Last Updated on Friday, 18 December 2009 10:19 Written by Alan Callow Friday, 05 June 2009 12:11

With the world economic output set to decline during the next 2 years whilst oil prices have risen sharply over the last 6 months and governments have poured $billions into their economies via fiscal aid to industry as well as quantitative easing is there a danger that we will see a return to inflation, or even the stagflation (a combination of high inflation and declining output) of the 1970s?

The truth is we cannot be complacent about inflation; however we can be confident that it does not HAVE to return.  Oil Prices will continue to rise for a number of reason, however the current deflation in the global economy will act as a counterbalance for at least 2 more years.  Stagflation is also unlikely, some forecasters are already predicting a return to growth for the USA by the end of 2009 with the rest of the developed world following 9 months to a year behind.  It is worth noting that the stagflation of the 1970s was only partly the fault of oil price hikes resulting from the Yom Kippur war and Iranian revolution.  Since that time, developed world economies have, for the most part, become much more responsive - a result of globalisation and the weakening of Trades Unions - thus allowing them to counter oil price increases.

Government led fiscal packages do present an inflationary risk as the world returns to growth, however these are manageable provided governments and central banks are ready to turn off the fiscal taps as soon as sustainable growth returns, in any case the need to claw back funds through taxation should act as an effective brake.