When I talk to business groups these days, the most common question is “Are we heading into stagflation?” I’m sure they found my response unsatisfactory, because I tell them it depends on their definition of the term.
If they understand that this means a period of rising unemployment combined with still very high inflation, the answer is that there is a very good chance we will have this disease for at least a few months. But if they are referring to something like the severe pain we experienced until the end of the 1970s, it is very unlikely that that would happen.
To explain the difference, consider two historical episodes.
First, look at 1979 to 1980, which shows what I think most people think of when they talk about stagflation. At the beginning of 1979 the annual inflation rate in the United States was 9%. The rise in oil prices after the Iranian revolution led to an increase in double-digit inflation. The Federal Reserve, under Paul Volcker, responded with tighter monetary policy, which led to a recession and a sharp rise in unemployment:
Recession lowered inflation but not enough, so the Fed tightened the screws even more, sending the economy into a double-dip (not shown in chart). This finally brought inflation down to about 4 percent, which was acceptable at the time, but at a colossal cost: unemployment peaked at 10.8 percent in 1982 and did not decline to 1979 levels until 1987.
Now look at the period from 2007 to fall 2008, just before the demise of Lehman Brothers. On the surface, it looks somewhat similar, with uncomfortably high inflation, caused by rising oil and other commodity prices, and rising unemployment:
And quite a few influential people are more concerned about runaway prices than about stagnation. According to the version of August 2008 meeting Of the Federal Open Market Committee, which sets monetary policy, there were 322 indications of inflation and only 28 indications of unemployment.
However, inflation quickly subsided. And while there was a severe recession – still commonly known as the Great Recession – it had nothing to do with getting inflation out of the economy and everything to do with the fallout from a severe financial crisis.
What is the difference between these episodes? At the beginning of the 1980s, inflation was deeply entrenched in the economy in the sense that everyone expected high inflation not only in the near term but also in the foreseeable future; Firms were setting prices and negotiating wage deals on the assumption that high inflation would persist, resulting in a self-fulfilling inflationary spiral. It took a massive and sustained rise in unemployment to break this downward spiral.
By contrast, in 2008, while people expected higher inflation in the near future—perhaps because they were extrapolating from higher gasoline prices—their medium to long-term expectations of inflation remained fairly low:
So there was no inflationary spiral that could be broken.
Where are we now? As the latest graph shows, consumer inflation expectations now look a lot like the 2008 forecast and absolutely nothing like those from 1979 to 1980: the public now expects higher inflation in the near term but a return to normal inflation after that. Financial markets, where you can extract implied inflation expectations from the spread between yields on bonds that are not indexed at consumer prices, are He tells the same storyInflation today but not so much tomorrow.
In short, inflation does not appear to be well established; 2022 is not 1980.
However, I would expect to see some rise in unemployment. Although we do not appear to be in an inflationary spiral, several indicators indicate that the economy is currently in a state of too hot to match price stability. Higher wages are good, but they seem to be rising at a rate unsustainable pace; Unlike in 2008, inflation is not limited to a few regions, it even measures it exclude extremists They run high.
So the Fed has to do its thing, raise interest rates to cool things off, and it’s hard to see how that cooldown happens without at least some increase in the unemployment rate. Will the slowdown be severe enough to be considered a recession? I don’t know, and the truth is nobody knows. But that doesn’t really matter. It is possible that we are heading into a period of weak labor markets while inflation remains elevated, and many commentators will certainly declare that we are suffering from stagflation.
But such statements, while technically correct, would be misleading. When people hear “stagflation”, most think of the late 1970s and early 1980s – but there is no evidence that we are experiencing anything similar now.
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