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Stagflation, dare I say it?


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April 28, 2005

Stagflation, dare I say it?

Amey Stone

I've been familiar with the term "stagflation" for years and understand well that it describes a disastrous economic condition where growth is stagnating, but inflation is climbing. But I think today was the first day I actually said the word aloud.

What prompted me to talk about such a troubling -- and farfetched -- scenario? It was today's report that gross domestic product grew just 3.1% in the first quarter. Economists were expecting 3.5% growth. It's increasingly clear that both businesses and consumers have slowed their spending -- at least for everything except real estate --at the same time that prices across the board have continued to rise (mainly due to higher oil).

Do I think we're headed into a period of stagflation? Certainly not. But I'm starting to see how one could arise. And that's pretty scary in and of itself.

The economic commentary I read can be divided between those who think the soft patch is only temporary (and that the Federal Reserve can raise rates further without doing much harm) and those who think the economic recovery is waning and that the biggest risk is that the Fed will keep raising rates, effectively slamming on the economic brakes and throwing the country into recession.

Either way, it's clear the Fed has a tough job at its May 3 meeting. This analysis from Dean Baker, Co-Director of the Center for Economic and Policy Research in Washington, D.C., sums up well the challenge today's GDP report presents for the Fed:

This report will have to be very worrying to the Fed. The hope for the recovery was always that a strong upturn in investment, ideally going along with an improvement in the trade balance, would offset the inevitably weakening of borrowing-driven consumption growth and the housing boom. At this point, the housing boom is presumably reaching an endpoint, and consumers are being stretched very thin, as savings rates move ever closer to zero. However, investment appears to be weakening, rather than strengthening and the trade deficit continues to grow.... The Fed will be left with the choice of trying to keep interest rates low to help sustain growth, or raising interest rates in an effort to choke off inflation.

02:01 PM

Economics

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Get out your leisure suits!

The 70's are back!

Posted by: T colbert at April 28, 2005 04:59 PM

high energy costs *relative to last year* will increase the cost of everything made and transported in USA. The low US dollar will make all imports more expensive. Wages are flat = stagflation.

Posted by: Mike Donovan at April 29, 2005 01:40 AM

I think the fears of inflation are overblown at this point. If the Fed goes ahead with this quarter-point raise, they should seriously consider taking the rest of the year off.

Posted by: D Springer at April 29, 2005 12:47 PM

Interesting subject you brought up, Amey...

If we were to use history as a guide-- I know, that always seems to be a dangerous thing to do-- we should expect two scenarios:

(1) The Fed will deal aggressively with inflation, squash it, and the economy could be faced with the possible risks of falling asset prices, as we deal with paying back our massive debts. Not pretty and hard to manage. Stagflation is less probable in this scenario, but a severe recession/depression is more of a possibility. Reference yourself to Japan in the early 1990's.

(2) The Fed will not be that aggressive, start targeting inflation in the 4%-6% range, and allow nominal GDP expansion-- plus the time value of money-- to pay down the debt. Not pretty, but a little easier to manage. Stagflation is more possible in this scenario...

The period of stagflation encountered in the late 70's occurred primarily due to price control policy mistakes made in the Nixon administration (some may debate that point). Prior to that, you had a period of economic expansion, and persistent inflation. We have a period right now where inflation is expanding faster than wages, but that's not stagflation-- it sure does feel like it, though, doesn't it?

Posted by: The Assetman at May 1, 2005 06:08 PM

When a congressman asked Chairman Greenspan about stagflation, he laughed! Our current economy is a wonderful economy. We went through a rough time immmediately before and after September 11, 2001, but the economic growth for the past couple of years has been fantastic. The world wide boom got a little strong which ran up commodity prices but the risk of high inflation is still tame. Productivity has been exceptionally high. Inflation and productivity simply do not go together well. Good topic, but we are not even close to stagflation.

Posted by: Jack K. Miller at May 9, 2005 03:40 PM


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