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June 15, 2006

Stagflation?

I'm skeptical of renewed concerns over stagflation. I remember talking about this a year ago, and oil shocks have actually smoothed since then. Crude prices, to be sure, are definitely approaching 70's era levels, but our economy is a whole helluva lot bigger nowadays, so unless there's a coming shock, the effect is bound to be muted. Growth is good, and the problem for the middle class isn't core inflation, but lack of of equity in this expansion. That wouldn't be terrifically rough to fix, though, we'd just need some political will to do it.

June 15, 2006 | Permalink

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Stagflation sneaks up on most everyone. A stock market balloon is sort of the same thing. No one complains (much) when the market goes into extra overdrive and prices get out of touch with reality (e.g. technology stocks in 1999-2000, or nearly all stocks in mid-spring this year), but when the 'correction' comes, as it nearly always does, then the bubble is universally recognized after the fact.

Governments world wide are raising interest rates, and nearly all the smart voices are substantially worried that interest rates increases will slow or shut down economic growth - as they are intended to do - before inflation goes into hyperdrive.

It is very hard for the central banks to precisely steer the economy with blunt tools, like interest rates (or money supply availability). So they usually overshoot, trying to shut down inflation - and succeeding because they shut off money demand by slowing down or halting growth.

In the 70's the Fed ultimately had interest rates in the high teens before the slowing of growth in the economy kicked in, but inflation is even harder to control - hence, price inflation with little growth, no growth, or negative growth in economic output.

Stagflation doesn't advertise that it is coming on highway billboards or teevee ads. It is almost always seen only in the rear view mirror. The conditions are in place for it real soon now, but will it happen? My guess is that the Fed will shut down the economic growth by increasing interest rates (which has dramatic effects on the annual cost of servicing the national debt - crowding out other programs and making tax policy hard to adjust), but the inflation will persist since energy is unlikely to fall much in price, and higher costs are deeply embedded in the economy.

The Republicans will never utter the word 'stagflation', and the media will follow that lead for a long time. But reality time will hit, probably sooner rather than later.

George Bush has set in place all the pieces needed for stagflation: out of control national spending, a war that eats away at economic productivity, maldistribution of the positive effects of previous growth toward the wealthy, leaving the average worker at great risk as layoffs start, home mortgage rates skyrocket, and revolving credit costs launch to the moon.

Posted by: JimPortlandOR | Jun 15, 2006 2:57:36 PM

The Fed pumped about 1.5 trillion dollars into the US economy when it lowered interest rates to 1% to pull us out of the early 00s recession. That was money manufactured out of thin air, which is virtually the definition of inflation. 1.5 trillion isn't all that much, but it comes on top of the generally inflationary stance of the Fed. Inflation is already much higher than measured by the CPI (because of weaknesses in the way the index is calculated). Look at the decline in the value of the USD compared to other currencies to get a better look at the current inflationary pressures (and that assumes the other currencies aren't inflating at the same time, but more slowly). There is also the trade imbalance, which suggests that the USD is too strong relative to other currencies, which argues for further devaluation (== inflation).

Inflation is caused by too much money chasing too few goods. Higher prices are a symptom of inflation, not a cause. Oil prices are high because of lagging production and surging demand, with a risk premium built in. The current price of oil is not causing inflation, though it is (to a minor extent) a reflection of inflation. It is, however, going to slow the economy.

Now, a growing economy will eventually "catch up" to a small amount of inflation by increasing the goods & services to balance the excess of money. However, the current economy (in the short run, at least) is slowing, partly from high oil prices and partly from interest rate increases (and possibly from cyclical pressures).

A slowing economy with ongoing inflationary pressures is a bad mix. Normally a slowing economy dampens inflation on its own. However, we haven't paid the inflationary price of the housing bubble yet, and the USD is looking way over-valued, especially if it stops being propped up by being the currency of all oil transactions.

In the interest of brevity, I haven't even touched on other imbalances, such as public & private debt. IMO, the economy is on a knife edge. If it manages to stay on the knife edge, we have stagflation. If we go one way, we have runaway inflation; the other way a deep recession (or worse).

Posted by: shargash | Jun 15, 2006 4:43:48 PM

"If it manages to stay on the knife edge, we have stagflation. If we go one way, we have runaway inflation; the other way a deep recession (or worse)."

I vote "C". Not really, but deflation is as likely as inflation. A slowdown approaching 0% GDP seems quite likely. Clue:Every new Fed Chairman has to establish inflation credibility by pushing the economy into a hole. Helicopter Ben will be no exception. 1-2 more hikes, a pause, and then starting to cut. This will hurt housing and consumer spending, but real estate is a slow deflator.

Ideally we get a minimal recession or low growth over the winter, and then Ben slowly brings the economy back up before 2008. Electoral perfection for Republicans.

Posted by: bob mcmanus | Jun 15, 2006 6:31:02 PM

Paul Krugman on Inflation ...via Mark Thoma of the Economists View.

Krugman goes over the issues pretty well. I correct myself. I suppose a GDP of 0-1% with an inflation at 2-4% would be stagflation, and would not be good, but also can't compete with the double-digit stuff of the 90s. It is also possible that the economy could get imbedded inflation through an expectation of continuous increases in energy and commodity prices. But that would discount the effects of rising energy costs on the economy.

Posted by: bob mcmanus | Jun 16, 2006 1:33:51 AM

W.I.N buttons! Whip Inflation Now!

That was Carter's solution. Then Ronnie came in and actaully fixed the problem.

Posted by: Fred Jones. | Jun 16, 2006 3:46:31 PM

"Then Ronnie came in and actaully fixed the problem."

Fred just lies, doesn't he. Carter appointed Volcker, who fixed the problem with the worst recession in decades. Various new oil producers coming online helped.
If anything, Reagan's tax cuts and deficit spending made Volcker's job more difficult.

Stagflation Talk Increasing ...Hale Stewart mostly cut-and-pastes, with some analysis

Posted by: bob mcmanus | Jun 16, 2006 8:02:41 PM

The Return of Abelson ...from Barry Ritholtz of Big Picture

This bear thinks we have an inflation problem, for anyone still reading this thread.

Posted by: bob mcmanus | Jun 17, 2006 11:42:31 AM

Fiscal Policy Multipliers ...Brad Delong takes on Greg Mankiw, with Brad's usual crowd of brilliant commenters

This is why I don't read books:Monologues are useless, you need multiple viewpoints to become adequately confused.

Posted by: bob mcmanus | Jun 17, 2006 3:57:07 PM

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