Stagflation Talk Increasing

Stagflation is an economic condition of increasing inflation and slowing economic growth.  This situation places interest rate policy makers in a quandary.  If they raise rates to slow inflation, the economy will continue to slow, possibly leading to a recession.  If they let inflation run, they run the risk of letting inflation getting out of control, possibly leading to early stage hyper-inflation.  In other words, no matter what the Fed does, they are bound to inflict pain on someone.

Talk of stagflation has increased over the last few months.  Below are the latest entries in the dialog.

The first entry came from Fed Chair Bernanke in a speech on June 5:

Real gross domestic product grew rapidly in the first quarter of this year, but the anticipated moderation of economic growth seems now to be under way.  Consumer spending, which makes up more than two-thirds of total spending, has decelerated noticeably in recent months. One source of this deceleration is higher energy prices, which have had an adverse impact on real household incomes and weighed on consumer attitudes.  As had been expected, recent readings also indicate that the housing market is cooling, partly in response to increases in mortgage rates. To be sure, the data on home sales and construction have been somewhat erratic from month to month, reflecting weather conditions, statistical noise, and other factors.  However, overall, housing activity has softened relative to the high levels of last summer, and the rate of house-price appreciation appears to have lessened.  A slowing of the real estate market will likely have the effect of restraining other forms of household spending as well, as homeowners no longer experience increases in the equity value of their homes at the rapid pace seen in recent years.

Here is the Fed Speak translation: the economy is slowing.  People are spending less and the housing market is cooling off.

Bernanke continues:

Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices.  Core inflation readings--that is, measures excluding the prices of food and energy--have also been higher in recent months. While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months.  For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent.  These are unwelcome developments.

Here is the Fed Speak translation: inflation is higher than we want it to be.  The markets interpreted this speech as indicating the Fed would continue raising rates.  This was the event that sent the markets tumbling.  I should note Bernanke's speech yesterday appeared to mollify traders concerned about the path of interest rates.

Speaking before the Economic Club of Chicago, Bernanke said inflation expectations had "fallen back somewhat" and that the impact of high energy prices on the economy has been limited. That offset worries from earlier this week when core consumer and producer price data rose above expectations.

His comments suggested the Fed may have room to pause in its two-year-long cycle of interest rate hikes in the next few months, investors said. Fed fund futures have fully priced in an interest rate hike at the Fed's next policy meeting on June 28-29.

Bernanke needs to work on his public relations abilities.

Two articles from yesterday's news highlight the growing talk of stagflation.  First is this article from the LA Times:

The consumer price index, the prices consumers pay for goods and services, rose 0.4% in May, in line with expectations, the government reported Wednesday. But core consumer prices, which exclude volatile energy and food costs, increased 0.3%, above the expected 0.2%.

A day earlier, the government reported that producer prices excluding energy and food rose faster than expected last month.

The series of bad inflation news makes it all but certain, economists say, that the Fed will raise its key short-term interest rate by 0.25 percentage point to 5.25% when its policy-setting committee meets this month.

A separate Fed survey of regional economic conditions released Wednesday showed that the economy was slowing, led by declines in home sales and manufacturing, and that inflation was on the rise.

Other recent data -- including retail sales, employment and wage data from April and May -- suggest that the Fed's previous rate hikes are slowing the economy. Economists said more increases by the Fed would run the risk of inducing a recession -- and wouldn't have much effect on inflation anyway because it was largely driven by the global demand for oil.

"The economy could be facing a bout with stagflation," said Peter Morici, a University of Maryland business school professor. "My feeling is we're headed for a tragedy here."

Dean Baker, co-director of the Center for Economic and Policy Research, said he also viewed stagflation as a possibility as credit tightening further damps the housing market and puts a crimp on the spending of homeowners.

"The May price data provides grounds for concern on several fronts," he said.

"I think we're in for some tough times."

There is also this article from the Asia Times Online:

Core producer prices - producer prices less food and energy - rose 0.3% in May. This was consistent with the consensus of forecasters and raises the likelihood that the Fed will raise interest rates. Inflation remains above Fed Chairman Ben Bernanke's target range. The only question now is how many more interest rate hikes will we get? The outlook for inflation is significantly colored by energy prices.

Gasoline prices surged in May. The average retail price of gasoline in May was $2.95 per gallon, up from $2.79 in April. Gas prices hit $2.99 per gallon on May 15 but then eased. In June gas prices are rising and will likely surge as the July 4 weekend approaches.

