Russia's economy is signaling a fate worse than recession

• Russian inflation is rising while the nation's economy cools, the country's central bank said.
• These are the key ingredients for stagflation, a scenario that's harder to combat than a recession.

As Russia's GDP and inflation figures move in the wrong direction, the worst-case scenario for any economy looms large over Moscow.

"There are signs of cooling domestic demand. However, there is no reduction in inflationary pressure," Russia's central bank cited in a summary of its latest policy meeting, translated by Bloomberg.

The unfortunate pairing, more often known as stagflation, is something policymakers prefer to avoid at all costs.

It's a scenario harder to thwart than a recession: when an economy slows down, central banks will loosen interest rates to revive activity. But if inflation keeps rising at the same time as a downturn, things quickly become complicated. Since interest rates must stay high to cool price growth, governments are left paralyzed.

Though the Bank of Russia did not specifically refer to stagflation, the conditions it described make it a sincere concern.

In a separate report this month, the bank projected that GDP was destined to sharply slowdown next year. Though Russia's economy has prospered under its wartime boom, sanctions, production output limitations, and a severe labor crunch are bound to wear it down by 2025.

According to the policy summary, OPEC+ oil production cuts are also denting Russian growth.

Against this backdrop, inflation is still on a tear in Russia. The central bank elected to hike interest rates to 19% this month, as prior efforts have not slowed it down.

To blame is Moscow's aggressive defense spending, projected to remain at historic highs through 2025. According to the country's latest draft budget, the spending will tick slightly lower in the two years that follow.

Also at fault are labor shortages — as the Ukrainian front required Russians, businesses have had to push up wages to attract new workers. By last year's end, the country was estimated to lack nearly 5 million workers.

There is one caveat to the stagflation fear: if domestic demand continues cooling, the central bank expects inflation to fall alongside it.

Nonetheless, current conditions do not bode well for Russia. When stagflation last hit the US in the 1970s, the US Federal Reserve was forced to initiate a deep recession to finally end the turmoil.