Washington – Stagflation. It was the dreaded “S-word” of the 1970s.
For Americans of a certain age, it conjures up memories of painfully long lines at gas stations, shuttered factories and President Gerald Ford’s much-derided “Whip Inflation Now” buttons.
Stagflation is the bitterest of economic pills: high inflation mixes with a weak labor market to produce a poisonous brew that punishes consumers and confuses economists.
For decades, most economists didn’t think such a nasty concoction was even possible. They had long assumed that inflation would only be high when the economy was strong and unemployment low.
But an unfortunate confluence of events has taken economists back to the disco days and the gloomy, high-inflation, high-unemployment economy of nearly half a century ago. Few people think stagflation is in sight. But as a longer-term threat, it can no longer be ruled out.
Last week, Treasury Secretary Janet Yellen invoked the word in remarks to reporters:
“The global economic outlook,” Yellen said, “is challenging and uncertain, and rising food and energy prices are having stagflationary effects, namely lower production and spending and higher l ‘inflation all over the world’.
Last Thursday, the government estimated that the economy had contracted at an annual rate of 1.5% from January to March. But the decline was primarily due to two factors that do not reflect the underlying strength of the economy: a growing trade gap caused by Americans’ appetite for foreign goods and a slowdown in business inventory replenishment after a sharp accumulation during the holiday season.
For now, economists agree that the US economy has enough momentum to avoid a recession. But the problems are piling up. Supply chain bottlenecks and disruptions from Russia’s war on Ukraine have pushed consumer prices up at their fastest pace in decades.
The Federal Reserve and other central banks, blinded by runaway inflation, are scrambling to catch up by aggressively raising interest rates. They hope to cool growth enough to bring inflation under control without triggering a recession.
This is a notoriously difficult task. The widespread fear, reflected in falling stock prices, is that the Fed will eventually rush it and crush the economy without delivering a fatal blow to inflation.
This month, former Fed Chairman Ben Bernanke told the New York Times that “inflation is still too high but falling. So there should be a period over the next couple of years when growth is weak, unemployment is at least a bit on the rise and inflation is still high.”
And then Bernanke summed up his thoughts: “You could call it stagflation.”
WHAT IS STAGFLATION?
There is no formal definition or specific statistical threshold.
Mark Zandi, chief economist at Moody’s Analytics, has his own rough guide: Stagflation comes to the United States, he says, when the unemployment rate hits at least 5% and consumer prices jump 5% or more compared to the previous year. The US unemployment rate is only 3.6%.
In the European Union, where unemployment is generally higher, Zandi’s threshold is different: 9% unemployment and 4% year-on-year inflation, he says, would combine to cause stagflation.
Until about 50 years ago, economists considered stagflation a near impossibility. They carved out something called the Phillips Curve, named after its creator, New Zealand economist AWH “Bill” Phillips (1914-1975). This theory held that inflation and unemployment move in different directions opposites.
It sounds like common sense: when the economy is weak and many people are out of work, companies find it hard to raise prices. Inflation should therefore remain low. Likewise, when the economy is warm enough for businesses to pass on large price increases to their customers, unemployment should stay quite low.
Somehow, the reality didn’t turn out that simple. What can turn things around is a supply shock – for example, a spike in the cost of raw materials that triggers inflation and leaves consumers with less money to spend on fueling the economy.
This is exactly what happened in the 1970s.
Saudi Arabia and other oil-producing countries imposed an oil embargo on the United States and other countries that supported Israel during the Yom Kippur War in 1973. Oil prices soared and remained high. The cost of living has become more unaffordable for many. The economy faltered.
Enter stagflation. Every year from 1974 to 1982, inflation and unemployment in the United States both exceeded 5%. The combination of the two figures, which has been called the “Misery Index”, peaked at 20.6 in 1980.
Stagflation, and particularly chronically high inflation, became a defining feature of the 1970s. Political figures struggled unsuccessfully to tackle the problem. President Richard Nixon resorted, unsuccessfully, to wage and price controls. The Ford administration has issued “Whip Inflation Now” buttons. The reaction was mostly contempt.
HAS STAGFLATION ARRIVED?
No. For now, the stagflation glass is only half full.
There is “flation” for sure: consumer prices rose 8.3% in April from a year earlier, just below the 41-year high reached the previous month.
Consumer prices are rising largely because the economy rebounded with unexpected strength from the brief but devastating pandemic recession. Factories, ports and freight stations have been overwhelmed trying to cope with an unexpected increase in customer orders. This resulted in delays, shortages and higher prices.
Critics also blame President Joe Biden’s $1.9 trillion March 2021 stimulus package for overheating an already hot economy. The war in Ukraine has made matters worse by disrupting energy and food trade and driving up prices.
But the “deer” has not yet arrived: even though the government announced on Thursday that economic output had fallen from January to March, the country’s job market continued to roar.
Every month over the past year, employers have added more than 400,000 jobs. At 3.6%, the unemployment rate is just a notch above 50-year lows. This week, the Fed reported that Americans are in good financial health: nearly eight in 10 adults said last fall that they were “doing well or living comfortably” – the highest proportion since the Fed began to ask the question in 2013.
However, the risks are piling up. The same goes for concerns about potential stagflation. Fed Chairman Jerome Powell acknowledged this month that the central bank may not be able to achieve a soft landing and avoid a recession. He told US state media’s “Marketplace” he was worried about “factors beyond our control” – the war in Ukraine, a slowdown in China, the lingering pandemic.
At the same time, inflation has eroded Americans’ purchasing power: prices have risen faster than hourly wages for 13 consecutive months. And the country’s savings rate, which soared in 2020 and 2021 as Americans cashed government relief checks, has fallen below pre-pandemic levels.
Europe is even more vulnerable to stagflation. Energy prices there have skyrocketed since Russia invaded Ukraine. Unemployment in the 27 EU countries is already at 6.2%.
WHY HAS STAGFLATION DISAPPEARED FOR SO LONG?
For four decades, the United States virtually banned inflation. In the early 1980s, Fed Chairman Paul Volcker had raised interest rates so high to fight inflation – 30-year mortgage rates were approaching the dizzying 19% in 1981 – that he caused consecutive recessions in 1980 and 1981-82. Yet Volcker achieved his goal: he succeeded in ridding the economy of high inflation. And he stayed away.
“The Fed has worked hard since the stagflation of the late 1970s and early 1980s,” Zandi said, “to keep inflation and inflation expectations closer to its target,” which is now d about 2%.
Other factors, including the rise of low-cost manufacturing in China and other developing countries, have limited the prices consumers and businesses pay.
The United States has seen periods of high unemployment – it reached 10% after the Great Recession of 2007-2009 and 14.7% after the outbreak of COVID-19 in 2020. Yet until last year , inflation had remained at bay. In fact, since 1990, the nation has not faced a year of Zandi’s standard 5% inflation and 5% unemployment.