Economic Commentary

Economic Commentary

May 16, 2024

Stagflation boogeyman won’t go away despite being unfounded

Most of the incoming economic data remains solid. That’s not to imply that everything is rosy – there are certainly challenges for businesses and individuals.

Yet, investors remain extremely focused on inflation. In fact, the mythical inflation boogeyman is alive and well and living “rent free” in the heads of most investors. Some have truncated the famous quote by the late, great economist Milton Friedman to be “Inflation is everywhere,” which has folks asking if stagflation is a threat once again. 

What is stagflation?

Stagflation is a condition whereby economic growth is stagnant (declining output), while unemployment and inflation rates are rising. It is not slower economic growth and rising inflation as some have oversimplified.

Declining output and rising unemployment tend to go hand in hand – lower production means fewer workers are needed, especially during a recession. But prices increasing (inflation) at the same time is highly unusual. In fact, prices typically drop during recessionary periods since demand falls and supply is slower to react; therefore, most companies want to clear excess inventories. Hence, stagflation is really a recession with rising inflation.

1970s U.S. stagflation period

Examples of stagflation are extremely rare. The most notable instance was in the U.S. during the 1970s – caused by a series of events and multiple policy mistakes. While some economic historians blame the 1973 OPEC oil embargo as the cause of the 1970s stagflation period, a series of major policy blunders preceded it by more than two years, including the Pay Board and Price Commission and a 10% tariff on all imports, along with ending the gold standard. Indeed, the 300% increase in crude oil was a key contributing factor, but inflation was already more than double the average of the 1960s, well before the OPEC oil embargo began (see slide 3). Moreover, U.S. crude oil production peaked three years before the OPEC oil embargo (see slide 4). Those problems were compounded by stop-go monetary policy changes by the Federal Reserve (Fed; see slide 5). The period was also marked by high unemployment (see slide 6). 

We also included comparisons of inflation-adjusted U.S. crude oil prices (see slide 7) and reduced energy intensity (see slide 8), which drive home the point that the U.S. economy’s situation is dramatically different than the 1970s.

Our Take

Stagflation comparisons are unfounded for three key reasons:

  • First, U.S. growth is running roughly in line with pre-pandemic levels, which should continue for several years.
  • Second, the employment situation is solid.
  • Third, the key factors that have spiked inflation have already peaked, including lagging factors such as housing costs.

Solid economic and employment growth should last for several more years (at least)

We expect the U.S. economy to grow in line with the pre-pandemic pace through 2024 (see slide 9) thanks to steady demand generally and boosted by fiscal support, including the CHIPS Act and the bipartisan Infrastructure Investment and Jobs Act (IIJA).

While growth has cooled somewhat compared to 2023, it’s important not to confuse gradual cooling and normalization with weakness and recession. Indeed, when viewing the labor metrics on a year-over-year basis, most appear cooler but certainly not weak (see slide 10).

Moreover, wage gains for most workers are once again outpacing inflation (see slide 11). This means more income for consumers, who remain on solid footing and account for more than two-thirds of the U.S. economy.

Lost in the discussion about higher wages is the positive impact on overall U.S. growth. Higher wages for workers will drive additional consumer spending and solid credit quality. Moreover, additional workers mean expanded capacity and higher sales for their employers, which typically lead to increased future business spending. Yet, wage gains are a double-edged sword – while they will drive economic growth modestly higher, they also push inflation higher.

Supply chain issues fading, but inflation will stay elevated

We expect inflation will stay above pre-pandemic levels for the foreseeable future (see slide 12). One of the biggest contributors to the recent spike in inflation were supply issues, especially for goods. These factors are fading (primarily used vehicle prices), which should continue as the economy normalizes.

The other big reason is housing, which remains massively undersupplied since the housing bubble burst in 2009 (see slide 13). However, rents have returned to the pre-pandemic trend after spiking for more than two years (see slide 14). Also, higher energy (crude oil) costs and wage pressures will contribute to keep inflation above pre-pandemic levels.

Bottom line

Alas, we believe inflation pressures will remain a headwind for the U.S. economy. While we believe inflation will stay somewhat above pre-pandemic levels due to higher housing costs, continued wage pressures, and elevated crude oil prices, we don’t expect it to upend the U.S. economy. We’ve already endured the worst of it in our view. 

Additionally, we anticipate that the unemployment rate will continue to slowly creep higher in the next year. Yet, steady job growth, coupled with wage growth, means more income for consumers, who remain on solid footing and account for more than two-thirds of the U.S. economy.

Ultimately, there is a very low risk of stagflation in the U.S. in the next few years in our opinion.

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