Global supply shocks generate stagflationary pressures and pose difficult tradeoffs for monetary policy. This paper studies how central banks respond to such shocks using panel and country-level structural VARs for eight ASEAN+3 economies over 1970–2024, and a broad set of global supply shock measures.

Raising interest rates in a stagflation-afflicted economy means trading one kind of pain (inflation) for another (recession). But the lack of political will to make tough fiscal decisions leaves the Bank of England with little choice.

The US services sector is again signaling stagflation: ISM Services PMI rose +0.1 point in July, to 54.1, while the employment index dropped -3.6 points, to 47.4, the lowest reading since March and back in contraction territory. This is also the 2nd-lowest reading since October and marks the 4th monthly contraction over the last 5. At the same time, the prices paid index surged +2.6 points, to 70.3, near the highest since October 2022. Prices paid have now trended higher for over 2 years, rising +16.9 points since March 2024. In other words, the economy is increasingly under pressure from both rising prices and a weakening labor market. The threat of stagflation is intensifying.

Today’s ISM report was yet another very stagflationary report. Prices paid spiked to 3-year highs, while employment fell to 2-year lows. How will policymakers respond if this persists? They will ease into weakness and look through inflation.