The Worst Case Scenario

Stagflation May Return as Price, Credit Risks Meet (Update1)

By Rich Miller

Dec. 17 (Bloomberg) -- The world economy is facing the risk of both recession and faster inflation.

Global growth this quarter and next may be the slowest in four years, while inflation might be the fastest in a decade, say economists at JPMorgan Chase & Co.

The worst U.S. housing slump in 16 years, coupled with a tightening of credit by banks, has brought the world's largest economy ``close to stall speed,'' according to former Federal Reserve Chairman Alan Greenspan. At the same time, rapid growth in China and other emerging markets is driving energy and food prices higher worldwide.

``What lies ahead is a period of stagflation -- slow or no growth combined with rising inflation -- in the advanced economies,'' says Joachim Fels, co-chief global economist at Morgan Stanley in London.

Harvard University economist Martin Feldstein is among those who say it would be just a mild case of what the world endured in the 1970s and early 1980s, when a 10-fold increase in oil prices drove both unemployment and inflation above 10 percent. Still, it poses a dilemma for the Fed and other central banks as they struggle to decide which problem they should tackle first.

How they respond will go a long way in determining which danger proves to be the biggest: a slumping global economy or rising prices worldwide.

For now, traders in futures markets are betting the Fed will remain focused on supporting growth, even after the latest government inflation reading last week showed consumer prices rose in November at the fastest pace in more than two years ...