GIS Radio: Europe’s quiet stagflation risk

I want you to imagine a nightmare scenario for an economy.

Just picture a situation where the prices of literally everything around you, your groceries,

your rent, your energy bills, they just keep climbing higher and higher.

Oh yeah, it's the absolute worst-case scenario.

Right.

But at the exact same time, the economy itself is completely stuck.

I mean, businesses aren't growing, jobs are scarce, wages are completely frozen.

Yeah, you're paying more just to survive, but your ability to actually earn is entirely

paralyzed.

It's an economic trap.

You're being squeezed from both sides.

And the usual escape routes that governments use to fix things they are completely blocked.

Right.

Which is why today, we're going to look at why that specific nightmare is keeping central

bankers up at night right now.

Welcome to The Deep Dive.

I'm your host, and our mission today is to unpack a really fascinating, newly published

report.

Yeah, from geopolitical intelligence services.

Exactly.

Written by economics expert, Elizabeth Kreck.

We're looking at a massive shift happening right under our noses.

She actually calls it Europe's quiet, stagflation risk.

And quiet is really the operative word there, I think.

We aren't looking at some sudden catastrophic market crash that makes the evening news.

It's more of a slow-bun.

Exactly.

It is a slow motion unraveling of the macroeconomic safety nets we've all kind of taken for granted

for the last two decades.

Okay.

Listen, pack this.

Because I know that it turned like macroeconomics might sound super dense to you listening, but

I promise this is a gripping story.

It's really about the end of an era.

It is to really understand where Europe is headed and why this report is sounding the

alarm.

We first have to understand the economic laws of gravity that policymakers have relied on

for generations.

And why those laws seem to be completely breaking down.

Let's start with the ghost of the 1970s.

Because when we talk about this nightmare scenario of high prices in a stuck economy,

we're talking about stagflation.

Right.

And for anyone who follows economics, you probably already know the basic intuition guiding

central banks, which is the Phillips curve.

The idea that inflation and unemployment are basically on a seesaw.

Exactly.

Historically, economic slacks so high unemployment and inflation move in opposite directions.

If growth is weak, you know, prices cool down.

If the economy is booming, well, prices get pushed up.

And central banks just manage their balance.

Yeah, exactly.

If inflation runs too hot, they raise interest rates to cool demand.

If unemployment spikes, they lower rates to stimulate borrowing and hiring.

But stagflation breaks that relationship entirely.

Because inflation and stagnation are happening at the exact same time, the central bank is

forced into this impossible choice.

Yeah, there are no clean trade-offs anymore.

I mean, if they raise rates to fight the rising prices, they crush an economy that is

already weak.

They destroy jobs.

And if they lower rates to help the economy grow, that inflation just hardens into something

permanent.

Right.

It's a lose-lose.

And that 1970s energy crisis is the textbook example here.

The source material brings up this really striking visceral image from the 1973 OPEC oil

crisis.

Oh, the gas station sign.

Yeah, just a simple sign sitting next to the gas pumps at a service station that says

in big red letters, sorry, and no jazz.

It was a massive negative supply shock.

But what's fascinating here is how recently we brushed up against that ghost again.

You mean the post-pandemic period?

Exactly.

Because the global economy reopened all at once, but supply chains were fundamentally broken.

I mean, later markets were fractured, governments had pumped unprecedented stimulus into the system.

Right.

Fiscal and monetary.

And then, of course, Russia invaded Ukraine, triggering a massive energy shock.

Especially in Europe, given their reliance on Russian gas, it looked like the 1970s were

back.

But that initial scare kind of faded, right?

Energy prices eventually retreated, and central banks launched the sharpest tightening cycle

in decades to bring inflation back under control.

But the ghost never fully left the room.

No, it didn't.

And the GIS report details how, in late 2025, the reality of stagflation reappeared primarily

in the United States.

And just a quick note for you listening before we get into this specific US context, we

are strictly unpacking the economic analysis provided in the report here.

We aren't taking sides.

We aren't endorsing or criticizing any political policies.

Right.

Absolutely.

We're just looking at the economic chain reaction these policies cause, according to the

data.

Exactly.

So, looking at the data from late 2025, this is over a year into President Donald Trump's

second term, the US faced a very specific landscape.

What did that look like?

Well, we saw a combination of restrictive immigration policies, aggressive tariffs,

and renewed trade tensions.

Okay.

Economically speaking, these factors weighed heavily on business activity and supply chains

while keeping inflation stubbornly high.

So the US Federal Reserve basically found themselves staring down that exact impossible choice

we just talked about.

