Economic Commentary – Stagflation smack down –stag = no, flation= yes

Economic Commentary

October 15, 2021

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; so 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 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).

Our take

Stagflation comparisons are unfounded for three key reasons:

  • First, U.S. growth is running well-above pre-pandemic levels, which should continue for several years.
  • Second, the employment situation is strong.
  • Thirdly, the transitory factors that have spiked inflation have already peaked.

Solid U.S. growth for several more years (at least)

We expect the U.S. economy to grow considerably above the pre-pandemic pace through 2023 (see slide 7) thanks to the massive fiscal support from COVID-19 relief programs, which overwhelmingly helped consumers build cash cushions and pay down debt. While growth will step down by 2023 as many of those programs fade, it should remain above the pre-pandemic pace, which assumes no additional federal spending programs beyond the recently agreed to bipartisan infrastructure deal.

The U.S. is currently struggling with supply issues, not demand issues.

We aren’t hearing complaints about a lack of demand. On the contrary, many companies are talking about “too much” demand for their capacity, which is being constrained by supply chain bottlenecks or insufficient labor, or both. Either way, that’s not a recipe for stagnant growth. In fact, we’re likely to see growth extended for a few years.

"Lost in the shuffle is that higher wages will boost overall U.S. growth.”

The employment situation is strong

Several recent employment data points illustrate the strength, including solid private hiring in September, which helped the unemployment rate fall to 4.8%. Looking ahead, we anticipate that it will continue to drift lower over the next year.

Moreover, wage gains for most workers rose at the fastest clip since June 2020; excluding the pandemic, that’s the highest since 1982. The better employment figures during September were especially strong in the face of challenges due to Hurricane Ida. Additionally, weekly initial jobless claims continue to trend lower. 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 shuffle is that higher wages will boost overall U.S. growth. Higher wages for workers will drive additional spending. Moreover, additional workers means expanded capacity and higher sales for their employers, which typically lead to increased future spending. But, wage gains are a double-edged sword –they will drive economic growth modestly higher in the next year or more, but they push inflation higher as well.

Transitory factors are fading, but inflation will stay elevated

Consistent with the best economic growth in decades, we expect inflation will stay above pre-pandemic levels. The two biggest contributors to the recent spike in inflation have been vehicles and the reopening sectors, such as airlines, rental cars, recreational goods and services, and apparel. These factors are fading (primarily used vehicle prices), which should continue as the economy normalizes (see slide 8).

However, the upward inflationary pressures are building, including housing, energy (both crude oil & natural gas), and wage pressures. These will buoy inflation, keeping it above pre-pandemic levels.

We now anticipate core personal consumption expenditures (PCE) inflation—the Fed’s preferred gauge—will average around 3.5% this year and 2.4% in 2022.That’s considerably hotter than the 1.8% average since 2001 (see slide 9).


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