There’s nothing scarier than reverting back to the days of yesteryear – when Jimmy Carter was president.
But evoking the memories of the 1970s and stagflation is now a common theme in the media. A disappointing rise in the producer price index [1] (PPI), by 1.0 percent in January, and a rise in core inflation [2] (with food and energy costs excluded), rising 0.4 percent, have cause the media, as a February 27 Washington Post headline read [3], to “raise the specter of stagflation.”
“Now, to the economy,” ABC “World News” anchor Charles Gibson said. “And a word not heard since the 1970s – stagflation. That occurs when prices go up just as the economy slows down – stagnation plus inflation. And the government that wholesale prices shot up 1 percent in January and are now up almost 7.5 percent in the past 12 months.”
Of course, the word has been heard – at least 20 times since the 1990s according to Nexis. The rare word has actually been used on all three networks in 2008.
Although economic growth has tapered off, from 3.9 percent in the third quarter of 2007 to forecasts of 0.6 percent in the fourth quarter of 2007 – stagflation takes time to develop according to Brian Wesbury, an economist for First Trust Advisors, L.P.
“Let me just put it this way, stagflation comes from the 1970s,” Wesbury said on CNBC’s February 21 “Power Lunch.” [4] “A lot of people throw this word around. They don’t know what they’re talking about. It takes a long time for stagflation to develop. It was because every time the economy kind of faltered in the 70s, we cut interest rates, like we just did, and that drove inflation higher. And then, when we raised interest rates to kind of fight inflation, that hurt the economy – then we cut interest rate really fast again.”
Wesbury’s solution to any stagflation threat coming down the road is for the Fed to raise interest rates and the government to lower taxes.
“Here’s the key: we got out of this whole situation by raising interest rates. [Former Federal Reserve Chairman] Paul Volkert jacked interest rates way up, and held them way up for a long time, and by cutting tax rates.”
Wesbury warned that the prospect of higher taxes in this economic environment poses a “dangerous” threat – implying there are some serious political implications. The two Democratic frontrunners, Sens. Hillary Clinton (D-N.Y.) and Barack Obama (D-Ill.) both have said publicly they will raise taxes [5].
“And here’s my fear – is that right now, we’re cutting interest rates and we’re talking about raising tax rates. That’s a dangerous mix of policy, so that down in 2009, 10 and 11, we could end up with stagflation, but I don’t think we have it today.”
Still, “World News” sounded the stagflation alarm, not realizing that it is condition not realized in the short-term.
“Just today, oil set a record high – a barrel of crude at just over $100,” ABC correspondent David Muir said. “And what so worries economists, is that potential dynamic – stagflation.”
Still, double-digit inflation that contributed to 1970s-era stagflation is not expected. Federal Reserve Chairman Ben Bernanke told the House Committee on Financial Service on February 27 [6] he expects inflation to slow down as the Fed expects real GDP “to grow only sluggishly.”
“The projections recently submitted by FOMC (Federal Open Market Committee) participants indicate that overall PCE (Personal Consumption Expenditure) inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections),” Bernanke said. “A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets. In addition, diminishing pressure on resources is also consistent with the projected slowing in inflation.”