Commentary: Debt crisis looms as outlook for growth remains uncertain

In this case, lower aggregate demand and slower growth would lead to lower inflation, stocks would correct to reflect the weaker growth outlook, and bond yields would fall further (because real yields and inflation expectations would be lower).

THE MOST LIKELY SCENARIO

Which of these four scenarios is most likely? While most market analysts and policymakers have been pushing the Goldilocks scenario, my fear is that the overheating scenario is more salient.

Given today’s loose monetary, fiscal, and credit policies, the fading of the Delta variant and its associated supply bottlenecks will overheat growth and will leave central banks stuck between a rock and a hard place.

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.

But over the medium term, as a variety of persistent negative supply shocks hit the global economy, we may end up with far worse than mild stagflation or overheating: a full stagflation with much lower growth and higher inflation.

The temptation to reduce the real value of large nominal fixed-rate debt ratios would lead central banks to accommodate inflation, rather than fight it and risk an economic and market crash.

But today’s debt ratios (both private and public) are substantially higher than they were in the stagflationary 1970s. Public and private agents with too much debt and much lower income will face insolvency once inflation risk premia push real interest rates higher, setting the stage for the stagflationary debt crises that I have warned about.

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.

Nouriel Roubini, Professor Emeritus at New York University’s Stern School of Business, is Chief Economist at Atlas Capital Team and CEO of Roubini Macro Associates. PROJECT SYNDICATE