They did.

And under pressure from the Trump administration, the Fed actually cut interest rates three

times between September and December of 2025.

Well, so they made a clear choice to prioritize employment and growth over fighting inflation.

Exactly.

So that significantly increases their exposure to stagnationary risks down the road.

It sounds like driving a car where the engine is stalling, but the speedometer says you're

going 100 miles an hour.

That's a great way to put it.

Right.

Because if you hit the brakes to fix the speedometer, the engine dies completely.

But if you hit the gas to keep the engine running, you just crash the car.

Yeah.

That is a perfect way to visualize the policy trap.

So okay.

If the US is essentially playing a game of chicken with inflation to keep employment high, does

Europe have the luxury of making that same choice?

Well, if you look at Europe on the surface, you might think they don't even need to make

a choice.

The report points out that core inflation has settled back down near the European Central

Bank's target of 2%.

So we're past those double-digit spikes.

Right.

And furthermore, unemployment across the Eurozone is sitting at roughly 6.4%, which is

historically quite low.

Wait, if unemployment is at 6.4%, and inflation is tamed at 2%, why is Elizabeth Crat calling

this an illusion in her report?

I mean, to the average person, doesn't that just look like a stable functioning economy?

It does look stable, but it's what economists call a brittle equilibrium.

A brittle equilibrium.

Okay, explain that.

Yeah.

Think of a legacy corporation that decides to completely eliminate its research and development

budget just to pay out massive quarterly dividends.

Okay.

So on paper, this quarter's earnings look fantastic.

Right.

The stock price might even go up.

But mathematically, because they aren't building anything new or fixing their aging infrastructure,

their future collapse is already locked in.

Oh, wow.

Yeah.

Europe is not in stagflation today, but it is trapped in a low-growth, moderate inflation

environment that is highly vulnerable to shocks.

I mean, the growth projections for 2025 and 2026 are hovering between a measly 1 and

1.4%.

And when you break that down country by country, the facade really starts to crumble, doesn't

it?

It really does.

They have historically been the industrial export-driven engine of the entire continent.

Now they're stuck in near zero growth, battered by high energy costs and struggling automotive

and chemical sectors.

Exactly.

Then you look at France, which is seeing rising deficits and immense budgetary pressure

with barely 0.6% growth projected for 2025 and Italy.

Italy relies heavily on exports.

So they were hit hard by the US terrace we mentioned.

They are looking at a mere 0.5% growth.

I know the report does note that Spain is technically seeing 3% growth, which sounds great.

It does sound great until you look at the mechanics of it.

That growth is artificially propped up by massive public sector hiring.

Right.

Adding government bureaucrats to the payroll boosts the GDP numbers on a spreadsheet.

But it doesn't represent a sudden boom in actual private sector productivity or innovation.

Exactly.

It just increases the state's financial burden.

OK, here's where it gets really interesting.

Because if we connect this to the bigger picture, we have to look under the hood at the structural

rock causing this brittle equilibrium.

Yeah.

The report outlines massive permanent shifts that are dragging the economy down.

These aren't temporary cyclical blips that can be fixed by tweaking interest rates.

They are fundamental changes.

It's like owning a 150-year-old historic home.

The roof isn't leaking today, so it looks fine from the street.

But the foundation is absolutely full of termites.

That's exactly it.

Let's walk through those structural termites starting with geopolitics.

Because we are operating in a permanently riskier, more fragmented world right now.

We are.

Wars, sanctions, the breakdown of global trade.

It all means that the era of hyper-efficient, cheap supply chains is just over.

Nations are prioritizing security over efficiency, which is inherently inflationary.

Very much so.

Because of these threats, defense spending across Europe is increasing sharply.

Defense spending is necessary for survival, obviously.

But purely from an economic output perspective, it is a deadweight loss.

Because you're diverting billions of euros away from productive investments.

Right.

Money that could go to infrastructure, education, or technology is instead building missiles

and artillery shells that will just be destroyed or sit in a warehouse.

It doesn't generate future economic returns.

Wow.

Okay.

So that's geopolitics.

It's a massive structural issue as demographics.

Europe's population is aging rapidly.

And the mechanism here is a double-edged sword for the economy.

On the supply side, as the baby boomer generation retires, you have fewer people in the active

workforce actually producing goods and services, which depresses overall productivity.

Exactly.

But then on the demand side, those retirees are living longer and requiring exponentially

more in terms of pension payouts and long-term healthcare.

So you have a shrinking pool of workers trying to fund an exploding welfare state.

Yes.

