack of fiscal space available for capital expenditures. The Economic Modernization Vision set a goal of JD41.4 billion in investment from the private and public sectors. These investments will be aimed at projects that create new sustainable job opportunities in the Jordanian labor market to lower unemployment and further tighten the labor market, as well as help Jordan reach its full economic growth potential.

Thirdly, with regards to stabilizing prices, it is important to highlight the fact that imported inflation is difficult to control since it is a result of global forces and a shock that is exogenous to the local economy. Implementing contractionary monetary policy to stabilize prices in Jordan will not solve global supply chain issues and the energy crisis globally. Yet, Jordan’s currency peg to the dollar means Jordan must follow the monetary policy decisions of the US Federal reserve, even if they continued to raise interest rates. Jordan has chosen to limit its monetary policy independence as it prioritizes the attractiveness of the Jordanian Dinar. This situation adds another dimension to the challenge of preventing stagflation, as it amplifies the risk of stagflation and hinders Jordan’s ability to fight it.

Stabilizing wages also plays a role in combating stagflation. “Wage increases are essential to support a rising standard of living and are generally a welcome development. However, with stagflation, wages tend to rise materially and persistently above the levels of productivity gains and inflation” (Powell, 2021) which can put the economy in a wage-price spiral which is dangerous and will exacerbate stagflation. This happens because workers demand more wages due to high inflation, which will increase production costs on firms and in turn will increase cost-push inflation, which will cause workers to demand higher wages, and so on. It is a cycle that is very difficult to break. Generally, wage increases that are consistent with increases in productivity and long-term inflation goals are healthy. In addition, an increase in wages due to higher investments, high production, higher output, and higher human capital will all help people survive in high inflationary environments and are a sign of sustainable and meaningful economic growth.

5. In conclusion

Stagflation is currently not a reality for Jordan; however, it is an eminent threat to the economic outlook, and prevention policies must be actively implemented to shield the Jordanian economy from the full force of global inflation dynamics. To implement appropriate policy, the two components of stagflation should be examined: inflation and unemployment. Inflation has been on the rise since the beginning of 2021, and inflation dynamics in Jordan are mainly a result of persistent supply shocks, uncertainty, and the current political and economic climate. As the experienced inflation today is driven by supply factors, it will diminish- yet it is difficult to predict when. It can be argued that Jordan has yet to experience the full impact of European (and global) inflation dynamics. Since inflation is mostly imported and challenging to control, working on lowering unemployment is compulsory to prevent stagflation.

Works Cited

IEA. (2021, March 21). Energy Fact Sheet: Why does Russian oil and gas matter? Retrieved from International Energy Agency: https://www.iea.org/articles/energy-fact-sheet-why-does-russian-oil-and-gas-matter

JSF. (2022). The Unemployment Challenge in Jordan: Between Demand & Supply . Amman: Jordan Strategy Forum .

Powell, J. (2021, August 27). Monetary Policy in the Time of COVID. Retrieved from Federal Reserve : https://www.federalreserve.gov/newsevents/speech/powell20210827a.htm

Can Jordan fight the risk of Stagflation with no monetary policy freedom?