Sep 17, 2021

No signs of stagflation yet

Comparing the current situation to the oil shocks of the 1970s suggests that these are very different phenomena.

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If your only tool is a hammer then every problem looks like a nail. That might explain why there is so much talk about stagflation these days.[1] But knowing a little – some stylized facts of a vaguely remembered economics textbook – is not enough. This is well illustrated by our Chart of the Week, which shows U.S. consumer-price inflation (headline CPI) against the output gap – how actual gross-domestic-product (GDP) growth compares to economic growth potential. For the 1970s, the inflationary peaks – triggered by the two oil shocks – happened before growth collapsed, resulting in large and persistent output gaps. Plainly, that meant many were willing and able to work but could not find jobs, partly due to strong unions pushing through high wages to protect the purchasing power of those still employed. Stagflation was used as a label for the politically toxic phenomena of persistently high inflation at a time of high unemployment.

Stagflation was used as a label for the politically toxic phenomena of persistently high inflation at a time of high unemployment.

Even when described in this very stylized framework, the Covid shock looks very different. For one thing, there is the timing: inflation and growth collapsed simultaneously, followed by a swift recovery in both. In the U.S. and elsewhere, the dramatic monetary and fiscal policy responses to the pandemic were designed to help firms and households during the acute health crisis. The hope was precisely for economies to recover more quickly than after the financial crisis of 2009. 

Covid-19 has been a very different sort of crisis than that of 2009 or those following the oil shocks of the 1970s.

20210917_CotW_Stagflation_CHART_EN.png

Sources: Haver Analytics Inc., DWS Investment GmbH as of 9/15/21

One probably needs to look closely at today’s issues – from demographic change and inequality to climate policies.

With U.S. labor markets healing, its growth could soon approach potential, perhaps resulting in inflationary pressures more persistent than some hope. If so, however, one probably needs to look closely at today’s issues – from demographic change and inequality to climate policies. The 1970s are an odd source of inspiration. It seems unlikely that global supply-chain disruptions will persist for years, as was effectively the case for oil. Unions are weaker. Fiscal stimulus is already fading. And in any case, Covid-19 has wreaked havoc in how economic statistics are gathered and calculated, making inflation series even harder than usual to interpret.[2] "For what it is worth, we are firmly in the camp of inflation moderating before too long," points out Christian Scherrmann, U.S. economist at DWS. Beyond that, we find the fascination with stagflation itself curious and are tempted to dabble a little into amateur sociology. Most of today’s market participants are probably too young to have experienced the stagflation of the 1970s as adults. Could the explanation be as simple as that?

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1. On the aphorism's disputed origin, see: https://quoteinvestigator.com/2014/05/08/hammer-nail/

2. Writing just a few weeks after the start of the crisis, Charles Goodhart and his co-author Manoj Pradhan pointed out that "[At] a time when the basket of goods and services that we buy was so suddenly distorted out of all recognition, it will have become almost impossible (…) to put together sensible and meaningful data for CPI, [consumer price indices…] or any other inflation series." Goodhart, Charles und Manoj Pradhan (2020). See: The Great Demographic Reversal: Ageing Societies, Waning Inequality and an Inflation Revival. Palgrave Macmillan, pp. 214

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