Are we at risk of stagflation as prices rise and growth slows?
Paul Davidson, USA TODAY
5 min read
Economists lately have been tossing around a word that may send shudders down the spines of many Americans, especially those who remember the 1970s: "stagflation."
While it sounds wonky, stagflation is a worst-of-all worlds scenario in which growth is sluggish while inflation is high – a predicament that kept the economy in a rut for years in the 1970s. The U.S. isn’t close to stagflation at the moment, with gross domestic product still projected to grow at the fastest pace since the early 1980s and inflation expected to moderate next year.
But a spike in prices in recent months, combined with downward revisions to GDP forecasts amid the spread of the delta coronavirus variant, have some economists worried about the risk of stagflation next year or beyond.
“It’s definitely a growing risk,” says economist Athanasios Vamvakidis of Bank of America Global Research.
Other economists downplay the possibility.
“I just don’t think we’re going to get stagflation in the U.S.,” says Gregory Daco, chief U.S. economist of Oxford Economics.
Here's a breakdown of the debate:
Why is stagflation a bad thing?
Normally, low unemployment and strong economic growth push inflation higher as robust demand for goods and services drive up prices. If inflation gets too high, the Federal Reserve raises interest rates to temper consumer and business borrowing, slowing economic activity.
Conversely, if unemployment is high and the economy is weak, inflation is typically modest as well, and the Fed lowers rates to stimulate the economy and nudge inflation higher.
It would be unusual for prices to be climbing sharply while growth is weak. In that scenario, high inflation likely would prompt consumers to pull back spending, further dampening an already sluggish economy. Excessive inflation also could lead the Fed to raise interest rates, slowing activity even more.
Finally, stagflation may leave investors few places to park their money, with slow growth hurting stocks and inflation eroding bond yields.
Some economists are starting to worry about the risk of stagflation -- a cocktail of higher prices and slow growth.
What caused stagflation in the 1970s?
Soaring oil prices, rooted in an embargo of Arab producers’ crude exports, set off inflation that eventually hit double digits. The sharply higher prices led consumers to rein in spending, hurting the economy and pushing up unemployment.
What’s prompting concerns about stagflation now?
In July, the consumer price index rose 5.4% from a year earlier, a 13-year high, and a core measure that excludes volatile food and energy items increased 4.3% -- both well above the Fed’s 2% target. In recent years, the Fed has had the opposite problem, struggling to coax tepid inflation up toward its 2% goal.
Behind the spike are items such as hotel rates and airline fares, which plunged last year in the early days of the pandemic and rose sharply from those lows this year as consumer demand returned amid the reopening economy.
Also fueling inflation are supply chain bottlenecks, with COVID-19-related worker absences at factories and ports still high, leading to low supplies and higher prices for consumer electronics, appliances and many other products. The crunch comes on top of a semiconductor shortage that has meant low inventories and higher prices for cars.
Meanwhile, dire worker shortages, particularly at restaurants, have pushed up wages and the cost of dining out.
At the same time, COVID-19 cases, fueled by the delta variant, have increased tenfold over the past six weeks, hurting consumer spending and job growth in August.
No, probably not. Fed chair Jerome Powell says the inflation surge is concentrated in pandemic-related services, like hotel stays and airplane trips, whose price increases should ease after the reopening economy’s initial burst and comparisons to last year’s bargain prices drop out of the equation.
The supply snags and labor shortages are also expected to wane as more people are vaccinated (64.4% of adults are fully vaccinated, according to the Centers for Disease Control and Prevention.)
Rising vaccinations and falling infections also should support healthy economic growth. Daco says there are already signs infections are peaking. Economists surveyed by Wolters Kluwer Blue Chip Economic indicators predict the economy will grow 6.2% this year, the most since 1984, and a sturdy 4.4% in 2022 – well above the 2% average in the decade following the Great Recession of 2007-09.
Those aren’t figures that suggest stagflation.
Is stagflation possible?
Vamvakidis, and other analysts, say yes. U.S. deaths have been rising, he notes, in part because of the country’s relatively low vaccination rate. If COVID-19 cases stay high, that could both lower consumer spending and prolong supply chain snarls well into next year, curtailing economic activity while driving up prices.
Goldman Sachs recently lowered its 2021 economic forecast from 6.4% to 6% while bumping up its inflation estimate.
Economists expect the CPI to fall to 2.9% at the end of next year and 2.3% by the end of 2023, according to a consensus forecast cited by Bank of America. But Vamvakidis says COVID-19 represents a wild card that could intensify the supply constraints and keep inflation higher for longer.
If sharp price increases persist, “The Fed will have to choose” between supporting growth and fighting inflation, he says. As a result, the central bank could move up a tentative roadmap that has rates rising in 2023, a strategy that may further hamper growth, Vamvakidis says.
More government spending should translate to stronger growth. But Joseph LaVorgna, chief economist of the Americas for Natixis, believes such spending will have mixed effects on growth while propelling inflation higher, opening the door to stagflation.
What’s the bottom line?
Most economists still view stagflation as highly unlikely. Daco notes the economy is still fundamentally strong and Americans are flush with $2.5 trillion in extra savings as a result of stimulus checks and money they squirreled away during pandemic-induced lockdowns.
And if inflation were to stay high, households would pull back their spending, causing producers to lower prices, Daco says.
