Everyone worried that the US economy is headed for a repeat of the 1970s ‘stagflation’ disaster is ignoring a critical part of the equation

(Business Insider) — The rate of inflation this year has been quite the surprise. Price increases have stuck around for longer than most analysts were expecting, myself included, and now concerns are turning something more ominous. Many policymakers, economists, and media have started to describe the creeping price hikes as “stagflation” – an economic situation where inflation is soaring, unemployment is high, and GDP growth is slow. The term was coined to describe the malaise of the 1970s economy.

And now fears that we may be in a repeat of those bad old days are popping up everywhere. The New York Times ran a story with the headline:, “A Stock Market Malaise with the Shadow of 70s-Style Stagflation.” Ditto Bloomberg: “What is Stagflation and Why Is Wall Street Suddenly Talking About it?” Even Fed Vice Chair Richard Clarida remarked that he sees a “flavor” of stagflation, albeit not a trend.

While stagflation is a risk, low in my view, that is not what is going on right now. The US economy is presently experiencing an inflationary boom – yes, there’s inflation but it’s coming with strong growth. And if this characterization is right, the Federal Reserve has the tools to deal with it before the “stag” piece comes into play.

Cancel the stag party 

To be in stagflation, the economy needs to by definition be stagnating, and the evidence for this is quite thin. By all accounts, the economy remains firmly in boom mode. 

  • In the third quarter, aggregate hours worked across private industries rose 5%, broadly in-line with the growth over the previous three quarters. Assuming no productivity growth, this gives you a rough proxy for GDP growth in the quarter. The payroll employment data have long been considered the most stable measure of activity. 
  • Surveys that track the pace of business activity have shown no let-up. The ISM Composite PMI, a blend of sentiment among manufacturing and services managers, averaged 62.3 in the third quarter. Historically, this is consistent with real GDP growth of roughly 5.5% to 6.0%. Again, like employment, business surveys tend to be more stable measures of activity. 
  • Finally, high-frequency economic data show a pick-up in activity of late. The Bureau of Economic Analysis spending estimates from payment card transactions show consumption up 10.6% for the week ending October 5 against a pre-pandemic baseline period. Travel appears to be picking up too; flight interest has ticked up as COVID-19 concern has declined. 

This is a booming economy. Demand is strong. But if we want to put a finer, data-oriented point on whether or not we’re getting into stagflation, we can break it down another way.

To do this I used the ISM survey’s new orders and prices paid indexes. On the one side is new orders, a proxy for the demand side of the equation or how much customers are buying. On the other side is prices paid, a proxy for the inflation side of things. For the economy to be in stagflation new orders must be below their long-run average – meaning there is weak demand from customers – while prices paid is above its long-run average – meaning inflation is high. A disinflationary boom (lots of demands as prices go down) would be the reverse. A deflationary bust would be when both metrics are below their long run average. Today, we are in an inflationary boom – new orders and prices are both strong.

Hard economic data confirm what we see in business surveys. I look at aggregate hours worked, or job growth times the workweek, and core PCE inflation. If the amount people are working is increasing, that would indicate a boom. Today, aggregate hours are up 6.4% annualized since June while core PCE inflation is up roughly 5%. Again, looking at this historically, this is wholly inconsistent with the stagflation period of the 1970s. The labor market is simply growing too rapidly.

In short, the economy is booming and the strong demand backdrop, especially for household durables is likely playing a role in putting pressure on already stretched global supply chains. 

For investors, I think a demand driven inflationary boom is a lot easier for monetary policymakers to deal with than stagflation. In the former, the Fed’s employment and inflation are not really in conflict. In the latter, they are – raising rates in a stagnant economy is something that should be resisted. The risk in the inflationary boom scenario should it persist is a more abrupt shift in policy, i.e. a more rapid increase in the federal funds rate. Full Loaf Hot Link Stagflation Original Article By: Neil Dutta

Rising Dough

Rising Dough - the question(s) that we need to think about from the reading.What are the signs that makes 2021 comparable to the 1970’s? Why is the term stagflation used?

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3 thoughts on “Everyone worried that the US economy is headed for a repeat of the 1970s ‘stagflation’ disaster is ignoring a critical part of the equation”
  1. Inflation boom is soaring. The same patterns are happening now as they are then. Prices are too high, people stooped working because they are underpaid, the government having financial issues and trade and supplies are down.

  2. the same economy patters that are happening right now are similar to the ones that were happening in the past . Prices are rising employees are quitting their jobs because of being underpaid, and the government is in debt and are having trade/supply issues. What will most likely happen in the next few months is the government is going to go on a hiatus/ shut down for a while.

  3. I can see why people would think that with the rise of the inflation it is something hard to not think about. And the prices will keep rising without any stop until it occurs again.

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