It makes the entire system astronomically more expensive to maintain.

Which feeds directly into the third issue, de-industrialization.

I know some argue that advanced economies naturally transition to services, right?

They do.

But the report stresses that without urgent investment and regulatory reform, Europe

risks losing millions of foundational industrial jobs.

A strong service sector is great, but a continent cannot survive purely on consulting

and tourism.

Right.

You need an industrial base for sovereignty.

Exactly.

If Europe loses its heavy industry to the US, where energy is cheaper, or to China,

where the state heavily subsidizes production, it deepens the continent's dependence on external

powers.

And many of those powers are autocratic.

Right.

Losing that industrial capacity permanently reduces Europe's potential growth rate.

And we haven't even touched on the twin transitions.

The green transition and artificial intelligence.

We often talk about AI as this massive deflationary force because of the productivity gains of

promises.

Sure, eventually.

But the transition period itself is where the pain happens.

Right.

It's incredibly costly.

Very.

Right now, AI requires trillions in capital expenditure for data centers and energy infrastructure.

And more importantly, it displaces massive segments of the workforce.

The friction of transitional unemployment.

Exactly.

Paying to re-skill those workers and supporting them while they find new roles in a newly structured

economy, that cost is wildly underestimated by the markets.

And the green transition operates on a really similar dynamic, doesn't it?

Climate policies are essential, but the sheer mechanics of them are inherently expensive.

Oh, massively.

Think about rebuilding the entire energy grid, retrofitting millions of homes to be energy

efficient, transitioning transport systems.

It requires immense capital.

When you aren't immediately producing more goods, you're just producing cleaner ones.

Right.

That raises the baseline cost structure in a region that already has some of the highest

costs in the world.

So when you aggregate all of these factors, the geopolitics, the aging population, the

de-industrialization, the immense costs of climate policy and AI disruption, you're looking

at a pretty bleak landscape.

Regulatory rigidity, capital outflows, stagnant incomes.

The former ECB President Mario Draghi actually recently warned that Europe faces a slow

agony if structural reforms don't happen.

A slow agony.

Yeah.

And currently, those reforms are moving at a glacial pace.

Okay.

So if the foundation of the European economy is rotting structurally, the natural question

for anyone who's watched the markets over the last 15 years is, why doesn't the central

bank just step in and fix it?

I mean, we've been conditioned to expect a bailout.

We have.

In the past, the European Central Bank's playbook was to unleash ultra-loose monetary

policy at the first sign of trouble.

The report gives a perfect example of this reflex, right?

It does.

In 2019, when Mario Draghi was still in charge, European growth was sitting at 1.6 percent,

which isn't a crisis.

Not at all.

There wasn't a banking crisis or a pandemic, it was just a mild cyclical slowdown.

And yet, the ECB launched a massive round of quantitative easing, pumping billions into

the financial system and keeping interest rates below zero.

They essentially treated a minor headache with economic morphine.

That is exactly what they did.

But today, the approach is entirely different because they hiked rates to fight the post-pandemic

inflation rate, keeping it 4.5 percent in September 2023.

Right.

And they eventually cut rates eight times through mid 2025 as inflation cooled.

But then they simply stopped.

They paused with the deposit rate at 2.0 percent.

I think current ECB president, Christine Lagarde, described their stance in late 2025 as

being in a weight and watch or weight and sea mode.

But wait, why is the old playbook suddenly considered toxic?

If quantitative easing was the hero of the 2010s, why keep it locked in the drawer now, even

when growth is flatlining in major economies like Germany?

Well, this raises an important question about how central banks actually view the economy

today.

It goes back to that Phillips curve we discussed earlier.

The inverse relationship between unemployment and inflation.

Exactly.

Over the last few decades, economists noticed something alarming.

The curve flattened out.

Flattened out.

What actually caused it to flatten?

Several factors, but the biggest was globalization.

For decades, domestic unemployment didn't really dictate the price of goods because companies

could just offshore production to places like China to keep costs low.

Oh, right.

Additionally, central banks became so credible at targeting 2 percent inflation that public

expectations became anchored.

Businesses didn't raise prices because they simply expected inflation to stay low.

Okay.

So because the curve flattened, the relationship became incredibly weak, pushing down on one

side barely moved the other.

Exactly.

And the practical consequence of a flat Phillips curve is something called the sacrifice ratio.

The sacrifice ratio.

Yeah.

It measures how much economic output and so how many jobs and businesses a central bank

has to destroy just to bring down a tiny bit of inflation.

Wow.

The curve is flat.

Monetary policy becomes a very blunt, costly instrument.