Until recently, strong productivity gains have permitted producers of most final goods and services to absorb higher fuel prices and wage increases without pushing up prices too much. However, May increases in both core producer and consumer prices indicate that energy price increases are spreading widely through the economy, and the hawks will have the upper hand at the June Fed meeting.

All of these stories point to the same thing.  The economy is slowing and inflation is becoming a concern.  Productivity gains may not be able to absorb these increases, which will force producers to pass-on the increased prices to consumers.  More importantly, energy is causing the basic problems. Energy costs are like water; they seep into every economic nook and cranny.  Energy is consumed from extraction of raw materials to the consumer buying an item and driving it home.  It's everywhere.  As energy rises, prices all along the supply chain increase.

All of this is just talk.  However, more people are talking about the same thing, implying the evidence is pointing people to the same conclusion.

Tags: Economy (all tags)




I sure wouldn't mind some price deflation for a change.

That said, what is driving this inflation? I thought the cause effect for inflation was that if more people had more money then the worth of money was generally less and the prices of goods rose. It seems to me that prices are rising far faster than wages have been for quite a few years now. What am I missing? Is this a side effect of the massive wealth redistribution efforts (from poor/middle class to the rich) underway since the reagan years?

by TimThe Terrible 2006-06-16 04:58AM | 0 recs
Re: Hmm

There are two types of inflation.

What you describe is demand pull -- an increase in the number of buyers pulls prices up.

Then there is cost push, where producers have to increase prices to pay for higher priced raw materials.

by Bonddad 2006-06-16 05:43AM | 0 recs
Re: Stagflation Talk Increasing

Isn't what we are seeing a "profit" rather than wage driven inflation.  Corporate profits are at an all time high, yet little of this money is trickling down.  The Fed is walking a very fine line and are about to fall off into.....what?  Nobody is really sure but it can't be pretty when it happens.  The economic perfect storm is almost upon us.

by Demo Dan in Dayton 2006-06-16 06:07AM | 0 recs
Re: Stagflation Talk Increasing

What's driving this?

1) Increase in oil prices.  Exxon Mobil saw its "cost of revenue" rise 30.2% in 2005 or a cool $49.5 billion (source yahoo finance, numbers don't quite jibe with their financial statements).  If oil as a material is 5% of GDP a 30% rise would total 1.5% for the economy.

2) Greed.  Take Exxon Mobil (please).  The amount of oil and oil products sold isn't zooming.  But prices rose some $72 billion or about $22.5 billion above the increase in supplies/materials.  That's nearly all gross profit and goes into taxes ($7.4 billion) and net income ($7.8 billion).  As for increased exploration, etc.  Well, forget about it.  BTW, overhead expenses "should"increased about $4 billion to handle inflation but instead rose $5 billion.  Profit on what Exxon Mobil admits is a commodity rose from 8% of sales to 10% of sales.

3) Trade imbalance.  The US has to keep the extra oil money here and more importantly the balance built up by China.  Rising interest rates are one way this is done (another way is a growing economy that has higher returns than Europe, Asia, etc. but the Bushies can't manage that.

4) Standard Republican economic policies.  When confronted by the true evil (inflation) squeeze the bejesus out of the economy by raising interest rates.  Squeeze elsewhere wherever possible.  Only the little people suffer.  Give them bread and circuses, AKA a Marriage Amendment, a war against abortion, and overseas adventures against the "enemy."

by David Kowalski 2006-06-16 08:05AM | 0 recs
Re: Stagflation Talk Increasing

High oil prices are part of the plan.

I'm not usually one for conspiracy theories, but this one actually seems plausable. cfm?ItemID=20953

In a nutshell, we went to war to keep Iraq's oil in the ground. Bush is driving the economy into the crapper because the wealthy are taking their money elsewhere, like China. The privatization of Social Security will finance the exodus.

by wayward 2006-06-16 04:19PM | 0 recs
Re: Stagflation Talk Increasing

Excellent post, a couple of comments also:
-The energy prices are an even bigger problem than they would be otherwise because they're not coming down anytime soon.  There's clearly no appetite in the White House for cracking down on oil companies' exorbitant profits, structural change to alternative energies is still years away and the Middle East is only going to get less stable, as the saber-rattling on Iran increases and Iraq descends into complete chaos (or even worse complete chaos than it's already in).

-Even if we wanted to spend our way out of the recession and hope that hyperinflation didn't result, there's no money left to spend, since our deficits are so enormous as is.  The huge deficit really limits our options for attempts at recovery.

by DanM 2006-06-16 03:07PM | 0 recs


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