By Naveen Athrappully
As the U.S. economy continues to struggle with high inflation and weak economic growth, concerns about the country slipping into stagflation are popping up.
Stagflation is an economic cycle marked by slow gross domestic product growth, high inflation, and a high unemployment rate. Policymakers usually find it difficult to handle such a situation because any attempt to boost or control one factor worsens others. The United States endured a bout of stagflation in the 1970s but hasn’t experienced another one since.
But now, experts are becoming apprehensive. All three relevant economic data—GDP growth, inflation, and the unemployment rate—suggest that stagflation may be around the corner.
Following the pandemic recovery, the country has registered depressing GDP growth over the past year. The first two quarters of 2022 registered negative growth. Though the third quarter saw GDP rising by 3.2 percent, it was the second-slowest growth rate since the third quarter of 2020.
Moreover, the quarterly growth rate has been declining since the third quarter of 2022, falling from 3.2 to 2.6 percent in the fourth quarter, and then to 1.3 percent in the first quarter of 2023.
On the inflation front, even as the annual inflation rate dipped to 4 percent in May after peaking at 9.1 percent in June 2022, it still remains way above the Federal Reserve’s target of 2 percent.
Annual inflation is more than double the 1.4 percent rate in January 2021, when Joe Biden became president. Since April 2021, annual inflation has remained at or above 4 percent every single month.
With regard to the unemployment rate, it has remained at or above 3.4 percent for more than a year. In May 2023, the unemployment rate hit 3.7 percent, which is the highest level in a year.
The stagflation of the 1970s was mostly a result of three events: a dovish policy by the Fed that tolerated high inflation in exchange for lower unemployment, rising government spending due to the Vietnam War and funding social programs, and rising prices due to an oil embargo and surging commodity prices.
At present, the U.S. economy is undergoing a similar scenario. Instead of tolerating inflation, the Fed is going all out against it, even at the cost of lower employment. Government spending has risen over the past years due to the COVID-19 pandemic, while commodity prices remain elevated. The scenario essentially sets up the stage for stagflation.
Multiple economic experts have raised alarm bells about the United States potentially facing a stagflation scenario. In April, economist Mohamed El-Erian warned in a Financial Times article that the series of bank collapses in March has raised the odds of a recession and stagflation affecting the United States.
“The flashing red light resulting from a speed-of-light run on the U.S. banking system, or what economists broadly refer to as financial contagion, is behind us,” he wrote.
“Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation.”
In an April 20 podcast, former Treasury Secretary Lawrence Summers also said that stagflation is a “real risk” facing the U.S. economy.
“Given where inflation is right now and given the downward pressures on the economy, I certainly think stagflation is a meaningful risk right now, and it’s probably a risk that’s underpriced in the markets,” he said.
More recently, John Waldron, president and chief operating officer at Goldman Sachs, warned about “mini” stagflation in the United States while speaking during a Bloomberg Invest conference in early June.
“If you want to paint a more cautious picture, you would say we might have a mini stagflationary scenario. It might not be massive stagflation, but if you have sluggish growth … and inflation doesn’t really get down below 3 percent and rates have to stay 3-plus percent for a while, that’s not going to be called a recession, but it’s not going to feel great,” Waldron said.
“That’s the scenario we kind of plan for, and worry about, because that’s a scenario that could persist for a while where you just get sluggish growth.”
Rate Hikes and Stagflation
The Federal Reserve has aggressively raised rates over the past year in a bid to contain inflation, thus pushing up its benchmark interest rate from 0.5 percent in April 2022 to a current range of 5.0 to 5.25 percent.
In June, the Fed kept its interest rate unchanged, ending the streak of 10 consecutive hikes. However, it did admit that two more rate hikes may be on the cards this year.
During a Risk Live conference in London on June 7, Anil Jhangiani, head of investment risk oversight at USS Investment Management, raised concerns that a stagflation scenario might end up making central banks stick to raising interest rates and thus risk “more policy errors.”
“If central banks still need to push rates up in 2023, and we have a prolonged stagflation environment, that’s really going to hit both bonds and equity portfolios, potentially,” he said, according to Risk.net.
“If we are in a world of stagflation for longer, inevitably, that leads to a lot of discontent, wage spirals—in part what we are seeing now—and I think that can only aggravate political risk.”
During stagflation, Americans have to grapple with consistently rising costs of living and lower employment opportunities. As the economy is sluggish and costs are high, companies tend to lay off employees. Both firms and individuals have to spend more to service their debts.