You have to inflict massive widespread economic pain to achieve diminishing returns on price

stability.

So the ECB knows that if they pump trillions of euros into the system right now to try

and paper over the structural rot we discussed, they won't actually fix the demographics

or the energy costs.

No, they won't.

They will just ignite permanent inflation.

And there's a much deeper, more profound realization happening within the central bank

itself regarding the damage they've already done.

Tell me about that.

Isabel Schnabel, an executive board member at the ECB, gave a remarkably candid speech

at Stanford University that the GIS report really highlights.

What did she say?

She admitted that the prolonged monetary expansion of the past were all those years of zero interest

rates and quantitative easing caused massive unintended consequences.

Wait, really?

So essentially she's admitting that the medicine they prescribed for a decade actually made

the patient sicker in the long run.

She is.

That's specifically to market dysfunction, financial instability, and crucially rising

wealth inequality.

Oh, wealth inequality.

Let's look at the mechanism of that because it is basically the hidden tax of the 2010s.

Oh, absolutely.

Because when a central bank buys government bonds and drops interest rates to zero yield

seeking capital has to go somewhere to find a return, right?

Right.

It floods into real estate inequities.

So if you were already wealthy enough to own a house or a massive stock portfolio, the

central bank essentially skyrocketed your net worth.

Exactly.

But if you rely on a wage to survive, you suddenly find that you rent his double, house prices

are permanently out of reach, and your paycheck hasn't moved.

The central bank was basically running a massive regressive wealth transfer under the

guise of macroeconomic stabilization.

Yes.

And Schnabel noted the severe reputational damage this caused to the central banks themselves,

the public loss trust.

I mean, the fact that a core architect of those bond buying programs is now standing

at a podium at Stanford, calling out their toxic side effects tells you everything you

need to know.

It really does.

They know they cannot go back to that playbook.

So what does this all mean for you, the listener?

I mean, if you are holding a mortgage in France, running a business in Germany, we're just

trying to navigate the job market in Spain.

This shift in the ECB's mission is going to hit you directly.

It is.

We are entering a completely new era.

The vocabulary at the European central bank is no longer about doing whatever it takes

to save the economy or bail out governments.

Right.

The buzzwords dominating their press conferences now are credibility and independence.

They are drawing a hard line in the sand.

The ECB is returning strictly to its original foundational mission, which is price stability

period.

So the era of using monetary policy to implicitly keep heavily indebted European states of

float, that's over.

It's over.

There will be no more systematic buying of sovereign debt.

Governments that run massive deficits can no longer rely on the central bank to print

money and inflate away their bad choices.

The central bank has effectively resigned from its role as the economic superhero of last

resort.

Yeah, that's exactly what the GIS report outlines as the most likely scenario moving forward.

And it is a stark reality check.

Debt actually matters again.

Because when governments borrow money, the bond markets will dictate the interest rates

and the central bank won't step in to suppress those yields precisely.

So to summarize where we stand right now, an immediate 1970s style textbook stagflation

crash is unlikely tomorrow.

The surface is holding right that brittle equilibrium.

But because that macro economic safety net has been removed, the brittle equilibrium

will eventually be tested.

When the shocks come and in a fracture geopolitical world, they definitely will come recessions

are going to happen adjustments are going to hurt.

They will.

The central argument of the report is that enduring these painful natural business cycles

and returning to strict fiscal discipline is Europe's only real defense against locking

in long term structural stagflation.

It is the bitter medicine that actually cures the disease rather than just masking the

symptoms with cheap debt until the whole system collapses.

Exactly.

And that leaves us with one final incredibly provocative thought for you to mull over.

We talked about how these economic choices become politically explosive.

If the central bank is no longer acting is the buyer of last resort, if they are no

longer stepping in to rescue governments from their own debt, what happens to the social

contract?

That is the million dollar question.

Because European voters are going to be asked to foot the massive tax bills required

to fund the green transition, to rebuild domestic supply chains, and to support an aging

population all entirely out of their own stagnant wages.

Yeah.

The democracies actually have the political willpower to endure that kind of structural

pain to accept higher taxes and lower services for the sake of long term stability.

It's a huge test.

Or will the slow agony of declining living standards eventually spark a political earthquake

that shatters the brittle equilibrium once and for all?

Think about that nightmare scenario we started with.

The true risk of stagflation isn't just a stalled economy, it's what happens to a society

when the escape routes are finally closed and the bill comes to.

Thank you for joining us on this deep dive.

Stay curious, keep questioning the consensus, and we'll see you next time.