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Inflation Stokes Stagflation Worries
February 24, 2008 12:08 AM
by
findingDulcinea Staff
Rising oil and consumer prices are fueling fears that the United States is headed toward a combination of recession and high inflation.
30-Second Summary
Data released on Wednesday show that 2008 will see both slower economic growth and higher inflation against the backdrop of a deepening credit crisis.
The Federal Reserve sharply lowered its economic growth forecast for 2008 on Wednesday while a Labor Department report showed inflation rose 4.3 percent since last January, its steepest increase in two years.
According to Michael Menatian, president of Sanborn Mortgage, the statistics prove that the Fed’s rate-cutting is not working. In fact, further rate cuts pose a danger to the economy as an influx of cheap money may boost inflation and trigger stagflation, wrote Larry Elliott, economics editor at the U.K. paper The Guardian.
Christina Romer, an economist at the University of California at Berkeley and a historian of Fed policy, disagrees. She told The Wall Street Journal that the stagflation of the 1970s will not recur as the Fed has managed the economy responsibly. Even though the central bank seems more concerned with remedying economic weakness for now, it said that it will consider reversing rate cuts when prospects for growth have improved, the Journal notes.
Stagflation occurs when an economic downturn overlaps with a period of high inflation. The phenomenon is difficult to deal with, as inflation and stagnation call for conflicting remedies.
According to the Journal, measures to combat inflation can be painful for workers and potentially dangerous for the politicians overseeing their application, which is why inflation got out of hand in the 1970s. To tackle high inflation in 1970s, the Fed under Paul Volcker increased interest rates dramatically, unleashing a deep recession in 1981–82.
The Federal Reserve sharply lowered its economic growth forecast for 2008 on Wednesday while a Labor Department report showed inflation rose 4.3 percent since last January, its steepest increase in two years.
According to Michael Menatian, president of Sanborn Mortgage, the statistics prove that the Fed’s rate-cutting is not working. In fact, further rate cuts pose a danger to the economy as an influx of cheap money may boost inflation and trigger stagflation, wrote Larry Elliott, economics editor at the U.K. paper The Guardian.
Christina Romer, an economist at the University of California at Berkeley and a historian of Fed policy, disagrees. She told The Wall Street Journal that the stagflation of the 1970s will not recur as the Fed has managed the economy responsibly. Even though the central bank seems more concerned with remedying economic weakness for now, it said that it will consider reversing rate cuts when prospects for growth have improved, the Journal notes.
Stagflation occurs when an economic downturn overlaps with a period of high inflation. The phenomenon is difficult to deal with, as inflation and stagnation call for conflicting remedies.
According to the Journal, measures to combat inflation can be painful for workers and potentially dangerous for the politicians overseeing their application, which is why inflation got out of hand in the 1970s. To tackle high inflation in 1970s, the Fed under Paul Volcker increased interest rates dramatically, unleashing a deep recession in 1981–82.
Headline Links: ‘Rising Inflation Limits the Fed as Growth Lags’
Rising consumer prices in the United States have fueled fears of inflation. The U.S. economy will grow more slowly than expected in 2008, according to the latest Federal Reserve forecast, despite a series of rate cuts over the last few months.
Source: Reuters
Further rate-cutting by the Fed is dangerous, as it could lead to high inflation, The New York Times writes. At 2.5 percent, inflation in the United States is already higher the Fed’s target of 1 to 2 percent. With the economy slowing and the credit crunch deepening at the same time, the likelihood of a rare phenomenon called stagflation occurring increases. Consumer prices in January rose 4.3 percent compared with a year earlier, their highest jump in two years.
Source: The New York Times
Opinion & Analysis: Headed toward stagflation?
The Fed cannot fight unemployment and inflation at the same time, as they require conflicting remedies, writes The Wall Street Journal. Stagflation occurs when a period of low or negative growth coincides with high inflation. Although inflation is higher than expected, it is far below the levels it reached in the 1970s, the last time the United States experienced stagflation. Rising oil prices, however, could push prices up further, stoking inflation.
Source: The Wall Street Journal (subscription may be required)
In a discussion initiated by MarketWatch columnist Herb Greenberg in January, many readers thought that while a stagflation as grave as the one in the 1970s is unlikely, rising commodity prices and continuing credit trouble has set the American economy on a slippery course.
Source: MarketWatch
Larry Elliott, the Guardian’s economics editor, wrote in December that a mild bout of stagflation is likely in 2008. There is plenty of external pressure on prices, Elliott argues, and once inflation starts mounting, reining it in will be painful for consumers. The author claims that what policymakers fear most is that “the root causes of the impending slowdown—bad lending practices, irrational exuberance and high levels of debt—will prove impervious to the effects of monetary easing, but that eventually all the cheap money being thrown at Western economies stokes the fires of inflation.”
Source: The Guardian
Before the 1970s, the prevailing wisdom among economists was that high inflation and recession were mutually exclusive: “Inflation would occur when the economy was strong, while a recession would cool inflationary pressures,” the BBC wrote. British policymakers learnt that this is not necessarily the case the hard way. External factors, such as high oil prices, can push prices up when the economy is either weak or strong.
Source: The BBC
Reference: The Federal Reserve
According to the minutes from the Fed’s meeting on Jan. 29–30, 2008, “Elevated energy and commodity prices, among other factors, might put upward pressure on inflation. In this context, the Committee judged that some inflation risk remained and said that it would continue to monitor inflation developments carefully.”
Source: Federal Reserve
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