Supply chain shocks, soaring consumer prices, rising energy costs, and a Federal Reserve determined to bring inflation under control — these are the attributes of the economy that have some experts worried over a possible return to “stagflation” reminiscent of the 1970s.
But what is stagflation?
Stagflation is the combination of high inflation and economic stagnation. It is characterized by high unemployment and soaring consumer prices.
In the 1970s and early 1980s, rising unemployment, spiking oil prices, and easy monetary policy pushed the consumer price index up to 14.8% by 1980, forcing the Fed to raise interest rates to almost 20%.
What are the signs of stagflation?
One telltale sign of stagflation is one the U.S. is already seeing — rising energy prices.
According to financial experts and economists, stagflation can occur when the cost of oil rapidly increases and reduces an economy’s productive capacity.
For example, in 1973 the Organization of Petroleum Exporting Countries imposed an oil supply embargo in response to U.S. support for Israel.
The embargo exacerbated an already upward ascent in oil prices, causing the price per barrel of oil to double and quadruple.
Rising costs of oil caused skyrocketing costs for consumers who were made to ration using measures including “odd-even” purchases determined by license plate numbers and confront long lines at the gas pump. This was a shock for Americans accustomed to foreign, cheap oil.
Although removing the oil embargo in 1974 helped the crisis fade, the Iranian revolution brought back dramatically high prices in a wave from 1978 to 1979.
Economists see current warning signs
Some economists see signs of “stagflation” today in the U.S. economy. Soaring inflation — reaching the highest level in 40 years — combined with the Russian invasion of Ukraine sent oil prices soaring.
As a result, the U.S. central bank expects to enact an aggressive series of rate hikes, tightening monetary policy.
According to former Treasury Secretary Larry Summers, who is considered hawkish on inflation, the Fed has waited too long to take action to stem the oil price spike after misinterpreting the inflation spike.
Summers wrote a recent op-ed column in the Washington Post that the central bank has laid the path for “stagflation.”
In the piece, Summers wrote, “I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework and needs to take far stronger action to support price stability than appears likely.
“The Fed’s current policy trajectory is likely to lead to stagflation, with average unemployment and inflation both averaging over five percent over the next few years — and ultimately to a major recession.”
